Initiating Coverage: Multi Commodity Exchange of India

Initiating Coverage | 12 September 2012

Multi Commodity Exchange of India

BSE SENSEX

S&P CNX

17,853

5,390

CMP: INR1,174

TP: INR1,440

Buy

Monopolistic. Cutting-edge. Xciting!

Dominant share; future ready; high growth potential

Bloomberg

MCX IN

Equity Shares (m)

51.0

52-Week Range (INR) 1,429/838

1,6,12 Rel. Perf. (%)

2/-9/-

M.Cap. (INR b)

59.9

M.Cap. (USD b)

1.1



Financial summary (INR m)

Y/E March

2012 2013E 2014E

Sales

5,262 5,172 6,152

PAT

2,862 2,824 3,394

EPS (INR)

56.1 55.4 66.5

EPS Gr. (%)

65.6 (1.3) 20.2

P/E (x)

20.9 21.2 17.6

P/BV (x)

6.0

5.3

4.6

RoE (%

31.0 26.5 27.8

RoCE (%)

24.8 25.5 26.9

EV/Sales (x)

9.1

9.0

7.4

EV/ EBITDA (x) 14.3 14.7 11.5

Payout (%)

50.0 52.8 49.2



Multi Commodity Exchange of India (MCX) is a state-of-the-art electronic commodities

futures exchange, with near monopolistic market share (86% in FY12).

Our expectation of sustained market leadership stems from its technological edge

and future readiness.

MCX's volumes have grown at a CAGR of 47% over FY07-12. Future potential remains

exciting given: [1] likelihood of new products and participants with the FCRA Bill, [2]

with 2m client accounts as compared with 19-20m demat accounts, the industry has

only scratched the surface with respect to potential volumes.

We believe value from MCX-SX (Stock exchange promoted by MCX and FTECH in

2008) is more definite than merely option value. Policy to maintain ~50% payout ratio

is a key valuation positive. Our target price of INR1,440 implies 23% upside. We

initiate coverage with a Buy rating.

Leading exchange, with contract volumes matching global leaders

Multi Commodity Exchange of India Limited (MCX) is a state-of-the-art electronic

commodity futures exchange, offering futures trading in over 47 commodities,

mainly including Gold, Silver, Copper and Crude Oil. It began operations in

November 2003, and has over 86% share (as at 31 March 2012) of the Indian

commodity futures market. In terms of contracts traded in CY11, it is the third-

largest globally, second-largest in Gold, largest in Silver, second-largest in Natural

Gas, and third-largest in crude oil.

Shareholding pattern %

As on

Promoter

Domestic Inst

Foreign

Others

Jun-12

26.0

23.5

31.6

18.9

Mar-12

26.0

22.4

33.3

18.3

5-year volume CAGR of 47%; huge growth potential

Volumes continue to grow at a healthy rate in a less-than-a-decade old and

highly regulated industry (CAGR of 51% over FY09-12). At MCX, volumes have

grown at a CAGR of 47% over FY07-12. Growth potential remains huge:

1) Number of clients trading on the commodities platform are less than 2m, as

compared to an estimated 18-20m in equities. Globally, the number of clients

trading in commodities is higher than those trading in equities.

2) Globally, futures Gold volumes are 70-80x that of physical trade, v/s 17-18x

in India, 20x in Crude v/s ~7x in India, 100x in Aluminum v/s 8-9x in India.

Stock performance (1 year)

Technological edge, future readiness to help sustain market leadership

MCX has held on to its market leadership position, with a share of 82-87% over

FY09-12. Supply of technology platform by its parent, Financial Technologies

India (FTECH), one of the leading developers of exchange related software and

technology, gives MCX a competitive edge that is difficult to replicate. If and

when commodity exchanges in India receive regulatory approval to trade in

new products like options, MCX will be able to quickly latch on to the opportunity,

having invested significant resources to ensure readiness for the same.

Additionally, new revenue sources like market data products and information

offerings will lend scalability.

Investors are advised to refer

through disclosures made at the end

of the Research Report.

Multi Commodity Exchange of India

Two potential value drivers

#1: Regulatory changes post the passage of the FCRA Bill:

We understand from the

management that the Bill to amend the outdated Forward Contracts (Regulation)

Act (FCRA) could be passed by the Parliament in the forthcoming session. This will

give a fillip to MCX's volumes on the following counts:

1) introduction of options trading,

2) introduction of new commodity classes such as freight, rainfall and commodity

indices

3) increased investor participation, as banks, mutual funds and foreign institutional

investors could be allowed to transact on India's commodity futures markets.

#2: Value unlocking from MCX-SX:

MCX-SX is a stock exchange recognized by SEBI,

that was promoted by MCX and FTECH in 2008, with currency futures and options

currently trading on the exchange. MCX-SX was recently cleared to become a full-

fledged stock exchange. Despite intense competition, we do not rule out the

possibility of the exchange garnering significant share, even if not match NSE's coup

over what was largely a BSE dominated space till 1992. The last transaction in NSE

happened at 11x revenues, which is also the multiple at which emerging market

exchanges like the Singapore Exchange trade. We expect MCX's revenues to surge

from INR391m in FY11 to at least ~INR1b by FY13, on:

1) 7 months of transaction charges in currency futures segment in FY12

2) additional 4 months of transaction charges in currency futures in FY13 and ~8

months of revenues from currency options

3) potential revenues from launch of equity operations.

Sustainable growth; value unlocking; healthy payout - Buy

Key positives



Near-monopoly market

Huge potential to grow

volumes

Future-readiness

Likely FCRA boost

Potential value

unlocking from MCX-SX

Payout ratio

MCX's volumes have grown at a CAGR of 47% over FY07-12. With the industry nascent,

and growth potential significant from multiple triggers, we expect sustained double

digit volume growth over the medium-to-long term, notwithstanding impact from

phases of low volatility.

We expect volume CAGR of 15% and PAT CAGR of 13% over FY12-15. Also, the RoE

should sustain at the high 20's. The company's decision to maintain its payout ratio

at ~50% too is a key valuation positive, and will support high multiples.

We value the standalone commodity exchange business at 20x FY14E earnings, in

line with the average multiple for global peers in emerging markets, despite MCX's

better competitive positioning and higher growth potential. This translates into a

value of INR1,330/share for the standalone commodity exchange business. We value

MCX-SX at INR14b, 11x the potential revenues of INR1.3b in FY14 (transactions in

FY10 had valued MCX-SX at INR45b). MCX's share in MCX-SX (including warrants)

contributes additional INR110/share to its valuation. Our target price is INR1,440.

Buy

for 23% upside.

Key risks

Commodity prices

Increase in

transaction fee by

FTECH

Regulatory

environment

Concentration risk

12 September 2012

Multi Commodity Exchange of India

Nascent industry; significant growth potential...

... from increasing penetration, new products, new participants



The government of India (GoI) authorized the establishment of commodity exchanges in

India only in April 2003, and the industry is far from mature.

Volume growth remains healthy in less-than-a-decade old and highly regulated industry.

The total value of commodity futures traded in India has grown at a CAGR of 51% over

FY09-12.

Growth potential remains significant given [1] 2m client accounts as compared with 19-

20m demat accounts, while globally the number exceeds equity members, [2] Derivatives

volumes as a multiple of physical trades is far lower than that seen across the globe.

Continued demand for underlying commodities in a growing economy and expansion in

the mix of hedgers and speculators will facilitate continued growth in traded volumes.

Nascent industry has registered high growth on a low base

Nascent industry,

volumes CAGR of 44%

over past 6 years

There are over 30 commodity futures and options exchanges worldwide, where

commodities like energy, metals, agricultural products and livestock are traded. The

total contracted commodity trading volume on these exchanges increased from 188m

contracts in FY84 to 22,295m contracts in FY10, implying a CAGR of 20.2% over the 26-

year period. In terms of traded value, Indian commodities futures volumes have gone

up from INR20.5t in FY06 to INR181.3t in FY12, a CAGR of 44% during this period.

Trading volumes increased at a CAGR of 44% over FY06-12

Spurt in volumes of Gold

(FY11 and FY12) and Silver

(FY12) drove increase in

overall volumes

5-yr CAGR of 44%

Source: Company, MOSL

5 Commodity exchanges,

including NCDEX, NMCE,

ICEX and ACE have a

combined market share

of ~99.5%+

In India, there are currently 21 commodity exchanges and associations, which are

recognized by the GoI and authorized to organize and regulate futures trading. Of

these, 16 are regional or localized exchanges, and five electronic exchanges have

come up after the GoI authorized the establishment of national multi-commodity

exchanges in April 2003. These are: Multi Commodity Exchange of India (MCX),

National Commodity & Derivatives Exchange (NCDEX), National Multi-Commodity

Exchange of India (NMCE), Indian Commodity Exchange (ICEX), and Ace Derivatives

and Commodity Exchange (ACE). Four of these – MCX, NCDEX, NMCE and ICEX – account

for over 98% of the turnover.

12 September 2012

Multi Commodity Exchange of India

The market is at a relatively nascent stage with Gold, silver, crude oil and copper

being the four largest commodities traded on the Indian exchanges, constituting

70%+ of the total traded value in FY11 and 80%+ of the total traded value in FY12.

Indian commodity exchange volumes concentrated towards gold, silver, copper and crude oil

Agri

commodities,

12.2%

Agri

commodities,

12.1%

Source: Company, MOSL

Operating in a highly regulated environment

Current regulations do

not allow trading in

options, do not allow

participation from MFs,

FIIs and banks

The industry is highly regulated. The Forward Contracts (Regulation) Act, 1952 (FCRA)

is the principal legislation for the commodity futures market in India. The FCRA and

the Forward Contracts (Regulation) Rules, 1954 (FCRR) provide for the regulation of

commodity futures trading under a three-tier system, which consists of the following

governing bodies:



the Department of Consumer Affairs, Ministry of Consumer Affairs Food and Public

Distribution,



the Forward Markets Commission (FMC), and



an Exchange or Association recognized by the GoI on the recommendation of the

FMC.

In the current regulatory environment, foreign institutional investors (FIIs), banks

and mutual funds cannot trade on commodity exchanges. Further, trading in options

on commodity futures is prohibited in India. The two constraints have been thus far

have been limiting the volumes potential on the exchanges.

Growing demand for commodities and need to hedge will drive volumes

Growth potential in the economy like India's remains huge over the next decade,

which is expected to drive the demand for commodities. The increase in physical

market volumes consequently increases the hedging requirements for industry

players, influencing derivative trading volumes. We expect the industry continue to

1) In developed markets, commodity derivatives volumes are at a much higher

multiple of the underlying physical commodity volumes. Indian commodities

market is ~4x the physical market, compared to 35-40x being the average range

globally. Futures volumes are 70-80x that of that of physical trade in Gold, v/s

17-18x in India, 20x in crude v/s ~7x in India, 100x in Aluminium v/s 8-9x in India.

12 September 2012

Multi Commodity Exchange of India

2) The total number of clients trading on commodities platform are less than 2m, as

compared to that in equities is estimated at ~18-20m. Globally, number of clients

trading in commodities is higher than those on equities.

Increasing prices had not deterred the surge in imports before 1QFY13

Source: Company, MOSL

Higher price volatility should increase speculator participation

Growth in trading volumes of any commodity on the exchanges has been a function

of price volatility. In this perspective, MCX enjoys an advantage, given the variety of

commodities that are traded on the exchange (although only four commodities drive

majority of the volumes today). Thus, the company benefits from volatility in gold

prices at one point, and silver, copper or crude prices at other points. As long as there

is volatility in the prices of a particular commodity, it will act as a volume growth

driver for the exchange.

Volumes traded and commodity prices have had high correlation, except in recent months (Gold)

- RHS

Barring the recent

volatility spurt, volumes

have had a strong

correlation with

commodity's price

Source: Company, MOSL

12 September 2012

Multi Commodity Exchange of India

Takeaways from interaction with NCDEX and FMC

FMC: Role limited in current environment; industry far from mature



"There seems to be lack

of unanimous agreement

within the Government

on the need for a futures

market in commodities"



Indian commodities exchange market is far from mature, and is still in a learning

process. There is a lack of unanimous agreement within the government on the

need for futures market in commodities, which has been the key hindrance in

the passage of amendments to the FCRA bill.

FMC's role is highly limited in its current form of existence. This is because unlike

SEBI, FMC is not an autonomous body, as a result of which, it is unable to take

decisions on its own accord. It does not even enjoy financial independence.

However, despite a moderate control environment, FMC is not witnessing

rampant unfair practices on the exchange.

Due to limited powers, it is currently unable to levy penalties on members who

breach the trading guidelines on the exchange. Currently, it is up to the exchanges

to levy these penalties.

Globally, there are separate regulators for commodities exchanges and equity

exchanges, and it makes a strong case for a similar structure in India too.

There is some interest on margin money, which is now being collected towards

Investor Protection Fund. The FMC has collected ~INR650m and it should continue

to grow.

NCDEX: Slow and gradual progress in Indian market evident, suitable



NCDEX's focus on

commodities relevant to

India may have cost it

market share in popular

global commodities



The progress in the regulatory changes albeit slow, has been gradual in the

evolving Indian Commodity Exchanges space, which still remains a very nascent

industry. The pace of progress is not entirely unacceptable given the maturity of

the industry today.

It is still very early days for the Indian commodities industry, and the scope for

growth remains huge. Type of participants will be allowed to increase eventually,

given that the regulators would want to ensure there is market making for

increasing number of hedgers.

NCDEX tends to focus on commodities which are relevant to the domestic

interests. In commodities (especially agricultural) where India has a significant

contribution in the global scheme of things, the exchanges here should be price

setters than price followers.

Gold is one commodity, where India should not be a price follower, but that has

not been the case so far. Endeavor at NCDEX is to facilitate an environment where

this can be achieved.

NCDEX's choice of role it envisaged to play in the commodities exchange also has

a part to play in its lower market share v/s the leader.

12 September 2012

Multi Commodity Exchange of India

Near monopolistic market share

Technological edge, future readiness to help sustain leadership



Multi Commodity Exchange of India (MCX) has held on to its market leadership position,

with a share of 82-87% over FY09-12.

Supply of technology platform by Financial Technologies India (FTECH), one of the leading

developers of exchange-related software and technology, gives MCX a competitive edge

that is difficult to replicate.

When commodity exchanges in India receive regulatory approval to trade in new products

like options, MCX will be able to quickly latch on to the opportunity, having invested

significant resources to ensure readiness for the same.

Also, new revenue sources like market data products and information offerings will lend

scalability.

Wide reach, dominant market share

MCX has 2,170 members and 346,000+ terminals including computer-to-computer links

(CTCLs) spread over 1,577 cities and towns across India as at the end of FY12. The

number of terminals has increased from 117,000 in FY10. Healthy terminal additions

partially offset the risk of lower volumes traded per member, with gradual ramp-up

in volumes expected from new additions.

Member additions continue, though at a slower rate

Growth in number of terminals remains strong

Source: Company, MOSL

MCX has maintained its leadership in the Indian commodity futures market, with 82%

share in FY11 and 86% share in FY12, in terms of value of commodities traded in the

futures market.

MCX enjoys a dominant market share, has maintained its leadership over the years

Source: Company, MOSL

12 September 2012

Multi Commodity Exchange of India

Technological edge – parent’s expertise a significant advantage

Infrastructure in place to

support multifold growth

in volumes without any

incremental costs

Exchange markets are characterized by rapid changes in technology, usage patterns

and client preferences, frequent product/service introductions, and emergence of

new industry standards/practices. MCX enjoys a competitive edge, given that its trading

platform is supplied by its promoter, Financial Technologies India (FTECH), which is a

leading developer of exchange related software and technology. Technology for the

exchange industry is difficult to replicate, thus providing the company with a

competitive advantage. Exchanges require constant technology upgrades and support,

necessitated by regulatory regime and market forces. MCX is able to obtain speedy

and efficient technology solutions from FTECH. MCX’s current technology

infrastructure is sufficient to handle daily trading volumes of up to 10,000,000. So far,

it has handled a high of 1,867,612 trades in a day.

High operating leverage compounds benefits to bottom line

60-70% of expenses

fixed; growth in volumes

to boost margin

A large proportion of the costs at MCX are fixed. The only significant variable cost in

its expenses is the fees paid as a percentage of transaction revenues towards technical

services agreement to its parent FTECH. Fixed price have ranged between 60-70% of

the overall expenditure at MCX for the past 6 years. Therefore, potential growth in

volumes at MCX implies even better profitability going forward.

High operating leverage facilitated margin expansion as volumes grew

Source: Company, MOSL

Future ready – proactively investing to take advantage of anticipated

changes

Will be able to quickly

bring out the new

products as and when

regulatory approvals

fall in place

MCX has invested significant resources to develop strategies and ideas for new

products in anticipation of proposed policy initiatives or regulatory measures,

particularly the proposal to amend the Forward Contract Regulation Act (FCRA). The

proposed amendments relate to allowing trading in options and derivatives,

demutualization of existing bourses and setting up of a separate clearing corporation.

Such measures, if brought into force, can potentially drive a spurt in volumes, given

the company’s readiness for the same from a technology standpoint.

12 September 2012

Multi Commodity Exchange of India

Scalable business model, with potential to generate revenue from new

streams

Being the largest commodity exchange in India, with near-monopolistic market share,

MCX is the key source of data on commodity trends. This gives MCX the opportunity

to benefit from new non-transaction revenue sources like market data product and

information offerings, as is the case for various leading exchanges in India and the

rest of the world. This not only provides scalability to the business model, but also

offers potential for growth with limited incremental costs. Growth in commodity

markets facilitate demand for better trading and analytical tools, risk management

tool, market data products and price information offerings which could be new revenue

streams.

Globally, exchanges derive 10-15% of their revenues from such services. Indian

exchanges do not match that number, especially in equities, given weak acceptance

of algorithmic trades. MCX is better placed to garner revenues from such sources,

given its speedier execution in such trades, which already constitute significant

proportion of the company’s volumes.

To facilitate the same, MCX has entered into agreements with financial information

service agencies to provide real time data-feed on trading prices, trading volume and

other information on the commodity futures contracts which are traded on the

Exchange and on the spot market. The company currently has such arrangements

with the following entities:

1. Bloomberg Finance L.P.,

2. NewsWire 18 Private Limited,

3. IQN Data Solutions Private Limited,

4. Reuters India Private Limited,

5. Interactive Data (Europe) Limited and

6. TickerPlant Limited.

Algorithmic trades led

data will drive additional

revenue from information

dissemination

12 September 2012

Multi Commodity Exchange of India

Two potential value drivers

Regulatory changes, value unlocking from MCX-SX



The Forward Contract Regulation Act (Amendment) Bill 2010 (FCRA Bill) has been on the

agenda for cabinet discussion. If passed, it will give a fillip to MCX’s volumes.

MCX Stock Exchange (MCX-SX) was recently cleared to become a full-fledged stock

exchange. We believe the value from MCX-SX is more definite than merely option value;

FY14 is expected to be first full year with operations in currency and equities.

Likely stimulus to volumes from FCRA Bill

FCRA bill, if passed, will

be a 3-fold push to

volumes from

introduction of: [1]

Options, [2] New Product

categories (indices), and

[3] New Participants (FIIs,

MFs, Banks)

The market still operates under the outdated Forward Contracts (Regulation) Act

(FCRA), 1952. Many of the contracts that have gained global prominence did not exist

in 1952. Within the constraints imposed by the existing statute, FMC's statutory powers

are far below those required and expose the FMC to judicial challenge for its regulatory

and just actions taken in the interest of the market and economy.

It is widely believed that the bill, which has been recommended by the Parliamentary

Standing Committee of the Ministry of Consumer Affairs, Food and Public Distribution,

on December 19, 2011, will be passed into law by the Parliament in the forthcoming

session. Amendments to FCRA have been ready for many years now. The Amendment

Bill will give the market's regulator, the FMC, the powers that befit a regulator of a

major commodity market, and enable systematic development of the market. It will

be a significant boost to volumes on following counts:



Introduction of options:

Options trading have witnessed huge potential in the

global commodity markets. Globally, options trading contributed 48 per cent of

the total futures and options volumes traded in CY 2011. Introduction of options

trading in India would increase the commodity volumes manifold, and facilitate

the participants with wider investment and hedging tools.



Introduction of new commodity classes:

If the trading of intangibles such as freight,

rainfall and commodity indices is permitted, these new contracts could drive

growth in the Indian commodity derivatives trading market.



Increased investor participation:

The GoI may consider permitting banks, mutual

funds and foreign institutional investors (FIIs) to trade in India‘s commodity futures

markets. This could drive two-pronged growth in volumes:



The hedgers would get access to a wide array of market makers, helping them

to close larger contract sizes on Indian exchanges than on other exchanges.



We understand from the management that it would also provide the

participants room for speculation. Currently, the regulations ensure that the

trading by Indian players on foreign bourses is purely for risk-management

purposes.

12 September 2012

Multi Commodity Exchange of India

3rd largest exchange globally in CY11 (no. of contracts), despite limited participants and products

Source: Company, MOSL

Significant potential of value unlocking from MCX-SX; following the right

approach

Sale of MCX-SX's warrants

within next 3 years could

unlock significant value

MCX-SX, promoted by MCX and FTECH, was recently cleared to become a full-fledged

stock exchange. Like BSE and NSE, it can now start trading in equities, equity derivatives

and other asset classes. Currently, MCX-SX only offers trading in currency futures

contracts.

MCX-SX is currently focusing on roping in members to trade on the exchange. Stocks

of companies can be traded without them being listed on MCX-SX, implying that the

company's key thrust is on member additions. The process of adding members may

take a couple of months, as the requisite approvals from SEBI take time. The exchange

is expected to go live in the equities segment by November 2012.

The exchange recently launched currency options from 10th August after having

completed four successful mock trading sessions. Within currency futures too, it had

a leading market share of ~44% in FY12.

Will MCX-SX be able to gain share in the equities exchange? Does not need

to look too far for a precedent

The Bombay stock exchange had a legacy of 132 years in India, a reliable brand, with

the letters almost becoming synonymous with investing in India. However, all this

was till NSE came onto the scene in 1992. Being a relatively new entity, NSE was

nimbler and more receptive to innovation. While it was difficult for NSE to carve a

niche initially, but quickly realizing the importance of IT and innovative products to

meet the growing sophistication of the financial markets, NSE raced ahead to rule

market share charts. How the share of it has continued to improve even after the shift

of balance in power is reflected in the turnover metrics on the two exchanges since

FY01.

12 September 2012

Multi Commodity Exchange of India

Turnover at NSE has continued to exceed BSE (indexed at 100)

Source: Company, MOSL

Stock exchange is an area with ample scope for innovation and betterment in

technology. MCX-SX, with its parentage of FTECH, has access to technology and

management having experience of operating exchanges successfully across the globe.

Global peers valuation

Sales - USD m

Mkt Cap

CY11

CY12E

CY13E USD m

NASDAQ OMX GROUP

LONDON STOCK EXCHANGE GROUP

DEUTSCHE BOERSE AG

SINGAPORE EXCHANGE LTD

3,438

1,300

3,294

517

1,661

1,326

2,785

562

1,741

1,465

2,916

619

3,946

4,092

9,741

5,711

Price/Sales

CY11

CY12E

CY13E

1.1

2.4

2.3

3.1

2.8

3.0

3.5

3.3

11.0

10.2

9.2

Source: Bloomberg

If valuations of NSE and Singapore exchange are anything to go by ...

NSE received a valuation of INR171b in the last known stake sale that happened in

December 2011, which discounted its FY12 revenues by 11x . This is at par with the

Price/Sales ratio that Singapore enjoys. MCX-SX had revenues of INR391m in FY11.

However, the levying of transaction charges in currency futures had commenced only

from August 2011, implying that in FY12, the company had ~7 months of additional

income in the form of transactional charges in FY12. Going by the volumes and rate

card, this translates into ~415m of revenues from transaction charges, and even if we

assume that other sources of income reduced as member additions may have fallen,

FY12 revenue would still be higher than INR600m.

In FY13, revenue growth will be boosted further by: [1] residual impact of four more

months of transaction income from currency futures, [2] income from operation of

currency options, which started in August FY12 and [3] Income from equity operations,

which are expected to launch around November 2012.

With the help of these, we see the exchange revenues easily cross INR1b in FY13.

Annualizing the volumes for the first 5 months, we get revenues from currency futures

alone at INR629m in FY13. This should surge further in FY14, which will be the first full

year of operations in 2 out of the 3 segments. Given the low base and high growth,

while the valuation multiple could be higher, we discount our FY14E revenue estimate

of INR1.3b by 11x, to arrive at a valuation of INR14b. MCX's stake in MCX-SX (including

warrants) amounts to INR5.4b.

12 September 2012

Multi Commodity Exchange of India

LSE's stake buy in DSE poses additional competitive threat to MCX-SX's equity

operations ...

British bourse has picked up a five per cent stake in Delhi Stock Exchange (DSE) and

aims to change the trading model by providing the fastest trading technology to the

latter to take on the Indian market. This implies that the risk to growth for MCX-SX is

not only from challenge of displacing the existing leaders, but also, fighting the parallel

attempt to resurgence by DSE.

… but mitigated by presence in other investment classes

Currency futures and currency options are already being traded on the exchange.

MCX-SX also cited significant market in interest rate derivatives in India, another

segment which will remain its focus. We believe the company's strategy is the right

one, as it adds members for these investment classes, and gradually growing its share

in the equity business as well.

Revenue at MCX-SX expected to surge with transaction fees from FY12 and clearance to operate as full - fledged exchange

Source: MCX RHP

Modalities of MCX's holding in MCX-SX

Within the next 18 months, the shareholding of MCX and FTECH in MCX-SX will have

to be reduced to ~2.5% each, as the approval is subject to the condition that the

combined voting rights of FTECH and MCX in MCX-SX will not exceed 5%.

Earlier, FTECH held 31% and MCX held 38% in MCX-SX. Then, to comply with SEBI

guidelines for starting equity trading, they reduced their stake in MCX-SX to 5% each.

This was done through conversion of excess equity stake (beyond 10%) to warrants.

This led to 68.2% reduction in capital from INR1.7b to INR0.54b. The warrants will be

sold to banks and financial institutions.

12 September 2012

Multi Commodity Exchange of India

Sustainable growth; value unlocking; healthy payout

Target price of INR1,440 implies 23% upside; Buy



MCX’s volumes have grown at a CAGR of 47% over FY07-12. With the industry still nascent,

growth potential remains huge as it adds [1] new participants, [2] volumes from existing

participants.

We expect higher volumes to translate into higher margins, aided by high operating

leverage. We estimate increase in EBIT margin from 58.4% in FY12 to 61.6% in FY15.

Decision to maintain payout ratio at ~50% is a key valuation positive. Also, superior growth

potential, near-monopolistic market share and improving profitability make a case for

premium valuations in standalone business. Besides, there is value unlocking potential

from the warrants it holds in MCX-SX.

Our target price of INR1,440 implies 23% upside. We initiate coverage with a Buy rating.

Expect sustained double digit volume growth

MCX’s volumes have grown at a CAGR of 47% over FY07-12. Volatility in different

commodities at various points of time (gold, silver, crude and copper) and a low base

have facilitated robust volume growth. However, volume growth for the first five

months of the year is down 3.7% YoY. Given the drop in volatility index over the last

couple of quarters, we assume flat volumes YoY in FY13. However, notwithstanding

low volatility in the near term that is affecting volumes, we believe there is enough

potential to grow volumes in double digits over the medium-to-long term.

Fixed/semi-fixed costs as a

percentage

total

expenditure (%)

FY07

FY08

FY09

FY10

FY11

FY12

55.9

60.5

70.1

68.1

68.8

~70.0

Source: Company/MOSL

Margins to continue improving, aided by high operating leverage…

MCX’s EBIT margin has improved from 20.9% in FY08 to 58.4% in FY12, aided by high

operating leverage. A large proportion of MCX’s costs is fixed/semi-fixed and is not

dependent on the trading volumes on the exchange. These include software support

charges, license fees, personnel costs and other administration costs like

communication expenses, electricity charges, insurance, etc.

Higher volumes have facilitated better operating margins over the years

(%)

EBIT Margin (%)

Source: Company/MOSL

12 September 2012

Multi Commodity Exchange of India

…but lower yields, higher technical fees may limit extent of expansion

Increase in software

services fees charged by

the parent could impact

the margin profile

While there is scope for further expansion in margins on higher volumes, given the

exchange’s scalability, we expect margin expansion to be limited by [1] lower

transaction yields due to increase in bulk trades and competition, [2] possible increase

in transaction fees to the parent for technology services. We expect EBIT margin over

the long term to be 65%, comparable to global peers and also justified by the

exchange’s high operating leverage.

Transaction yields have been falling with higher number of bulk transactions

MCX rate card

Avg Daily

Transaction fee

Turn over

(per INR100k)

Upto INR2.5b

INR2.5

INR2.5b-10b

INR1.25

INR10b+

INR1.0

Source: Company, MOSL

Valuing standalone business at 20x FY14E earnings

We value MCX's standalone business at 20x FY14E, in-line with the average multiple

to commodity exchanges in the emerging markets. We believe there is enough reason

for MCX to even trade at a premium given: [1] scope to outgrow peer exchanges

globally, given that the potential is still untapped in India, [2] higher growth will be

augmented by even better earnings and improvement in return ratios (variable costs

largely only in the form of transaction fees paid to parent), and [3] near-monopolistic

market share, to which there is little threat, given MCX’s technology backbone and

readiness to latch on to new opportunities. We value MCX’s standalone business at

20x FY14E EPS of INR66.5 – INR1,330.

MCX should trade at a premium to global peers, given its superior financials (%)

Company

2012-14

Sales CAGR

8.1

9.3

8.1

5.3

9.1

9.5

11.9

5.2

-0.5

4.9

7.4

9.9

8.8

2012-14

EPS CAGR

15.5

12.1

8.9

14.7

15.8

2.2

18.9

9.4

-2.0

4.5

9.0

9.2

10.6

EBITDA Margin

2012 2013E 2014E

67.9

70.2

63.6

50.1

54.7

58.5

53.5

55.0

67.0

77.2

61.2

71.5

57.2

68.8

72.3

61.3

51.5

55.6

55.1

51.8

56.4

66.3

77.0

61.3

73.4

58.3

71.4

73.4

64.0

53.5

57.7

54.3

51.5

55.9

65.2

77.3

63.3

74.3

59.3

2012

10.5

17.7

31.0

8.6

56.9

21.2

14.9

24.6

31.9

11.4

36.2

44.6

17.4

RoE

2013E

11.4

17.8

26.5

10.0

55.2

16.6

14.9

24.7

30.5

11.7

37.9

44.7

19.0

2014E

5.7

15.4

27.8

11.0

44.7

17.1

12.2

24.6

28.9

12.4

40.7

43.0

20.3

P/E (x)

2012 2013E 2014E

18.4

16.2

13.8

17.6

15.6

14.0

20.9

21.2

17.6

9.5

8.2

7.2

18.0

15.7

13.4

10.6

11.0

10.2

15.5

13.0

11.0

10.8

9.6

9.1

10.3

10.4

10.7

15.5

15.2

14.2

24.5

22.9

20.6

26.2

23.9

21.9

21.4

19.1

17.5

Source: Bloomberg

CME Group Inc

Intercontinental Exchange Inc

Multi Commodity Exchange India

Nasdaq OMX Group/THE

CBOE Holdings Inc

London Stock Exchange Group

TMX Group Inc

Deutsche Boerse AG

Bolsas Y Mercados Espanoles

ASX Ltd

Singapore Exchange Ltd

Hong Kong Exchanges & Clear

Bursa Malaysia BHD

12 September 2012

Multi Commodity Exchange of India

Adding potential value from MCX-SX; Buy with a TP of INR1,440, 23% upside

While we value MCX’s standalone business at INR1,330, we separately assign a value

to MCX's stake in MCX-SX (including warrants). The transactions in MCX-SX stake that

happened in FY10 valued the exchange at ~INR45b. The latest transaction in National

Stock Exchange of India (NSE) stake valued NSE at INR171b.

Assuming a revenue base of INR1.3b in FY14, at 11x FY14 Sales, MCX-SX's valuation is

INR14b (much lesser than that implied in the last stake sale). Stake in MCX-SX (including

warrants) contributes additional INR110 per share to MCX. Our target price is thus,

INR1,440 (INR1,330 for standalone business + INR110 for warrants in MCX-SX).

Buy

for

23% upside.

We expect volumes CAGR of 15% over FY12-15 and a PAT CAGR of 13% over this period.

Also, the ROE should sustain its level in the high 20's. The company's decision to

maintain its payout ratio at ~50% in the future too is a key valuation positive, and will

support high multiples.

Blip in revenue and EPS growth in FY13 expected due to low volume growth on high FY12 base and volatility drop

Expect return ratios to remain high

Source: Company, MOSL

12 September 2012

Multi Commodity Exchange of India

Key risks

The Technical services

agreement with the

parent FTIL is likely to

come up for discussion

again in FY13

Significant proportion of costs incurred towards parent and group companies

Over 40% of MCX’s operating costs are towards various fees paid to the parent, FTECH

and promoter group companies. Its technical services agreement (TSA) with FTECH

for IT infrastructure and software services, which costs MCX 12.5% of its transaction

fees in addition to a fixed charge of INR120m per annum, constitutes a major portion

of operating costs. Costs that are incurred towards FTECH have gone up from ~19% of

operating expenses in FY08 to ~47% in FY12. Also, the variable fee was revised upwards

to 12.5% in FY11, from 10% before that, and will come up for discussion again this year.

Fees to FTECH under TSA increasing as a percentage of costs

Source: Company, MOSL

Given that FTECH’s ownership in MCX is the minimum when compared to its holdings

in other group companies, the overhang of increase in technical services fee (as a

percentage of transaction fee) could be potential threat to MCX’s profitability.

Declining volumes of

trading in Gold and Silver

have so far limited the

growth in overall

volumes at the

exchange in FY13

Concentration of turnover in four commodities

The aggregate value of commodity futures traded at MCX has been concentrated

mainly in four commodities – gold, silver, copper and crude oil. During FY04-12, 83-

94% of the total traded value has been from these four commodities. Any period of

parallel inaction in terms of volumes on any counter would impact overall volumes

adversely. April 2012 was one instance – volumes in gold, silver and crude were down

MoM, and 12.2% MoM increase in copper volumes could not offset the 17.5% MoM

decline in overall value of contracts traded on the exchange.

Four commodities currently dominate the turnover at MCX

Source: Company, MOSL

12 September 2012

Multi Commodity Exchange of India

Regulatory paralysis could impact growth

In the current regulatory environment, foreign institutional investors, banks and

mutual funds cannot trade on commodity exchanges. Also, trading in options on

commodity futures is prohibited in India. While the possible passage of the FCRA Bill

could boost MCX’s volumes and provide a sentimental fillip to the stock, there is a risk

that the amendments may not be enforced in a timely manner.

Sharp fall in commodity prices

Trading volumes on the exchange are dependent on volatility in commodity prices,

which may in turn be dictated by the directional movement in commodity prices. A

number of factors outside the control of the company could impact volatility, and as a

result, volumes on the exchange.

12 September 2012

Multi Commodity Exchange of India

About MCX

A state-of-the-art electronic commodity futures exchange

Headquartered in Mumbai, Multi Commodity Exchange of India Limited (MCX) is a

state-of-the-art electronic commodity futures exchange. It has permanent recognition

from the Government of India (GoI) to facilitate online trading, and clearing and

settlement operations for commodity futures.

MCX began operations in November 2003, and has over 86% share (as at 31 March

2012) of the Indian commodity futures market. It has more than 2,170 registered

members operating through over 346,000 trading terminals (including CTCLs), spread

over 1,577 cities and towns across India. MCX was the third largest commodity futures

exchange in the world in terms of the number of contracts traded in CY11.

MCX offers 49 commodities across segments such as bullion, ferrous and non-ferrous

metals, energy, and a number of agri-commodities on its platform. It introduces

standardized commodity futures contracts on its platform, providing an anonymous

trading environment for price discovery. It is the world’s largest exchange for silver

and gold, the second largest for natural gas, and the third largest for crude oil, in

terms of the number of futures contracts traded.

MCX has been at the forefront of commodities exchange development in India, with

many firsts:



MCX was the first exchange in India to initiate evening sessions to synchronise

with the trading hours of global exchanges in London, New York and other major

international markets.



It was the first exchange in India to offer futures trading in steel, crude oil, and

almonds.



In June 2005, MCX launched MCXCOMDEX, India’s first real time composite

commodity futures index, which provides members with information regarding

market movements in key commodities, as determined by physical market size in

India, which are actively traded on MCX.



In December 2009, it launched EFP transactions for the first time in India, enabling

parties with futures positions to swap their positions in the physical markets and

vice versa.

Technology

MCX’s operations are sustained by the exchange related support infrastructure and

software that it sources from its promoter, Financial Technologies India (FTECH).

Technology for the exchange industry is difficult to replicate, thus providing it with a

competitive advantage. The company has made significant investments in developing

fixed operating infrastructure, including technology systems, to support anticipated

growth and increase in the demand for its products. Its technology platform and

business model are highly scalable and have the potential to generate better margins

at greater volumes. Its current technology infrastructure is sufficient to handle daily

trading volumes of up to 10m. So far, it has handled a high of 1.9m trades in a day.

12 September 2012

Multi Commodity Exchange of India

Membership

Members are classified into four general categories:



Trading members (TMs) have rights to trade on their own account as well as on

account of clients. However, TMs have no right to clear and settle such trades.



Trading-cum-clearing members (TCMs) are entitled to trade on their own account

as well as on clients' account. TCMs can also clear and settle trades themselves.



Institutional trading cum clearing members (ITCMs) are entitled to trade on their

own account as well as on account of their clients, clear and settle trades executed

by themselves as well as of trading members and trading cum clearing members.



Professional Clearing Members (PCMs) are entitled only to clear and settle trades

executed by trading-cum clearing members or trading members.

Membership fee structure

Trading

Member

Eligible Entities

Individuals

(including sole

proprietorships),

registered partner-

ship firms,

corporate bodies

and Hindu

Undivided Families

(HUFs).

Non-Deposit

Based TCM

Sole proprietors,

partnership firms,

HUFs, companies,

co-operative

societies, public

sector organiza-

-tions, statutory

organizations or

any other

Government or

non-Government

entities

INR2,500k

INR3,000k

Deposit-Based

TCM

Sole proprietors,

partnership firms,

HUFs, companies,

co-operative

societies, public

sector organiza-

-tions, statutory

organizations or

any other

Government or

non-Government

entities

INR1,000k

INR6,500k

Institutional Trading

cum Clearing Member

(ITCM)

Companies,

institutions

Professional Clearing

Member (PCM)

Companies,

institutions

Admission Fees

Security Deposit

Annual Subs.

Processing Fees

VSAT Deposit

Min. monthly

Terminal fees

Min. Networth

INR750k

PCMs and ITCMs

shall collect

deposits from

Trading Members

INR10k

INR165k

INR1k

Corporate: INR2500k

Non-corporate:

INR1,000k

Have rights to trade

on their own a/c

as well as on a/c

of their clients

INR2,500k

INR10,000k

INR1,000k

INR10,000k

INR75k

INR10k

INR165k

INR1k

INR7,500k

INR75k

INR10k

INR165k

INR1k

INR7,500k

INR100k

INR10k

INR165k

INR1k

INR10,000k

INR100k

INR10k

INR165k

INR1k

INR50,000k

Authorized

activities

Entitled to trade

on their own

account as

well as on account

of their clients,

and clear and

settle these trades

themselves

Entitled to trade

on their own a/c

as well as on

account of their

clients, and clear

and settle these

trades themselves

Transferability

of membership/

refund

Membership

transferable

after three years

Membership

transferable

after three years

Entitled to trade

on their own

account as well

as on account

of their clients,

clear and settle

trades executed

by themselves as

well as TMs and

TCMs of the

Exchange

Deposit refundable Deposit refundable

after three years

Entitled to only clear

and settle trades

executed by TMs and

TCMs of the Exchange

Deposit refundable

after three years

Source: MCX RHP

12 September 2012

Multi Commodity Exchange of India

Operating performance snapshot

Volume traded (INR t)

Revenue (INR m)

5-yr CAGR of 91%

5-yr CAGR of 26%

EBITDA (INR)

PAT (INR m)

5-yr CAGR of 29%

5-yr CAGR of 25%

RoE (%)

RoCE

Source: Company, MOSL

12 September 2012

Multi Commodity Exchange of India

Financials and Valuation

Income Statement

Y/E March

Sales

Change (%)

Cost of Services

SG&A Expenses

EBITDA

% of Net Sales

Depreciation

Other Income

EO Item (net)

PBT

Tax

Rate (%)

PAT

Net Income

Change (%)

2010

2,874

35.3

218

1,240

1,416

49.3

247

2,062

3,230

1,024

31.7

2,206

39.6

2011

3,689

28.4

264

1,507

1,918

52.0

247

784

2,455

727

29.6

1,728

(21.7)

2012

5,262

42.6

280

1,635

3,347

63.6

272

1,027

142

3,960

1,098

27.7

2,862

65.6

2013E

5,172

(1.7)

340

1,661

3,171

61.3

285

1,044

3,930

1,106

28.1

2,824

(1.3)

2014E

6,152

19.0

368

1,846

3,939

64.0

338

1,113

4,714

1,320

28.0

3,394

20.2

(INR Million)

2015E

7,200

17.0

386

2,016

4,798

66.6

360

1,216

5,654

1,583

28.0

4,071

19.9

Balance Sheet

Y/E March

Share Capital

Reserves

Net Worth

Loan and other

long term liabilities

Capital Employed

Net Block

CWIP

Other LT Assets

Investments

Curr. Assets

Current Investments

Debtors

Cash & Bank Balance

Loans & Advances

Other Current Assets

Current Liab. & Prov

Net Current Assets

Application of Funds

E: MOSL Estimates

2010

408

6,562

6,970

106

7,076

1,925

10,362

6,172

304

2,700

1,108

5,214

5,148

7,076

2011

510

7,975

8,485

127

8,612

1,953

13,044

8,236

489

3,310

897

113

6,385

6,659

8,612

2012

508

9,461

9,969

432

10,401

1,369

1,907

2,208

13,274

9,294

514

3,124

283

8,358

4,916

10,401

2013E

508

10,836

11,343

432

11,776

1,387

1,907

2,208

14,546

9,294

686

4,109

381

8,275

6,272

11,776

2014E

508

12,543

13,051

432

13,483

1,299

1,907

2,208

16,235

9,294

817

5,579

454

8,167

8,068

13,483

2015E

508

14,468

14,976

432

15,408

1,189

1,907

2,208

18,642

9,294

957

7,753

531

106

8,539

10,103

15,408

12 September 2012

Multi Commodity Exchange of India

Financials and Valuation

Ratios

Y/E March

Basic (INR)

EPS

Cash EPS

Book Value

DPS

Payout %

Valuation (x)

P/E

Cash P/E

EV/EBITDA

EV/Sales

Price/Book Value

Dividend Yield (%)

Profitability Ratios (%)

RoE

RoCE

Turnover Ratios

Debtors (Days)

Fixed Asset Turnover (x)

2010

43.2

48.1

136.7

4.0

10.8

2011

33.9

38.7

166.4

5.0

17.1

2012

56.1

61.4

195.5

24.0

50.0

2013E

55.4

61.0

222.4

25.0

52.8

2014E

66.5

73.2

255.9

28.0

49.2

2015E

79.8

86.9

293.7

34.0

49.8

20.9

19.1

14.3

9.1

6.0

2.4

21.2

19.3

14.7

9.0

5.3

2.5

17.6

16.0

11.5

7.4

4.6

2.8

14.7

13.5

9.0

6.0

4.0

3.4

37.0

7.2

22.4

16.7

31.0

24.8

26.5

25.5

27.8

26.9

29.0

28.2

38.6

24.0

48.4

27.0

35.7

31.2

45.0

26.7

45.0

29.5

45.0

31.6

Cash Flow Statement

Y/E March

CF from Operations

Cash for Working Capital

Net Operating CF

Net Purchase of FA

Net Purchase of Invest.

Net Cash from Invest.

Dividend Payments

Cash Flow from Fin.

Free Cash Flow

Net Cash Flow

Opening Cash Bal.

Add: Net Cash

Closing Cash Bal.

E: MOSL Estimates

2010

1,101

(2,013)

(912)

(87)

(42)

(129)

(239)

(1,000)

(1,280)

1,764

(1,280)

484

2011

1,619

1,080

2,700

(286)

(2,042)

(2,328)

(238)

2,414

134

484

134

624

2012

1,600

1,160

2,760

(200)

(2,723)

(2,923)

(296)

2,561

(459)

624

(459)

165

2013E

2,107

(371)

1,736

(300)

1,040

740

(1,492)

1,436

985

165

985

1,150

2014E

2,603

(326)

2,277

(250)

1,113

863

(1,671)

2,027

1,470

1,150

1,470

2,620

2015E

3,097

140

3,237

(250)

1,216

966

(2,029)

2,987

2,174

2,620

2,174

4,794

12 September 2012

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Multi Commodity Exchange of India

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