Singapore Exchange Limited: The Baltic Exchange Acquisition September 16, 2016

PSR Recommendation: REDUCEStatus: MaintainedTarget Price: 7.99
  • Acquisition of The Baltic Exchange for approximately £87mn
  • Synergies from the acquisition unlikely to happen within the next 12 months
  • Acquisition should benefit SGX’s Market Data and Connectivity business
  • Maintain “Accumulate” with unchanged TP of S$7.99

Background of The Baltic Exchange. The Baltic Exchange had been a mutual company wherein the members/owners of the exchange are also the clients of exchange. Therefore The Baltic Exchange functioned primarily as a utility to provide services to its members/owners and not so much a profit oriented enterprise. By acquiring The Baltic Exchange, Singapore Exchange (SGX) seeks to capitalise on the Intellectual Property and institutional knowledge of The Baltic Exchange to (i) expand dry bulk Freight Forward Agreement (FFA) user base; and (ii) to develop the FFA as a product for profit.

Post-acquisition Strategies. As SGX attempts to drive up the users for dry bulk FFA, we see profit driven from two sources:

  1. Clearing increased volumes of dry bulk FFA trades. Now SGX can earn license fees from other major clearing houses that also clear the dry bulk FFA trades. Presently, Baltex, which is Baltic Exchange’s regulated trading venue, represents 40% of all dry bulk FFA volumes. Of that volume traded on Baltex, SGX clears 40% of the trades, LCH clears another 40% and remaining 20% are cleared by Nordic, CME and Nasdaq. By acquiring Baltic Exchange, SGX retains the optionality to clear dry bulk FFA trades, or to issue clearing licence to other clearing houses, or combination of both.
  2. Provision of information services (c.11% of Baltic’s FY16 revenue). Revenue generated from clearing houses for information services grew c.10% year-on-year (y-o-y) in FY16. The revenue of £0.884mn was contributed by (i) £0.345mn from new fee arrangements; and (ii) £0.365mn from Baltex platform revenue growth (+310% year-on-year).

As such, we think profit growth momentum could continue with Baltic expanding the sale of information to broader range of customers. We think that non-conventional industry players, such as trading houses, commodity industry players and financial institutions that provide trade finance, are potential customers of “real time” freight prices. The additional information provides these customers better estimation of shipping cost volatility and therefore aids in their risk management.

Provision of Information Services Business to offset sluggish Freight Forwarding Business amid macroeconomic challenges. Figure 1 shows the Freight Forward Derivatives volume for SGX on a monthly basis. The recent continuous month-on-month (m-o-m) drop since April 2016 is a reflection of decline in global trade. On the derivatives side, we do not expect Freight Forward Derivatives volumes to grow strongly as the world economy continues to grapple with slowing global trade. Instead, we view that The Baltic Exchange acquisition allows SGX to secure a foothold in the dry bulk FFA business and provide longer runway to develop dry bulk FFA as a product for market data. So we believe the positive impact of the acquisition should accrue to the SGX’s Market Data and Connectivity business rather than the Derivatives business.

Figure 1: SGX Freight Forward Derivatives volume

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Source: PSR, company

No significant immediate impact to SGX’s bottom line. Based on Baltic’s FY2016 income statement, we estimate Baltic’s earnings (adjusted for realised gains in disposal of investments and loss on fair value movement of investments) to add S$3.42mn to SGX’s bottom line. This represents approximately 1% of SGX’s FY2016 PATMI. However the profit impact to business segment is more significant. Baltic’s sale of information is c.£0.884mn (equivalent to S$1.59mn*) in FY16. We estimate SGX’s FY2016 Market Data & Connectivity net profit was S$38.6mn. So that would already add 4% to Market Data & Connectivity FY16 net profit.

*Assume exchange rate of £1 to S$1.8

 

Investment Actions

We believe it is difficult to visualise the potential of the Baltic business to the Market Data and Connectivity business. But if it turns out successful, confidence in SGX’s business acumen and foresight will be further enhanced. Nonetheless, we do not think that there will be any significant impact from acquisition synergies in the next 12 months.

Maintain “Accumulate” with unchanged TP of S$7.99.

 

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About the author

Profile photo of Jeremy Teong

Jeremy Teong
Investment Analyst
Phillip Securities Research Pte Ltd

Jeremy covers primarily the Banking and Finance sector. He has 6 years’ experience in equities related dealing and research roles.

He graduated with Bachelors of Mechanical Engineering from Nanyang Technological University.

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