Description

Warsaw Stock Exchange is the primary stock exchange in the eighth largest economy in the EU, and one of the few economies in that region that is growing nicely.  We believe this is a business with a moat around it – there are regulatory barriers and much of the business is a quasi- monopoly.  It is no coincidence that the business earns high margins and high return on capital year after year.  We view it as an interesting way to be involved in emerging markets as they return to favor.

Poland is an interesting place.  After centuries of tragic history, the nation has taken the ball and run with it since achieving independence.  It sits on the edge of the EU, a member with most of the benefits, but having its own currency gives it flexibility and advantage.  Real GDP is growing at 3.5%, which has slowed, but is still above nearly anyplace else in Europe.  Poland has avoided the stagnation of other emerging markets the last few years.  Poland was one of the few countries to maintain GDP growth in 2008 and 2009.  It is a low-cost manufacturing exporter to Western Europe and has a number of successful and growing mid-sized companies.

The stock market declined 12% last year in local currency as it is hard to get out of the way when an ETF allocator can sell Brazil at the push of a button, while also selling Poland and everywhere else!  There was some political noise that spooked investors, but it seems to have subsided.  Poland knows they have a good thing going and don’t want to mess it up.  In 2016 emerging markets have been recovering and foreign investors are starting to take notice.  Poland is a relatively developed emerging market, with an economy much bigger than some “developed” nations in Europe like Portugal and Greece.  The equity market is very much emerging though, with limited liquidity, though it does have a broader range of listed companies in our experience than any other central European country except Turkey.

Which brings us to this investment idea, the Warsaw Stock Exchange.  This is the primary exchange for everything that goes on in Poland, from equities to fixed income to derivatives to a large business in electricity and gas trading.  The business has high margins, a 17% return on equity (despite Z200 million of excess cash), and has been a very steady earner.  The earnings flow through as free cash flow, most of which is returned to shareholders in the form of a dividend (yields 7%).

Their disclosure in English is clear and thorough.

If we look at the world’s publically traded stock exchanges, at 11x earnings, GPW has the lowest P/E ratio of any except Russia. The only other one even close to their multiple is Bolsas Mercados in Spain, which we also own.  Most trade at high teens multiples.

Keeping this simple, we have a good business at a low multiple – we see this as a classic “magic formula” stock. In my experience the magic formula tool has been an interesting way to sort out emerging market stocks.  We tend to find these deeper in the markets, well off the track of the emerging markets indices which tend to be heavy on telecom, banks and commodity producers, few of which look like anything special as investments.

We see two potential catalysts for this investment.  The first is revenues have been depressed by investor neglect of emerging markets, and even more so by the decline in the Polish stock market index.  Their largest source of revenues (32%) is a toll on trading activity (toll x volume x price).  If the price part recovers, revenues get a boost.  Emerging markets have underperformed for four years, ending last year on global asset allocators’ hate list.  Poland is an emerging market if you want to categorize things, but its not Brazil by any means.  We just saw the first Wall Street Journal article in years saying nice things about emerging markets as an investment opportunity.  We think you will be seeing more of those as investors tip-toe back into a sector they were all proudly underweight or zero at the end of last year.  Poland is a baby step back into EM investing as it is one of the more stable ones with a decent growth outlook and no huge problems. 

The second and our favorite catalyst is we see WSE as an acquisition.  It is bite-sized in a consolidating industry, representing the #1 market in central Europe and #8 in the EU.  The global exchange industry has consolidated into four-going-on-three players, each of which have scooped up smaller exchanges over the years. 

NYSE acquired Euronext (which was the merger of Belgium, France and the Netherlands exchanges) which acquired the Portugal exchange (2002).  Deutche Borse is currently trying to merge with London Stock Exchange which bought the Italian exchange (2007).  Nasdaq has consolidated US regionals and has bought an equity stake in the Turkey exchange (2013).

There are about fifteen exchanges around the world which are still independent.  Owning some of the lower valuations in this group interested us as it allows us to diversify somewhat among markets, but capture the economics of a good business and the potential to be taken over at a good premium (we would anticipate at least 16-18x earnings in a deal, which is where comps are currently trading).

We would point out that Poland does have a history of its companies being acquired, mainly small industrials being acquired by German companies, so we don’t overly worry about government roadblocks if a deal partner emerges.

On the financials, lets keep this simple.  Market cap is Z1.4 billion.  Excess cash on the balance sheet is 200 million, so an enterprise value of Z1.2 billion.  It has been earning about 120 million a year.  First quarter of 2016 looks bad because of about 6 million of one time items affecting the compare.  11 or 12x earnings, less than that if we take out the excess cash.  Comps are trading in the mid to high teens.

Free cash flow looks like earnings except for 2015, but working capital reversed in the first quarter of 2016, so it turned out to be just a working capital delay.

They use the free cash flow to pay a large dividend.  Really simple.  The dividend yield is 7%.

The views expressed are those of the author and do not necessarily represent the views of any other person.  The information herein is obtained from public sources believed to be accurate, reliable and current as of the date of writing.  The author will not undertake to supplement, update or revise such information at a later date.  The author may hold a position in the securities discussed.

Catalyst

Improved perception of emerging markets

Takeover