Description
We and our affiliates are long TASE IT. We may buy or sell shares without notification. This is not a recommendation to buy or sell shares.
For a more fulsome review of the TASE investment thesis, please see the .pdf in the attached dropbox link:
https://www.dropbox.com/sh/17ppphdkr2fd5pz/AAATIyHx8aO89JCVZtLo3Lwja?dl=0
Description
TASE is a monopoly financial infrastructure asset that plays a central role in Israel’s capital markets and overall economy. The company is unique among global exchanges in that it spans Israel’s entire capital markets infrastructure, offering products and services including: (a) listing, (b) trading in equities, fixed income, and derivatives, (c) clearing and settlement, (d) securities lending, (e) IT/co-location, (f) market data, and (g) indices. TASE’s revenue streams are diverse, with non-transactional and transactional revenues accounting for 60% and 40%, respectively, of total revenue.
By way of background, TASE began operations in 1953 when a group of Israeli financial institutions formed the exchange. Over the next half century, TASE established markets for equity, fixed income, and derivatives trading, as well as a clearing house, electronic trading capabilities, and a market for exchange-traded notes. In 2000, the Israeli Knesset authorized dual listing of U.S.-listed Israeli companies on TASE. Soon after, the company began dual listing securities trading in the UK, Hong Kong, Singapore, and Canada. In 2017, the Knesset approved changes to TASE's ownership structure, paving the way for the company’s demutualization and IPO in July 2019.
Demutualizations, particularly those involving financial exchanges, are often extremely attractive investment opportunities. We believe TASE has all the attributes necessary to be another success, starting with a realignment of incentives. Historically, TASE operated as a member-owned, not-for-profit entity run primarily for the benefit of Israeli banks. Strategic and financial decisions were made largely to serve their interests as owners of the exchange. TASE’s demutualization reduces these conflicts of interest and gives the company freedom to operate independently. In addition, TASE has a new, commercially focused management team led by Ittai Ben-Zeev. An outsider when he joined in 2017, Ben-Zeev is highly incentivized to create value through stock and option ownership, a critical factor in aligning his interests with shareholders rather than TASE’s former members.
While these changes set the stage for outperformance, we believe that several idiosyncratic factors will drive significant value appreciation over time:
Long runway for HSD/LDD revenue growth. There are several factors contributing to this growth profile. First, at a macro level, Israeli GDP grows ~5% annually, fueled by an advanced and highly entrepreneurial economy. But in capital markets terms, the country lags other developed markets with a very low ratio of total equity market cap to GDP. Second, there are sizable dual listing and homegrown IPO opportunities. Third, TASE is implementing several initiatives to modernize the exchange, reduce friction, enhance liquidity, and attract new market participants. New offerings include co-location services, pre-offering clearing services, a centralized lending pool, and cross-listing foreign ETFs, the combination of which we think can contribute meaningfully to revenue over time. We would note that non variable revenue grew 18% during Q2-21 and growth should remain strong for years to come. Fourth, there is a substantial latent pricing opportunity as the company’s prices across all products and services are among the lowest in the world.
EBITDA margins can double or more over time. Because of its history as a member-owned, not-for-profit entity, TASE’s margins are very low compared to other exchanges around the world. In 2020, the company’s EBITDA margin was ~31%. This compares to 55-75% margins for more mature, for-profit exchanges. We do not expect TASE to close the gap overnight, but there is a clear path for improvement over time as revenue grows while the cost base remains largely fixed, resulting in high incremental margins. The experience of Australia’s ASX, a similar demutualization/privatization in the late 1990s, provides a useful case study. In the eight years following its 1998 demutualization, ASX grew revenue at a 10% CAGR and expanded operating margins from 13% to 54%.
Sizable hidden assets and other sources of value. TASE owns its corporate headquarters in downtown Tel Aviv, which could be monetized via sale-leaseback. Applying cap rates for similar local properties, we think the building is worth nearly 500 million ILS, or ~4.63 ILS per share (vs. a current share price of 16.78 ILS). A second hidden asset results from an unusual arrangement in which pre-demutualization shareholders (primarily the member banks) received shares in the new company entitling them to a maximum of 5.08 ILS per share, with excess proceeds going to TASE upon a sale. Currently these shareholders own ~19% of the company. If these shares were sold at the current price, TASE would receive cash proceeds of ~2.14 ILS per share. In recent months TASE and these shareholders explored a structure that would enable the buyback and allotment of shares to pre-IPO shareholders with the goal of incentivizing them to sell their “Arrangement Shares.” While discussions have been terminated for the time being (apparently because of pushback from the regulator over a technical interpretation of the law), we remain optimistic that all parties will continue to work towards a resolution that’s amenable for all stakeholders. In addition to these assets, we believe the company’s net cash balance will grow to ~4.07 ILS per share by the end of 2025. All told, these non-core sources of value total ~10.84 ILS per share, or about ~65% of the current share price.
Risks
We believe the primary risk involves potentially adverse regulation. Given TASE’s relatively recent privatization, the regulatory environment in Israel is not yet well defined, which can create scope for surprises. All indications thus far are that Anat Guetta, Chairwoman of the Israeli Securities Authority, is pro-market and has goals of increasing capital markets participation and opening the Israeli market to foreign investors and other market participants. Second, geopolitical risk, particularly in the Middle East, can be difficult to handicap. Third, the pace of revenue growth and margin expansion could take longer than anticipated. Finally, there is limited daily trading liquidity in TASE common stock. We believe that liquidity will likely improve over time as TASE moves past its demutualization and relatively recent IPO and develops a track record with investors, but this could take longer than anticipated or not materialize at all.
Valuation
In our base case, we expect TASE to earn about 1.85 ILS per share in 2026. This assumes a 5-year revenue growth CAGR of 11% and a 2026 EBITDA margin of 55%. Our top line assumptions are underpinned by high single digit growth in variable revenue accompanied by LDD growth in non-variable revenues. We expect cash operating expenses to grow in the 3-4% range annually. We value the core business at 26x and add the value of the real estate, cash proceeds from member share sales, net cash on the balance sheet, and dividend payments. This results in total value of ~61.42 ILS per share, or a ~36% IRR over 4.25 years. Using the same operating assumptions but valuing the hidden assets at zero results in total value of ~54.65 ILS per share, or a 32% IRR over 4.25 years. This is an unrealistic assumption as these assets have latent value even if they are not monetized in the short-to-medium term (and given the company’s ample net cash balance and strong free cash flow generation, there is little need for the additional capital at this point), but it highlights just how cheap the core business is today.
In a bull case with revenue growing 300 bps faster per year and a 59% EBITDA margin in 2026, we think total value per share could be nearly 85.00 ILS per share, resulting in a ~47% IRR. The stock currently trades at 16.78 ILS per share.
We would note that TASE trades at a material discount to its global exchange peers despite considerably higher growth potential and margins that are approximately half of peer levels. Using 2022 consensus estimates, TASE trades at ~10.5x EBITDA vs. exchange peers in the 13.5-14.5x range. This discount should narrow over time.
I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.
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