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The JSE Ltd – operator of South Africa’s stock exchange – is looking to flex its muscles in the lucrative bond and interest rate markets as it seeks to recondition its revenue engine. Although over the past five years the JSE has proved a good investment there are many questioning whether its stock has much left in its tank. At 1900c/share in 2007, the JSE rocketed to 9200c/share in January 2008 as the global financial crisis sent massive surges of volatility through equity, futures and bond markets – driving up trade revenue.
In March 2009 the counter slipped to a low of 3600c and is currently trading at around 6500c/share. Two aspects on the plus side for long-term investors in the JSE is its growing cash pile and one of the more robust business models in the financial sector relative to banks and insurers.
At year-end 2010 the group had amassed more than R1bn cash in hand, which has prompted some speculation about a special dividend being declared in the not too distant future. Previously, the JSE has pointed to onerous technology investments as it seeks to build on a world-class exchange. But having sunk many of those costs in its previous financial year we can expect shareholders to now put some pressure on management.
The JSE has its own shortcomings, which have been exposed over the past three years, such as:
* Once the fastest growing and one of the most liquid single stock futures (SSF) markets worldwide, volumes have dried up since the crash of 2008 and punters at both retail and institutional levels are quite happy to dabble in the “un-regulated” contracts for difference (CFD) market as an alternative.
* The JSE’s AltX market for small and medium-sized companies may work hard on its PR but the reality is the financial crisis and limited liquidity in many of those counters mean it’s hardly been a roaring success.
* Much noise has been made about the JSE’s plans for the rest of Africa, but with just two listings on its Africa board – financial services firm TrustCo and tourism group Wilderness Holdings – it’s hardly been a roaring success. Until it can start attracting the likes of an Econet, Ecobank or a Safaricom the jury will remain out.
* Predatory firms overseas have lined up gems such as Massmart and Metorex, and while that provides good news over the short term if decisions are taken to delist firms like these, then that has a meaningful impact on trade volumes and the attractiveness of its equity platform.
That leaves the lucrative old boy network of SA’s debt and interest rate markets. Once the preserve of both the JSE and the Bond Exchange of South Africa (Besa), the landscape was shifted in June 2009 when the JSE received permission to take over its rival.
At the JSE’s most recent results presentations, CEO Russell Loubser fired an early warning shot across the bows of the investment banking groups which have run the debt markets since they came into being. On the subject of the Besa transaction Loubser said: “The JSE continues to discuss the model and ways forward with all market participants.”
Market commentators who spoke to Finweek pointed out that was a veiled threat to those bankers who have unofficially been acting as both players and referees in this market, which trades more than R14 trillion/year in SA.
The message seems to be clear: the JSE wants a slice of that pie and it doesn’t intend asking nicely, seeing it’s eliminated the alternative competition. That slice of the pie is going to be dressed up as improved transparency and pricing, as well as technology for market participants. In other words, the JSE will want a piece of the pricing, facilitating and trade of various listed debt instruments. However, it’s pointed out that was exactly what Besa was trying to do – with limited success – before the JSE came a calling.
In an interview earlier this year, Purple Capital chairman Mark Barnes warned that there were signs of people questioning the hasty decision by regulators to allow the JSE to take over Besa and effectively eliminate domestic competition for market participants. Barnes, as one of the minority shareholders in Besa, led an 11th hour bid to stop the transaction going through on competition grounds.
However, not everybody agrees. Craig Brewer, a principal at investment banking group Absa Capital and one of the advisers on the original Besa and JSE deal, says the transaction made sense and that SA is better served by a single “powerhouse” exchange. But Brewer did acknowledge the JSE “had to do something” about the debt market going forward.
However, he does add a word of caution: “The JSE shouldn’t dictate to the market what they want but should rather get feedback from market participants.”
One point both Barnes and Brewer agree on is that the JSE now faces stiff competition, particularly from European competitors in the debt market, as South African companies start to flex their muscles overseas.
In a paper written for the World Federation of Exchanges, Monica Ambrosi, a senior strategist at the JSE, noted international competition was a reality in SA’s debt market, but added: “Ultimately, however, up to 85% of the central Government’s borrowing requirements are satisfied in the domestic market, sustaining domestic issuance and liquidity; while as the economy grows, the investor pool is expected to widen.”
At first glance that might seem a storm in a teacup, with the JSE simply able to flex its muscles and pull its market players into line. The reality is somewhat different and, to put it in context, people should think back to the JSE’s original charm offensive, which was covertly trying to move institutional players away from the CFD market on to the JSE’s platform under the guise of better-regulated markets.
The JSE didn’t win that fight and it’s going to have to work many times harder to force its way into those debt markets – where there’s much more to play for.
Incoming CE Nicky Newton-King, who takes over from Loubser in January next year, has a tough fight ahead to keep all the players onside. Does she have the mettle? “She scares me more than Russell does,” jokes one banker. Humour aside, there are few people who’d argue Newton-King doesn’t have the skills or know-how to operate Africa’s leading exchange and take it forward.
Analysts have also warned that the JSE needs a catalyst to drive it into the future. In a March 2011 report – “More Black Swans needed to drive strong earnings in FY11” – analyst Zaheer Joosub, of Citigroup, emphasised the point when he upgraded the stock to a “buy” recommendation with a price target of 8300c/share for the year.
As the table on p22 shows, the JSE depends heavily on equity trading volumes to drive earnings. If those are down it needs to either look towards higher levels of volatility or revenue growth in other parts of the business.
Commenting on the current pressure points for group earnings, Joosub pointed to:
* A decline in “Other operating income”.
* A steep rise in “Other operating expenses”, particularly driven by technology investments that should pay off over the long run as new instruments are brought on board.
* A contraction in net financing revenue, due to lower interest rates.
* A rise in the effective tax rate to 29,9%.
Equity trading on the JSE has benefited from the volatile trading environment, which has included an equity market crash, sovereign debt issues in Europe and natural disasters – most recently in Japan. But that leaves much uncertainty in terms of forecasting future earnings.
Hence the need for growth in the more “predictable” markets, such as the interest market, especially as it’s one where the JSE can pencil in 25% plus growth in earnings.
For investors in the JSE, that also has a lot to do with earnings expectations and attractiveness from a corporate action perspective. While it’s unlikely regulators would allow the JSE to be completely taken over by an overseas operator, the global trend is consolidation. That’s highlighted by the recent attempt by the Nasdaq to take over the New York Stock Exchange’s Euronext exchange.
As the table on p23 shows, the JSE is currently trading on an earnings multiple of around 15 times. That would seem to indicate that – on its current growth figures – it’s trading at a premium to many of its counterparts. It’s only justified if it can deliver decent earnings growth somewhere.
A look at data from the unit trust industry would suggest fund managers see some value in the counter. However, it’s noticeable that there aren’t too many managers with “stock-picking” credentials who are buyers: 36One and the team from the Kagiso Equity Alpha funds hold the stock, with many of the rest being financial sector funds. In other words, it’s probably being viewed as a safe performer without too many expectations of outperformance.
Finweek’s view? You probably can’t go too far wrong buying into a monopoly that makes money – irrespective of whether the market goes up or down and thrives on volatility. And its 3% dividend yield and the prospect of a special dividend are also hard to ignore.
In March 2009 the counter slipped to a low of 3600c and is currently trading at around 6500c/share. Two aspects on the plus side for long-term investors in the JSE is its growing cash pile and one of the more robust business models in the financial sector relative to banks and insurers.
At year-end 2010 the group had amassed more than R1bn cash in hand, which has prompted some speculation about a special dividend being declared in the not too distant future. Previously, the JSE has pointed to onerous technology investments as it seeks to build on a world-class exchange. But having sunk many of those costs in its previous financial year we can expect shareholders to now put some pressure on management.
The JSE has its own shortcomings, which have been exposed over the past three years, such as:
* Once the fastest growing and one of the most liquid single stock futures (SSF) markets worldwide, volumes have dried up since the crash of 2008 and punters at both retail and institutional levels are quite happy to dabble in the “un-regulated” contracts for difference (CFD) market as an alternative.
* The JSE’s AltX market for small and medium-sized companies may work hard on its PR but the reality is the financial crisis and limited liquidity in many of those counters mean it’s hardly been a roaring success.
* Much noise has been made about the JSE’s plans for the rest of Africa, but with just two listings on its Africa board – financial services firm TrustCo and tourism group Wilderness Holdings – it’s hardly been a roaring success. Until it can start attracting the likes of an Econet, Ecobank or a Safaricom the jury will remain out.
* Predatory firms overseas have lined up gems such as Massmart and Metorex, and while that provides good news over the short term if decisions are taken to delist firms like these, then that has a meaningful impact on trade volumes and the attractiveness of its equity platform.
That leaves the lucrative old boy network of SA’s debt and interest rate markets. Once the preserve of both the JSE and the Bond Exchange of South Africa (Besa), the landscape was shifted in June 2009 when the JSE received permission to take over its rival.
At the JSE’s most recent results presentations, CEO Russell Loubser fired an early warning shot across the bows of the investment banking groups which have run the debt markets since they came into being. On the subject of the Besa transaction Loubser said: “The JSE continues to discuss the model and ways forward with all market participants.”
Market commentators who spoke to Finweek pointed out that was a veiled threat to those bankers who have unofficially been acting as both players and referees in this market, which trades more than R14 trillion/year in SA.
The message seems to be clear: the JSE wants a slice of that pie and it doesn’t intend asking nicely, seeing it’s eliminated the alternative competition. That slice of the pie is going to be dressed up as improved transparency and pricing, as well as technology for market participants. In other words, the JSE will want a piece of the pricing, facilitating and trade of various listed debt instruments. However, it’s pointed out that was exactly what Besa was trying to do – with limited success – before the JSE came a calling.
In an interview earlier this year, Purple Capital chairman Mark Barnes warned that there were signs of people questioning the hasty decision by regulators to allow the JSE to take over Besa and effectively eliminate domestic competition for market participants. Barnes, as one of the minority shareholders in Besa, led an 11th hour bid to stop the transaction going through on competition grounds.
However, not everybody agrees. Craig Brewer, a principal at investment banking group Absa Capital and one of the advisers on the original Besa and JSE deal, says the transaction made sense and that SA is better served by a single “powerhouse” exchange. But Brewer did acknowledge the JSE “had to do something” about the debt market going forward.
However, he does add a word of caution: “The JSE shouldn’t dictate to the market what they want but should rather get feedback from market participants.”
One point both Barnes and Brewer agree on is that the JSE now faces stiff competition, particularly from European competitors in the debt market, as South African companies start to flex their muscles overseas.
In a paper written for the World Federation of Exchanges, Monica Ambrosi, a senior strategist at the JSE, noted international competition was a reality in SA’s debt market, but added: “Ultimately, however, up to 85% of the central Government’s borrowing requirements are satisfied in the domestic market, sustaining domestic issuance and liquidity; while as the economy grows, the investor pool is expected to widen.”
At first glance that might seem a storm in a teacup, with the JSE simply able to flex its muscles and pull its market players into line. The reality is somewhat different and, to put it in context, people should think back to the JSE’s original charm offensive, which was covertly trying to move institutional players away from the CFD market on to the JSE’s platform under the guise of better-regulated markets.
The JSE didn’t win that fight and it’s going to have to work many times harder to force its way into those debt markets – where there’s much more to play for.
Incoming CE Nicky Newton-King, who takes over from Loubser in January next year, has a tough fight ahead to keep all the players onside. Does she have the mettle? “She scares me more than Russell does,” jokes one banker. Humour aside, there are few people who’d argue Newton-King doesn’t have the skills or know-how to operate Africa’s leading exchange and take it forward.
Analysts have also warned that the JSE needs a catalyst to drive it into the future. In a March 2011 report – “More Black Swans needed to drive strong earnings in FY11” – analyst Zaheer Joosub, of Citigroup, emphasised the point when he upgraded the stock to a “buy” recommendation with a price target of 8300c/share for the year.
As the table on p22 shows, the JSE depends heavily on equity trading volumes to drive earnings. If those are down it needs to either look towards higher levels of volatility or revenue growth in other parts of the business.
Commenting on the current pressure points for group earnings, Joosub pointed to:
* A decline in “Other operating income”.
* A steep rise in “Other operating expenses”, particularly driven by technology investments that should pay off over the long run as new instruments are brought on board.
* A contraction in net financing revenue, due to lower interest rates.
* A rise in the effective tax rate to 29,9%.
Equity trading on the JSE has benefited from the volatile trading environment, which has included an equity market crash, sovereign debt issues in Europe and natural disasters – most recently in Japan. But that leaves much uncertainty in terms of forecasting future earnings.
Hence the need for growth in the more “predictable” markets, such as the interest market, especially as it’s one where the JSE can pencil in 25% plus growth in earnings.
For investors in the JSE, that also has a lot to do with earnings expectations and attractiveness from a corporate action perspective. While it’s unlikely regulators would allow the JSE to be completely taken over by an overseas operator, the global trend is consolidation. That’s highlighted by the recent attempt by the Nasdaq to take over the New York Stock Exchange’s Euronext exchange.
As the table on p23 shows, the JSE is currently trading on an earnings multiple of around 15 times. That would seem to indicate that – on its current growth figures – it’s trading at a premium to many of its counterparts. It’s only justified if it can deliver decent earnings growth somewhere.
A look at data from the unit trust industry would suggest fund managers see some value in the counter. However, it’s noticeable that there aren’t too many managers with “stock-picking” credentials who are buyers: 36One and the team from the Kagiso Equity Alpha funds hold the stock, with many of the rest being financial sector funds. In other words, it’s probably being viewed as a safe performer without too many expectations of outperformance.
Finweek’s view? You probably can’t go too far wrong buying into a monopoly that makes money – irrespective of whether the market goes up or down and thrives on volatility. And its 3% dividend yield and the prospect of a special dividend are also hard to ignore.
