EQUITIES | INDIA | IPO 18th February 2012

DOHA BROKERAGE

Research Analyst: Sharon K Abraham e-mail: research@dbfsindia.com Helpline: 0484-3060126

Multi Commodity Exchange of India Ltd - IPO Analysis

A company with an insurmountable moat
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Company Description
The Multi Commodity Exchange of India Ltd (MCX) headquartered having operations in India since 2003 currently has over 80% of the market share of the Commodity Futures Market in India. The Exchange has permanent recognition from the Government of India to facilitate online trading, and clearing and settlement operations for commodity futures across the country. The company has more than 2153 registered members operating through over 296896 trading terminals spread over 1572 cities and towns across India. The Exchange was the fifth largest commodity exchange, among all the commodity exchanges considered in the Futures Industry Association survey, in terms of the number of contracts traded for the six months ended June 30, 2011. MCX offers more than 40 commodities across various segments such as bullion, ferrous and non-ferrous metals, energy, and a number of agri-commodities on its platform. The Exchange is the worlds largest exchange in Silver, the second largest in Gold, Copper and Natural Gas and the third largest in Crude Oil futures, based on the comparison of the trading volumes of our Exchange with those of the leading global commodity futures exchanges in the world, for the calendar year 2010 and the six months ended June 30, 2011.

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MCX has been certified to three ISO standards including ISO 9001:2008 Quality Management System standard, ISO 14001:2004 Environmental Management System standard and ISO/IEC 27001:2005 Information Security Management System standard. The Exchanges platform enables anonymous trades, leading to efficient price discovery. Moreover, for globally-traded commodities, MCXs platform enables domestic participants to trade in Indian currency. The company launched MCXCOMDEX, Indias first real time composite commodity futures index, which provides its members with valuable information regarding market movements in the key commodities, as determined by physical market size in India, which are actively traded on our Exchange. We have introduced several other indices, including MCXAgri (agricultural commodities index), MCXEnergy (energy commodities index) and MCXMetal (metal commodities index). The company recently introduced three rain indices, namely RAINDEXMUM (Mumbai), RAINDEXIDR (Indore), and RAINDEXJAI (Jaipur) which track the progress of monsoon rains in their respective geographic locations. The company has formed strategic alliances with a number of exchanges such as the London Metal Exchange, the New York Mercantile Exchange, the LIFFE Administration and Management (under renewal), the Baltic Exchange Limited, Shanghai Futures Exchange and Taiwan Futures Exchange.

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Superior fundamentals to back the company in the long term

We are pretty optimistic in the prospects of the company in the long term. Taking a closer look in the performance of the company in the past few years, it is clearly visible that the company has some sort of a durable competitive advantage working on behalf of its favor. Going forward, we feel that as time passes on the company is likely to emerge as a major player in the commodity exchange markets. When the company began its operations in 2003, India was in the threshold of a major economic growth phase. The commodity markets were then unorganized, and both these factors together played a pivotal role in the initial phases of the companys growth. Economic growth of the nation is the main source of growth in revenues for an exchange. The modernization of Indias commodity industry still has a long way to go and as the economy surges forward, the industry itself could witness structural changes thus forcing it to embrace modernization. With India emerging as a global player, complex financial instruments like commodity derivatives and futures are likely to get more popular in the coming years. The recent high volatility in the commodity prices are all factors that substantiate our view that we could witness higher volumes in the commodity exchanges in the near future.

A growing market share to consolidate its position in the space

The company has a successfully been able to improve its market share in the commodity trading segment and currently offers futures trading in bullion, ferrous and non-ferrous metals, energy and a number of agriculture commodities, and has a more than 80% market share in commodity futures trading in India. It should be noted that this was a mere 62% in 2006. The company has demonstrated its ability by improving its capability and spreading its operations into related businesses by starting a currency exchange MCX-SX in which it has a 5% stake currently. Going forward we are convinced that the companys strong clientele and growing market share could witness some pressure from the increasing competition from other players in the industry. To maintain its leadership the company has allied itself with major other commodity exchanges like the CME Group, EuroNext, The Baltic Exchange, and London Metal Exchange. The industry is anticipating chances of a common platform to be introduced in the future for trading in commodities the company, is well positioned to take advantage of such a situation. This is also likely to increase the companys market share from international clients trading with India in the space as India emerges as a global player.

Technological Infrastructure of superior quality

The company has developed its platform on the most advanced technological software available. It has updated the platform and improved the network to various places. The exchanges trading platform is supported by the companys promoter Financial Technologies (India) Ltd which is a pioneer in developing exchange related software and technology in the country. The superior technology of the company is difficult to replicate thus providing the company a moat that cannot be penetrated easily.
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Risk and Concerns

Macro economic trends
The industry witnesses a strong amount of cyclicality and this is likely to be reflected in the earnings of the company. Though the long term prospects of the company are intact, the company could witness seasonal volatility in the short term thus increasing the volatility of the prices of the companys shares.

Technological Advancements
Though the company enjoys a superior position in this area, the dynamics keep on changing and the company would be forced to keep on spending heavily in this area to maintain its position as the leader by providing more efficient trade executions, to increase the economies of scale of the company and improving the connectivity options in the exchange .

Trading Volumes

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The main revenue driver for the company is the increase in trading volumes in the exchange of which the company virtually has almost no control. This is purely linked to the global economic activity and the forces of demand and supply. A prolonged global slowdown could negative impact the companys earnings in the long run.

Competition
Competition is increasing in the sector from already established players in the industry endeavoring to expand their product offerings. And market presence. Though there is no major threat emanating from competitors. The company would find it difficult to increase its market share in the commodity exchange market from hereon.

Moderately Bullish But valuation a cause of concern

On taking a broader look at the company, it is quite certain that the company has a strong competitive advantage working in its favor. The companys loyal clientele and superior profit margins all are all positives as far as the company is concerned. Stronger volumes could be witnessed in the commodity segments going forward. Competition is likely to intensify in the future thus taking a portion of the companys market share. Though there is ample scope for growth in the long term, we are anticipating the company to witness a much more moderate growth phase with seasonable dips in revenues during slowdowns. Overall, the long term prospects of the industry as a whole are much predictable and MCX being the market leader has a lot of opportunities to tap along the way. Taking a look at listed peers around the world, exchanges in the developed markets generally trade in a range of 15-18 times PE, while their Asian peers which come under the developing category generally trade at a much higher valuation of 25 times PE.

However the price band of Rs.860-1032 per share at the upcoming public issue seems to be on the higher side. With the post IPO market cap likely to be around Rs.5610-6120 crores, the net profit of the company at Rs.172.8 crores, the company can be valued at around a price to earnings of 33 times post IPO which according to our view is bit expensive. However it must be kept in mind that once the global economy witnesses a turnaround, we could expect a much higher increase in the bottomline numbers in the coming years. On the onset of a significant rally in the domestic as well as global markets, buying momentum is likely to sustain for a much longer time, and the upcoming IPO is likely to witness a fanfare among investors due to its and superior fundamentals and superior management. Investors could apply for the IPO and take opportunities to book profits at higher levels. It must be kept in mind that on a strict valuation perspective, the stock appears to be overvalued.

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Analyst Certification I Sharon K Abraham hereby certify that the views expressed in this research report accurately reflect my personal views about the subject securities and issuers. I also certify that no part of my compensation was, is or will be, directly or indirectly, related to the specific recommendations or view expressed in this research report.

Disclaimer This research report provides general information only. Recommendations, opinions or suggestions are given with the understanding that readers acting on this information assume all risks involved. The information provided herein is not, and should not be construed as an offer to buy or sell any securities or other financial instrument or any derivative related to such securities or instruments. This report is not intended to provide personal investment advice and it does not take into account the specific investment objectives, financial situation and the particular needs of any specific person. Investors should seek financial advice regarding the appropriateness of investing in financial instruments and implementing investment strategies discussed or recommended in this report and should understand that statements regarding future prospects may not be realized. Any decision to purchase or subscribe for securities in any offering must be based solely on existing public information on such security or the information in the prospectus or other offering document issued in connection with such offering, and not on this report. We have reviewed the report, and in so far as it includes current or historical information, it is believed to be reliable though its accuracy or completeness cannot be guaranteed. All such information and opinions are subject to change without notice. This document has been produced independently of any company or companies mentioned herein, and forward looking statements; opinions and expectations contained herein are subject to change without notice. Price and value of the investments referred to in this material may go up or down. Past performance is not a guide for future performance. Certain transactions -including those involving futures, options and other derivatives as well as non-investment grade securities - involve substantial risk and are not suitable for all investors. Reports based on technical analysis centers on studying charts of a stocks price movement and trading volume, as opposed to focusing on a companys fundamentals and as such, may not match with a report on a companys fundamentals. Opinions expressed are our current opinions as of the date appearing on this material only. While we endeavor to update on a reasonable basis the information discussed in this material, there may be regulatory, compliance, or other reasons that prevent us from doing so.

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