Cash cow

Typically, once an exchange and related infrastructure is set up, it starts generating revenues in the form of transaction fees among others with minimal need for capital (or increase in operating costs) even as the business scales up.

MCX, which is in the nascent stage and generating healthy cash, has been paying back almost a third of its profits to the shareholders in the form of dividends. Despite this, it is sitting on ~700 crore of cash and equivalent, which is fairly large for a company with a networth of ~1,100 crore. Globally too, exchanges generate high cash and return on equity (20.5 per cent in the case of MCX) and hence pay huge dividends like in the case of Hong Kong Exchange, which distributes almost 8090 per cent of its profits in the form of dividends.

Annuity business

Not surprisingly, investors thus see exchanges as more of an annuity investment or from a dividend yielding stock. This is also a reason that globally exchanges trade at an average 5 times their book value and 18-20 times earnings.

In the case of MCX, at the upper price band of ~8601,032, its shares are valued at 4.3 times annualised book value and 21 times annualised earnings, which looks fair, considering its business model, leadership and size of growth opportunity relative to its global peers, cash in the books and return profile. Also, some of MCX's investments in other exchanges like MCX-SX, SME and MCX-CCL are in the nascent stage and could add value in future.

Growth strategy

MCX started its operation in 2003. Since then, its revenue and trading volumes have grown strongly. Though competition has also increased and there has been a key risk, the company still enjoys a leadership position on the back of its first mover advantage and technological support provided by its promoter company, Financial Technologies. The company continues to focus on increasing the number of members and terminals through geographical and product expansion. It already has 2,153 members, a total which is almost equal to the trading members in the equity segment of BSE and NSE put together.

So, while there may not be an exponential growth in members, future growth is likely to come from increase in trading terminals and clients. For instance, for the nine months to December 2011, while the company has added 34 new members, the terminal base has expanded by almost 100,000 to 296,896, which should reflect in higher trading volumes for the company.