November 18, 2009 - 2:45pm EST by
2009 2010
Price: 29.00 EPS C2.50 C2.80
Shares Out. (in M): 74 P/E 11.6x 10.4x
Market Cap (in $M): 2,160 P/FCF 11x 10x
Net Debt (in $M): 250 EBIT 260 280
TEV ($): 2,410 TEV/EBIT 9.3x 8.6x

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TMX Group (X CN) owns and operates cash, derivatives, energy, fixed income markets and clearing houses in Canada and the United States.  Though certain segments of its business are facing competitive threats that will erode its market share over time, the diversity of the overall business and growth profile of other segments provides ample downside protection. 

At a recent price of C$29, TMX Group is undervalued by approximately 30-50%, and should ultimately trade back to its historical multiples as the profit contribution from its growth businesses continues to exceed that of its others 


TMX Group's diverse set of businesses can be broken out as follows:

Cash Markets (approx 22% of revenues): Consists of the Toronto Stock Exchange and TSC Venture Exchange, which are the primary venues for capital formation and liquidity in Canada

Derivatives Markets (approx 14% of revenues): Consists of the derivatives exchange, MX (Montreal Exchange, acquired in 2008), which is Canada's only standardized financial derivatives exchange, offers interest rate, index and equity derivatives

Listing fees/Issuer services (approx 27% of revenues): Generates revenues from listing fees for IPOs in capital, ongoing listings and other services (e.g., Investor relations and corporate communications)

Market Data Fees (approx 26% of revenues): Based on real-time data reflecting orders and executed transactions from the trading activity on the Company's exchanges, as well as other sources of data (e.g., historical market data)

Other sources of revenues include business services, which installs and operates trading and related systems at other global exchanges.

While TMX Group's topline and earnings is clearly tied to activity in the financial markets, the long-term trend of their business (and other such exchanges) is favorable, driven by transparency, further market participation, innovation, and listings.  Indeed, as an example, common equity issuance in Canada has grown at a CAGR of 8% over the past 50 years.  The growth in derivatives has been even more favorable, and given Canada's relative underdevelopment of its equity derivatives market, there remains additional upside.

Investment Thesis

TMX's cash markets is clearly being impacted by competitive exchanges, as alternative platforms such as Alpha have chipped away at TMX's cash market share.  Moreover, the pricing impact is unfavorable as well.  That being said, a review of the United States market suggests that market share should decline from about 90% to 70% in 2010.  While this certainly doesn't bode well, it is important to note that TMX Group "only" derives 22% of its revenues from Cash Markets, and hence the performance of its other businesses, which do not face nearly the headwinds that TMX's Cash Markets do, is more critical.

Indeed, TMX's derivatives markets - or rather Canada's, is only 0.33x of its cash market value traded, compared to 2.06x globally.  This is after MX's annual derivatives volume growing at a CAGR of approximately 16% since 2002.

TMX's Market Data Fees continue to remain relatively resilient  in the fact of the declining markets (e.g., while the TSX dropped 40% between June '08 and March '09, data subscriptions declined only 9%) and provides a subscription-based, recurring revenue model that helps offset some of the volatility inherent in the other business lines.  For example, market data revenues increased 23% during 2008, despite the market meltdown.

As mentioned earlier, issuance fees is a continuous, long-term growth story, and should continue to increase in the foreseeable future.

In fact, over the last twelve months (through September 2009), TMX has performed very well in terms of volumes and revenues for its businesses:

TSX volumes: +23%

MX equity derivative volumes: +8%

TSX new equity financing: +71%

Market Data Revenue: +17%

NCG Revenue: +37%

Total Revenues: +13%

At the same time, Canada exhibits strong fundamentals with the lowest deficit-to-GDP among the G7, a well-regulated banking system and a significant resource base. 

Ultimately, when looking at TMX Group as a whole (rather than just focusing on the Cash Markets competitive threat headlines), the outlook for the business, including nascent markets of energy trading, etc., is positive, with secular drivers. 


For the quarter ended 9/30/09, TMX earned $0.56/share, or an annualized $2.24.  Forward earnings are expected to be higher given expectations of listings growth, new products and derivatives, offset somewhat by market share loss in the cash markets. 

On both an absolute and relative basis, TMX Group is cheap.  At approximately 10x consensus cash earnings, TMX trades at a 50% discount to its historical multiple, and at a 5.2% dividend yield.  At the same time, compared to other exchanges, TMX is relatively cheap as well, trading at an approximate 10-15% discount (versus a historical premium).  On a forward EV/EBITDA basis, TMX Group trades at approximately 7.7x, a 20-30% discount to its historical average in the double digits.


TMX Group is led by Thomas Kloet, who became CEO on July 14, 2008.  Kloet has had a wide range of experience in the exchange industry, serving as the first CEO of Singapore Exchange Limited, and as COO of the AMerican Zone for Fimat.  While Kloet has yet to make any major moves since taking over, he is generally very well regarded in the industry.  In terms of shareholder orientation, the company currently pays a dividend of C$1.52/year, and repurchased C$285m of stock in 2008 (though it has since slowed repurchases w/ only $30m in 2009/


Risks to TMX Group include:

Canadian macro-risk; specific concentration in mining

Faster erosion of market share in cash markets than anticpated


General market volatility (or in some cases lack thereof)


Increase in volumes

Pricing incresae in certain products


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