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Safal Niveshak StockTalk: MCX

Statutory Warning: This report may cause a reaction, and acting on it can be injurious to your wealth.

Note: This StockTalk analysis has been written by Sunny Gupta.

Most tribesmen reading this would know about the business moat (read how a business moat looks like) and its importance, and how identifying businesses with strong and durable economic moat is key to investment success (when properly combined with other important ingredients like margin of safety).

It is also evident that businesses that possess strong and durable economic moat tend to have little competition, high margins (or return on invested capital, ROIC), low working capital needs and low to zero debt.

One such company in the Indian context is Multi-Commodity Exchange of India Ltd. (MCXIL), the only listed “financial security exchange” stock.

Let’s see if this good looking business is indeed beautiful, and if it can also be a good investment opportunity.

Before we start the analysis, I want to introduce the readers to an interesting concept used in engineering projects is “Risk Log” or a Risk Register.

A Risk Log helps us collate various risks associated with a project and list their probability of occurrence and impact. This is a good thing for investing too, since, as Charlie Munger said, “Don’t go where you may die”, the objective of business analysis should be to identify the risks associated with the investment, and then weigh them all to take an informed investment decision.

On this thought, I’d keep collecting potential risks as we identify them during the course of analysis in our Investment Risk Log (see below).

Let us start looking into the business of MCXIL.

MCX’s Business
MCXIL is India’s largest commodity derivative trading exchange, and also the world’s third largest. Further, it boasts of the largest trading of silver and gold futures (after all, we Indians love these precious metals so much!).

While commodity derivatives trading maybe a complicated, stressful and dangerous profession as a trader, it is simple to understand the business of a commodity derivatives trading exchange. The exchange provides a platform for traders to exchange cash and securities, with well-defined rules and framework. One trader sells a security while other buys and the exchange (like MCXIL) only services them “exchange”, and receives a transaction fee in return of this service.

In order to serve these transactions, MCXIL needs to spend money on the following key heads:

  • Employee compensation
  • Software charges, for the intricate software system and its maintenance which is needed to ensure trading is accurate and timely, with nearly zero failures.
  • Other SG&A expenses (sales, general, and administrative)

The major cost items for the company are its software support charges (30%), and employee expenses (20%, where total strength of employees was 266 as on 31st March 2012).

However, an inference from the cost model for MCXIL is that their costs are relatively fixed, as they’ve build infrastructure to support 10 million daily trades, while the current daily volume is only around 1.5 million trades. This means that their cost of operations will remain relatively constant for a long time (they can become 6 times bigger without having to spend on capex), and as volumes increase, their operating margins will improve.

This is also evident from the fact that MCXIL’s operating margins have increased from a low of 20% to a healthy 60% in FY2011-12. Hence, looking at the business as a “cash generating system”, we can picture MCXIL using the following diagram…

How have revenues grown in the past?
We note that (see chart taken from FY11-12 annual report below) MCXIL has been able to maintain and grow its market share in the past five years. There have been many attempts by other players, especially financial institutions like banks and brokerage firms, but we still see that MCXIL has been able to maintain its dominant market position by holding more than 80% of the total market in India.

If this can continue going forward, MCXIL can grow at the same pace as Indian commodity futures market. However, we’ll need to watch out for reasons which can bring tough competition going forward, and MCXIL may not be able to maintain its market share to such a high value of 80%+ levels.

What kinds of transactions take place on MCX?
A study of its annual reports tells us that the contracts volume is focused in precious metals, which is as high as 60% of total transactions. This indicates risk of concentration in a specific segment. We’ll analyse this further in next section.

In fact, large part of the phenomenal growth in MCXIL’s revenues in the past is attributed to growth in precious metals segment, and this means that we should be conservative of the future growth of the company. We’ll take this up in the valuations section.

Next thing to study about a security transaction exchange is robustness of its services. Any technical issues arising in the services of MCXIL can lead to dis-satisfaction within traders, who may incur large notional or real financial losses. And if such events occur (forget about them occurring frequently, they’re killers for financial service providers like banks, brokers and exchanges), they’ll lead to loss of revenues as people will switch to more robust exchanges.

Towards this end, MCXIL implements the following features, which makes its services robust (this is evident from the fact that it has grown its contracts volumes ever since it started operations in 2003, and also the fact that a Google search on history of “technical errors on MCX servers’ did not return any meaningful results, indicating near flawless operation since they commenced operations. Indeed, if someone remembers a technical glitch that occurred in the past, please share details of the same in Comments section):

  • Fault Tolerant FTIL (Financial Technologies India Ltd.) server with 99.999% availability.
  • Multiple mediums of connectivity like VSAT, VPN, leased lines etc.
  • Strategic tie-ups with other major exchanges, financial institutions etc. This helps reduce risk and hedge positions.

While the above points do not guarantee that technical failures would not happen, it is evident that the company is cognizant of the importance of providing a robust trading platform, and this gives confidence to its clients, which may have been one of the loyalty factors leading to growth of the company in the past.

Economic Moat
In order to study the economic moat and its durability, one should consider few key points, which we do here for MCXIL:

  1. Bargaining power of customers of MCXIL is not high, since they can’t command or negotiate for the transaction charges with the exchange. This is good for MCXIL since this allows them to pass on the costs and even increase their margins occasionally. This fact is evident from the fact that MCX has had a very good revenue growth while also increasing its operating profit margins.
  2. Bargaining power of suppliers of MCXIL is tricky to estimate. The only major cost for MCXIL is that of software charges, which it pays to Financial Technologies (FTIL), who is also the promoter of MCXIL, and holds a 26% (controlling) stake in the company. This relationship means that FTIL would not charge irrational amount in software services to MCXIL, and hence we can assume that bargaining power of suppliers is not too high or too low, and it has a neutral effect on the moat for MCXIL.
  3. Risk of new entrant for MCXIL is quite high, since the business is an asset-light, high margin business (low barrier to entry), which will attract a lot of competition. However, it is also important to mention that technical know-how and expertise are needed in setting up such a business, and continuous innovation in products and offering is key to sustain this high margin business. We’ll address this in detail later.
  4. Risk of substitute for MCXIL business is moderate. If a financial security provides traders to earn high returns with lower risks, MCXIL may leave commodity trading and deal with this new financial security.
  5. Existing competition for MCXIL has not proven to be a big threat, as is evident from the 80%+ market share of the company, and the fact that many attempts to setup commodities exchanges have failed.

Overall, based on the points mentioned above, we can say that MCXIL has a moderate economic moat, which is reasonably durable. Further, since it has demonstrated this growth for over 9 years now, and when many commodities exchanges came and went by, it is not by sheer luck that MCXIL has proven to possess this economic moat.

Indeed, we need to find what MCXIL is doing to withstand competition that’ll come its way in future.

Financial Health
Let us now study the financial health of MCXIL. We gather the following points after studying numbers in last 5 years’ financial statements…

  • Improved operating profit margins as volumes of transactions have increased
  • Zero debt throughout the 5 year period
  • All capital expenditure needs funded from operating profits. MCXIL spent Rs 1.6 billion as capex in last 5 years, and it earned over Rs 6.8 billion as operating profit, indicating very good incremental return on capex.
  • A significant non-operational revenue stream from interest and dividend income, and sales proceed of investments. In fact, we see that a major part of net-worth of the business is invested into current and non-current investments, which generate about 20% of annual revenues. Hence, if we take whole of equity as base, we get a near constant ROE of 28% for last 5 years. On the other hand, if MCXIL were to hypothetically liquidate all of its investments and give away a major part of it back to shareholders as dividends, the equity base will reduce to 1/3rd of what it is today, but operating profits would only come down by 25%, resulting in a true ROIC of over 50%.
  • Cash flow from operations is also decent. In the last 5 years, only once has the CFO been negative on accounts of trade receivables. MCXIL generates CFO greater than PAT most of the times.
  • As we’ve seen earlier, MCXIL can grow its contracts volumes by 6 times from where it is now, without any major increase needed in capex or working capital, and hence it’s in an excellent position to “grow for free”, and generate increasingly better returns for the shareholders.

After having a look at the business of MCXIL, we find the following characteristics…

  • Consistent earning power which is growing as volumes increase
  • High return on invested capital
  • Near recession proof business, as human tendency to speculate doesn’t go away during recessionary times
  • A business which needs to keep up with technology and keep innovating (susceptible to rapid change). However, presence of FTIL as the promoter helps MCXIL obtain the latest financial technologies in time.
  • We didn’t talk a lot about it, but dividend payout ratio is healthy, at 15% of PAT on average in last 5 years, but it is not growing.
  • Good cash flow situation, and very low working capital needs

Before we go and study what’s good about the business, let us find out the concerns for its future, since this will avoid us getting biased to the good, attractive things.

What Can Go Wrong?
In this section, we study internal and external factors to the business that can go wrong. Let’s start with things that are in control of the business.

Costs: Here’re few things on cost front that might go wrong, let’s see how probable they’re and add them to risk log accordingly.

  1. Write off costs due to defaulters: It is possible that a trader makes huge losses in commodity trading due to the leveraged nature of the trade, and he’s then unable to pay the exchange for the losses. MCXIL has adequate measures in place (like minimum networth, margin and MTM loss monitoring systems, along with limited insurance of members) to minimize any major risks of write off costs due to defaulters.
  2. Further increase in management compensation: Total cost in employee compensation was 10% of PAT for FY11-12, out of which, the CEO’s fixed compensation apart from ESOPs was Rs 1.7 crores, about 1% of PAT. We’re not sure if these numbers are high in relative sense. It is understandable that businesses like MCXIL will need professional management and considering the complexity of business, I personally think that CEO compensation is not too high, and employee compensation, like many other knowledge industries (consider a bank, or an IT company), employee compensation is a major cost for these businesses.
  3. Software charges: This is the biggest single cost head for MCXIL, and as we discussed earlier in “bargaining power of suppliers”, it is not a high risk that this cost will increase to exorbitant levels.
    Overall, on cost front, risks of things going wrong for MCXIL are not so high, except that we need to keep a watch on top management compensation.

Innovation: While I’d not want to go into details here, the annual report and MD&A indicate various innovative offerings the company has come up with from time to time. The management has focused on quality and technology standards.

I believe that the management and promoter group are conscious about the fact that they operate in a very dynamic industry where innovation and timely delivery of new products which market needs is extremely important and rule for survival.

However, if the management doesn’t continue to innovate and keep pace with rapidly changing environment, it can be a big negative to the prospects of MCXIL business.

Management: Let’s now come to a very important factor in business analysis – the management. I strongly believe that while a good management may not be able to revive an ailing business, a bad management can easily cripple even an excellent business. So, let us put MCXIL management to test using the following checkpoints:

  1. MCXIL management has succeeded in maintaining healthy returns and performed good capital allocation, which is evident from the financial numbers we saw above.
  2. The management compensation is high, even if justified for the “knowledge industries”.
  3. The promoter (Financial Technologies), despite selling their stake in IPO, retains 26% controlling stake in MCXIL, which boosts the confidence that the parent technology leader believes in the future prospects of the business.
  4. It is unfortunate that top management has sold shares after CTT imposition.
  5. Nothing doubtful evident from related party transactions, which have majorly been with FTIL for software charges and asset purchase, and MCX ESOP Trust.
  6. Director’s report and MD&A doesn’t look over-optimistic and promotional. On the contrary, MD&A looks very reasonable where every statement is supported by data, and the analysis is balanced, listing both opportunities and threats equally.
  7. MCXIL’s board and top management is composed of right people from related sectors like FMC, banks, exchanges, academia, and other financial backgrounds, including financial technology.
  8. I performed some searches on ‘corporate governance issues” with MCX and FTIL, and found the following links (here and here). They do show some concerns about lack of transparency on part of FTIL management, especially in launching MCX-Stock exchange.

However, searching independent senior management names for any problems related to governance did not show up anything. But this doesn’t mean a green flag – rather, we’ll need to rely on scuttlebutt and people who know of any issues are requested to post in comments section.

Let’s now see what can go wrong on the external front.

Competition: Even though MCXIL has been able to maintain its market share to 80%+ levels in the past, rising competition can hamper this, leading to reduction in revenue growth for MCXIL, and as we saw above, the key for MCXIL to maintain and increase operating revenues is to increase volumes.

Government Control & Regulations: Government regulations and policy paralysis can impact MCXIL business in the following ways…

  1. MCXIL has a concentrated revenue stream from precious metal commodity futures transactions. As it happened recently, the government has increased the commodity transaction tax (CTT) on non-agri products, which will impact the volumes of MCXIL contracts. While management estimates that introduction of CTT on non-agri commodities will impact up to 20% of volumes for MCXIL, it has also taken steps recently to get aggressive on growing the agricultural commodities segments, and hence offset for the losses.
  2. Management relies on liberalization in commodities trading in India, which will be the next big source of growth and expansion for MCXIL and the industry. However, government may not do so for a long time, even though they’ve recently given autonomy to Forwards Market Commission (FMC), the regulatory body for commodities in India.

Threat of substitutes: As we studied in economic moat above, this is a moderate risk to MCXIL business.

Having studied what can go wrong, it’s time to look at the positive aspects of the business and its prospects in future.

What’s Good about the Business and its Prospects?
As we’ve studied above, here’s a list of what’s good about MCXIL’s business…

  • Increasing operating margins as volumes increase, which means that MCXIL can become more profitable and gets full advantage of economies of scale.
  • Healthy financial situation, zero debt, and a market leader position.
  • As mentioned in MD&A, liberalization in Indian commodities trading regulations, which can open up this segment to large financial institutions like banks, mutual funds etc., and further, introduction of commodity options will bring in more revenues as then businesses can use more efficient financial instruments to hedge their raw material costs. Further, if FMC decides to remove CTT (as many experts believe that CTT is a killer for India’s commodity market which is still young and growing). Hence, introduction of commodities options, opening the market to financial institutions, and abolishment of CTT can turn out to be positive black swan events / positive catalysts to MCXIL business prospects.
  • Large equivalent cash position which can help MCX make thoughtful acquisitions to grow. For instance, if MCX is allowed to acquire some agri-focussed commodities exchanges, it’ll help offset for the revenue losses due to CTT quite rapidly, as opposed to organically growing their agri segment.

The Investment Risk Log
Here’s a list of risks to our investment in MCXIL…

High Risks

  1. Risk of new entrants with innovative products and offering that can greatly hamper the market share of MCXIL.
  2. Government regulations like retaining imposed CTT and not allowing commodities options or financial institutions to trade in commodities can become big negative catalysts to MCXIL business prospects.

Medium Risks

  1. Increase in management compensation can impact profitability.
  2. Unknown problems with management and corporate governance can pose a risk to the investment.

As Vishal mentioned in his analysis of Amara Raja Batteries, this is the haziest part of the business analysis, and there’re strong chances that our valuation turns out to be wrong. Hence, we’ll try to find if we have sufficient margin of safety in our valuation estimate.

Let us first discount what we know – assuming that CTT will impact revenues for next year by 25%, and using past 2 years average (as the company has grown pretty fast in last few years, and taking longer averages will be quite inaccurate), we get the following:

  1. Average of last 2 years operating revenue, and reducing 25% thereof gives us an estimated operating revenue of Rs 3.4 billion for FY12 (with CTT in effect), and it gives Rs 1.9 billion as operating profit. Adding Rs 0.9 billion of average non-operating revenue (at 100% gross margin since this is interest and dividend income on investments), we get an estimated profit before tax (PBT) of Rs 2.8 billion. Using the trend for the business that “Free Cash Flow” is nearly same as PBT, we get a base FCF of Rs 2.78 billion.
  2. However, the business is still growing pretty fast, so let’s assume a 20% growth for next 5 years, 15% growth for next 7 years, and 2% thereafter. I chose 3-stage DCF since commodities industry in India is still in a nascent stage, and a lot of “reforms” are possible going forward. The growth rates chosen are definitely less than what the business has clocked in the past. Using this 3-stage DCF, 12% discount rate and the base FCF calculated in step 1, it gives us “Intrinsic Value of DCF per share” of Rs 1650.

On the average P/E front, we lack a lot of data – MCX stock has traded for less than 3 years, and leaving aside the last 6 months, it has traded at a P/E ratio of 20 or above. Assuming a more reasonable P/E ratio of 17, and the current EPS (based on reduced revenues due to CTT) of about Rs 50, we get a P/E based fair value based on historical P/E of Rs 850 a share.

Further, as we believe that the business can still grow at a good pace, if big negatives don’t happen, at the current growth rate of over 40%, a P/E of 20 (resulting in PEG ratio of 0.5 being an undervalued stock) is justified for MCXIL stock (for the period where it can still clock over 40% growth), and that gives a fair value based on PEG ratio less than 0.5 of Rs 1000 for the stock.

Using these three numbers, we get the range of fair value as Rs 1,165 to Rs 990. Taking the upper limit and different margins of safety, we arrive at the following table…

As I said, valuation can be quite incorrect, but I also believe somewhat in market dynamics, and I see that after CTT news, MCX stock price has taken good support at Rs 820 several times, and taking this “supporting evidence”, I’d consider buying MCX stock around Rs 820-840 levels which gives a decent margin of safety, provided all other “more important” considerations support a buying decision, and not just because I’m now anchored to this price level.

Final Summary
Well, after this analysis of MCXIL business, I can say that the business has got a decent economic moat, and while competition and regulations can pose a risk to revenue growth and its sustenance, ability and experience of management in adapting to the changing environment and innovating in bringing new values to the customers should remain key to future growth of MCX business.

If the business can manage to grow revenues like the way it has done in the past, while fully recognizing that law of diminishing returns always plays a role in slowing down growth rates, there’s a large potential for MCX to deliver very good value to shareholders, who are prudent in buying the stock at the right price, and doing a staggered buying while being cognizant of fast changing dynamics related to CTT and related regulations.

What do you think about this business and the investment? As an analyst, one can only study what “he can see”, but he must thereafter rely on critical reviews and the scuttlebutt others can bring in to the analysis, i.e., finding “disconfirming evidences” to make the analysis more rational and remove biases.

Hence, my mirror test begins, and I’ll sleep over this analysis, and try my best to avoid the bias of “I’ve done a great analysis, so let me buy the stock which is presently available around the safe purchase price Rs 825.”

Happy and safe investing 🙂

Here is the StockTalk list for the next six months…

If your name is in the list, and you haven’t written to me as yet, please send me an email at vishal[at]safalniveshak[dot]com, so that I can contact you directly to discuss the report format, deliveries etc.

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About the Author

Vishal Khandelwal is the founder of Safal Niveshak. He works with small investors to help them become smart and independent in their stock market investing decisions. He is a SEBI registered Research Analyst. Connect with Vishal on Twitter.


  1. Jana Vembunarayanan says:

    Hi Sunny,

    Thanks for the great analysis.

    On the secion of What can go wrong

    1. Write off costs due to defaulters
    Since the risk is spread across several traders the risk of few defaults should not bring down MCXIL. Do you know if there is a maximum CAP on how much a trader can trade?

    2. Software charges
    More than the cost of the software for me the dependence on Financial Technologies is worrying. The most important asset for MCXIL is the trading platform. Did you look at the stability of Financial Technologies?

    Your idea of doing a google search on history of “technical errors on MCX servers’ is very cool and I am not sure if it tells me a lot.


    • Sanjeev Bhatia says:

      Agree To 1, Jana. The Exchanges have several mechanisms to ensure there is no default which include cap on broker margins, MTM recovery and freezing of broker account.

      However, I would not be too much worried about the dependence on Financial Technologies. It has specialization in Financial Softwares and also supplies ODIN, one of the most common trading platform for Equity Exchanges. I have been using it for quite a few years and have no issues with it.

      Further, FT needs MCX as much as MCX needs FT. There are quite a few other players for trading platform and this will keep FT on leash. Also, the stake of FT in MCX will further ensure there are no glitches.

      Happy Investing 🙂

      • Thanks Jana and Sanjeev, indeed the risk of defaulters is not so high, as many people have responded.

        On the dependence on FTIL and its technology, I’ll respond to further comments in detail, but I do agree with Sanjeev’s point that both FTIL and MCX need each other.

  2. Hi Sunny,

    Thank you for sharing your analysis with us. The big unknown is — why the MD is selling stock. As a long term investor you might agree, one thing you do not like is uncertainty. Lack of any good explanation for the same is worrisome, since they know more than you do. Maybe someone in the government is bringing a case against them, which is like the worst-case.

    I can’t pull the trigger on this one unfortunately.


    • Thanks for this perspective, Prasanna. I’ll study more on selling pattern of insiders and provide an update shortly. There have been few inputs on this point, both relieving and concerning, so let’s look at all of them and draw a consensus…

  3. Shiv Kedia says:

    What about the parent Financial Technology?

  4. Hi Sunny,

    Firstly Kudos to all you guys for starting this beautiful journey. A collective effort will always be better than one individual thinking. With collaboration, we can achieve a lot and learn a lot.

    Secondly, thanks for this wonderful write up on MCX. Looks like you have done lot of homework on this one. Some of the things I noticed which did not get mentioned are provided below.

    Most of the fixed assets in the balance sheet are funded by accounts payables and almost all of the networth is either invested in short term or fixed instruments. So, the negative working capital (other people money) is a big plus. However, as per the annual report there is some conflict on how to handle the margin money of the investors.

    Not sure how this will impact its balance sheet. Excerpts of the note is given below. They mention this as parent company. I am not sure if this is referring to the parent which is MCX or reference is to MCX-SC..

    (Note 37 in Annual Report) “The Parent Company does not treat member’s margins and income thereon as part of SGF as contemplated under the FMC guidelines of SGF issued in 2006 and therefore credits the said income (amount unascertained) to statement of profit and loss. Representations have been made to FMC and a response is awaited.”

    A Positive that got missed is the network effect. Just like Google or eBay, this field has first mover advantage. Traders will always go to exchanges where maximum trading happens. No one wants to trade in an exchange where the volumes are very thin because of the spread. No matter how many new plays come, unless there is some big time bad event like bad technology let down or something, this particular moat is strong. So, commodity wise this is a big positive. But the same argument has a big negative in terms of the stock trading that they are trying to get into as their market share here is very small or non existent.

    In the bargaining power of suppliers you had mentioned that because the promoter holds 26% they will not increase cost. I do not agree to this argument. Promoter stake is higher in FTIL than here. In that scenario, where would the promoters interest be?

    FTIL has significant debt on its balance sheet and if the interest cost of this goes up, what would FTIL do other than increasing the price, when it is the same promoter that has a controlling stake albeit a small one in MCX?

    Even if we forget the same promoter holding, I see this dependency on one supplier a significant risk. A significant black swan event or which destroys FTIL will destroy or at least have a very big impact on MCX operational abilities. Glad to hear your thoughts on these.


    • Thanks Ravi, you’ve given a new direction to the analysis. Here’s my point wise response.

      1. Indeed, collaboration helps know what one doesn’t see and doesn’t know, and it’s a great way to find “dis-confirming evidences”

      2. I did not get into this depth on financials, but yes, I’ll need to work on this to see if this accounting process would artificially inflate P&L

      3. Yes, I didn’t realize network effect, and that kind of offsets the risk of losing market share due to new entrant to some degree! Thanks for letting us know this fact 🙂

      4. I agree, since promoters have higher stakes in FTIL, and FTIL needs funds, they might increase the software charges and put pressure on margins for MCX. In fact, when I mentioned that MCX costs would increase much and they can grow 6 times bigger for nearly no capex, I need to go back and check the software charges agreement between MCX and FTIL – what if it is based on “average daily volumes”, as it may be likely that as MCX grows, FTIL’s revenues from MCX also grows in the same proportion. On the other hand, I also feel that presence of other shareholders (58% institutional / public shareholding) will keep a check on FTIL mis-using their controlling stake in MCX by irrational increase in software charges. But yes, need to re-evaluate the understanding about “growing operating margins with growing volumes” from software charges perspective.

      Thanks for these points, I’ll come back with an answer soon.

  5. Thanks for a comprehensive analysis, Sunny!

    A few questions/concerns –

    1. Have a look at this link from BSE’s website that shows all insider trading activity for the company. And the entire list is of insiders selling their stock! You have mentioned about insiders selling in your report, but such an extent of continuous selling is worrisome.

    2. On their business front, as you have mentioned, a large part of revenues over the past few years have come on account of trading in bullion. Maybe the bull run in gold and silver – and the intense speculation in these metals – helped them. Now, with gold cooling off, revenues could get impacted big time. Right assumption?

    3. Their core competency seems to be their technology platform, which I believe cannot be a sustainable moat. Also, since they get the tech from FTIL, it’s important to look at the performance of the latter as well. You have already mentioned in your risk log that there’s a “risk of new entrants with innovative products”. So there goes the moat, which seems shaky!

    More to come. 🙂 Thanks anyways for the analysis!


    • Thanks Vishal. Indeed valid points, and here’re my responses:

      1. Yes, we need to study why so much insider selling? As many readers have pointed, this is now looking like a major concern, as in do insiders know something we don’t know, and they’ve been selling for the fear, or it is just that they got a good exit opportunity to liquidate their “ESOP earnings”? We need to dig deeper on this front

      2. I agree major revenues have come from bullion, but I believe that derivative trading is not just about a “bull run” in a commodity – yes volumes can reduce a little, but people will still find opportunities to sell and make money. Further, if some trader is good at making money in bullion, just because bull run in these commodities is over, would he stop trading. I agree volumes will decrease, but they may not dry up. Also, as I mentioned, taking cognizance of the fact that CTT is an unfortunate reality, they’ve started strengthening their competency in agricultural commodities recently. Finally, we’ve already assumed a 25% reduction in revenue when calculating the intrinsic value and that would provide some margin of safety from this perspective.

      3. Yes, new and better technology and innovation is a risk, and possibly another important action is to study how capable is FTIL in continuing to innovate and deliver best quality technology to MCX. It’s kind of a marriage between the two firms – they’re made for each other. If something really bad happens to FTIL, it’ll indeed be a big negative black swan event for MCX too.

      Another perspective however, on the third point, based on my understanding of software systems. Considering that FTIL-MCX already have a “state of the art” technology developed and working robustly for a while now, if for some reason, FTIL were to close down some day, MCX has got two options:

      a. They buy the software technology from dying FTIL and keeps a support team to maintain it. Probably, even license this technology to others, but such models are not sustainable, as we’ve seen in the past (Motorola – Freescale being one of them, where a parent was the only customer for a spin-off)

      b. A much better option, and which looks very likely, is that a third party with some exposure in financial software solutions, like Infosys or TCS or alike, buys dying FTIL and gives a new life to the technology. If this occurs, it may cause an increase of software charges for MCX, but since it’s a win-win situation for both FTIL’s debtors / investors as well as the new business like Infosys / TCS, this is a much more likely option, and thereafter, market forces will set the right price for software charges, and competition within software providers will keep a check on exorbitant software charges. Why this is not happening today is probably due to the fact that MCX holds nearly the whole of commodities trading market share, and they’ll never take technology from anyone other than FTIL, and hence no point for Infosys and TCS alike to invest right now in this market. But if FTIL were to die some day (possibly due to huge debts as others mentioned, I’ve not checked this yet myself), this will open up the market for new software players and probably be a balanced if not favorable situation for MCX

      Overall, I agree you’ve raised very valid points, but I think apart from insider selling, other two are medium risks that’re probably covered by our margin of safety 🙂

  6. Jana Vembunarayanan says:

    Thanks Sunny and Vishal.


  7. Thank you for this extensive analysis which is well researched and provides actionable output.
    Regarding insiders selling stock I wont be very worried if such insiders are employees given that stock options are part of compensation and any employee would need some liquidity. Further, however much confident you may be of a business there will be elements (risks) you cannot fathom especially in technology dependent businesses, so it is expected that employees would sell from time to time. But yes any large quantities offloaded can bother investors. However as value investors we should focus mainly on the business.
    Another risk i.e. regulatory risk is such that it can just suddenly stall operations. It hardly occurs in reality but we must be cognizant of the same.

    • Thanks Sudhir, yes I agree it may just be routine liquidation of ESOPs by employees, but looking at the link Vishal shared, I see a huge selling concentration around Feb 2013, i.e. the budget time when CTT was re-introduced. Now this also coincides with MCX stock peaking to Rs 1600 or so, and it’ll be challenging to find what were the true motives of these insider sellers.

      Yes, regulatory risks prevail and are quite high, but then, I think that presence of former FMC senior executives and other leaders from various related industries gives then some level of influence in what FMC eventually decides – but agree, this can turn to be a huge positive or negative catalyst for MCX

  8. Hardik Kalaria says:

    Hi, one thing I wanted to add was the network effect of exchange markets. People prefer to trade in the most liquid markets. And as more people trade in that market, the more liquid it becomes and hence attracts more people to that market. It’s a virtuous cycle much stronger than any other reason for the moat that MCX has. Another eg is why NSE has and will continue to have the most liquid market for the same reason.

    • Agree, this is similar to the media business. More the readers, viewers, users more the advertisers.

    • Sanjeev Bhatia says:

      Dorsey, in his wonderful book, The Little Book That Builds Wealth, has dwelt upon this network effect quite extensively. I wouldnot be worried about competition at this stage since in speculative market (since it is more in nature of cash settlement of contracts rather than physical delivery), people will flock to exchange where Liquidity/Volume is the highest and consequently there is better price discovery mechanism. A case in point is of Equity Futures being launched by BSE. Despite being the oldest exchange, volumes in futures and options segment have not taken off on BSE simply because the bulk of India trades through NSE only (including yours truly 🙂 ).

      • Thanks Hardik, Sudhir and Sanjeev. Indeed this is an important point I overlooked. It’s an interesting learning for me, and gives us a good cushion against rising competition.

  9. Rahul Chauhan says:

    Dear Sunny / Vishal

    I got these links (here and here) on promoters selling stake, hope this is meaningful.

    Seems like they are doing it based on SEBI guidelines.

    Rahul Chauhan

    • Thanks Rahul, yes, quite possible that it was SEBI guideline that led to selling by insiders. But I’m worried about timing, and I’d want to study if the insiders still hold close to upper limit set by SEBI, or they’ve significantly diluted their holdings in MCX

    • The links shared talk abt MCX and FTIL reducing stake in MCX-SX t allign themselves with SEBI guidelines.

      This link does not talk about insiders selling stake in MCX.


  10. Hi Vishal,

    Thanks for the interesting write-up.

    Considering myself a value investor, I am however very uncomfortable having a 30% margin of safety on a price derived from a model in which the company increases its cash flows more than sixfold over the next 13 years and having a discount rate of only 12%, given that the company is highly dependent on the precious metal segment, regulation and one strong supplier. Is it possible that you might have a bias towards understating these risks (regulatory, growth slowing down…) since you live in the country yourself ? Over here in Europe I too use that 12% discount rate sometimes, but for companies with greater transparency, a longer track-record, less political risk, ..

    Looking forward to your next write-ups.

    • Hello Bartvp, indeed, the higher discount rate you assume, the better you gain 🙂 But I think it is still reasonable to set discount rate to what you’d like to earn from the investment in long run – I’ll be happy to earn 12% consistently over my holding period. Anything better will be a bonus. And 30% margin of safety for a good business like this is probably rare in India…not sure about Europe…

  11. Sanjeev Bhatia says:

    Wonderful Analysis Sunny.

    My two cents:-
    1. I believe the fact that MCX will not require any capital infusion even if it grows to more than six times its present size is a big big plus in this high interest rates regime. Ability to scale up without putting up any capex (except perhaps some employee costs, which will be offset by increased revenue) can further lead to much better economy of scale.

    2. I wouldnot be too much worried about the concentration on bullion trade. The trades are mostly of speculative nature (the profit/loss being settled in cash, actual physical deliveries are minuscule). Historically too, people have been trading mostly in Gold, Silver, Crude and to some extent in metals like nickel etc (as hedging mechanism). In any case, whatever the prevailing rates (as Vishal was worried 🙂 ), the number of long positions will ALWAYS equal those short. So the prevailing prices will not have that much effect on volumes.

    3. The network effect, explained elsewhere, is a powerful moat as on date. Even if some competition were to offer other innovative products (like options on commodities), MCX is in perfect position to exploit its position of strength and can offer the same with much better volumes.

    4. Probability of default, in a major way, is not possible since exchanges have a lot of mechanisms to reduce such risks. Explained above.
    5. Management Compensation seems to be on the higher side although it can be attributed to some extent on the complex nature of business.
    6. FT has mjor stake in its own venture versus 26% in MCX. So if it increases cost of the trading platform, FT will gain to a larger extent than loose towards its 26% stake in MCX. However, since there are other vendors too in this arena, chances of a free run remain low. On the other hand, 26% stake of FT will ensure that no other vendor will be able to penetrate MCX, a strong possbility of crony capitalism/vested interests. We have to live with it, unfortunately.

    7. The most risk, as I feel, comes from the market regulations. It has been seen in the past that Govt. has knee-jerk reactions to all the problems. Price of a commodity rises, say Sugar, and govt feels like clamping down on trades in Futures. This can severly effect the volume growth.

    8. Where will incremental increase in volumes come from? As such, I see many people leaving commodities trading (after incurring huge losses 🙂 ). Though it can be argued that a country the size of India will never feel shortage of speculators 🙂 , still I would like to see the company I am invested in grow its volumes and consequently revenues.

    9. Insider selling? Quite possibly the employees sold off the exercised options.

    Bottomline? I would be interested in buying in a major way at higher MoS, say around 700 – 750 or so.

    Happy Investing.

    • Thanks Sanjeev, agree to most of your points. Specifically,

      – On 1) we need to verify this – what if MCX has an obligation to pay software charges to FTIL proportional to volumes, and this leaves operating margin constant? But yes, no major capex needed for many years to come

      – Agree on 2) but got an interesting yet simple point this afternoon – if GOLD prices go down significantly, it’ll reduce future premium and hence commission incomes too, but I believe that the exchange still would earn due to increased volumes…

      – Agree fully on 3) through 7)

      – On 8) I think it’d be next wave in commodity investing – commodity options and opening of this space for banks, mutual funds and insurance companies will bring a new dimension and help grow this industry rapidly. Yes, it’d be a HUGE positive catalyst for MCX, but yes, it’s a big bet too

      – On 9) need to review in detail, most concerning being the timing of large stake sale…

  12. Thanks Team for wonderful feedback. Based on discussions so far, I’m collecting the “open action items” here, and appreciate if we as a “Team” can work to find answers, especially dis-confirming evidence to not invest in this business.

    1. Why have insiders sold, so much, around CTT introduction, around the peak market prices of MCX stock, whether their ESOPs vested, or what it due to SEBI requirements?

    2. Does MCX revenues depend on commodities cycle? If commodities get cheaper across the board, will it reduce transaction amount and hence the commission revenues for MCX? In other words, is MCX business cyclical and has strong dependence on commodity cycles?

    3. Do software charges increase with increasing contracts volume, and if so, will it mean a nearly fixed operating margin for MCX, contrary to what was originally perceived to be a “grow revenue, grow margin” equation?

    4. Is MCX playing with financial numbers and accounting investor margin money as “profit and loss”, as highlighted by Ravi above in a comment? Are there any further financial shenanigans done by MCX in its financial statements?

    4. Study if FTIL is in deep waters, and could something go seriously wrong with it in next 2-3 years, such that the technology for MCX gets at a significant risk and hamper continued operations?

    Please add any other concerns / actions to this thread of comments, and let’s work on answering them quickly 🙂

    • Hello friends, it took my a long time, but have finally written down what I found about those 5/6 questions that came up. As a summary, I think that the risk due to these points is “not high enough” to warrant us from ignoring this otherwise healthy business, and whatever risks these points bring is priced in the ever so much fallen price of MCX stock, which has gone below Rs. 800 in recent days.

      As a caution, however, please note that one must always catch a falling knife slowly, and one should be “well aware” about the knife they’re catching. Hence, please carry your own deep analysis before taking a call on the stock – even if I buy them, the stock may be hazardous to your health and wealth 😉

      1. Why have insiders sold, so much, around CTT introduction, around the peak market prices of MCX stock, whether their ESOPs vested, or what it due to SEBI requirements?

      It is seen that VCs like banks, NSE and promoters were allotted shared at Rs 10 a piece in 2004-2005, and they’ve made huge profits in IPO – this is fair, that any early investor looks for exit route through IPO, since they would not be able to continue to earn superb returns post IPO, but for retail investors, MCX can still earn over 12-15% annually if things don’t go seriously bad.

      Does the same hold true about executives selling their stake post IPO? After analysing the insider selling pattern, we find that:
      a. Major selling happened in Dec-2012 and Feb-2013
      b. CTT was introduced in end of Feb-2013, but possibly there were talks already and hence these insiders sold.
      c. Dec-2012 coincides with all-time high of the stock price
      d. Most of the selling has been done by only two names

      a. Paras Ajmera (non-executive director, FTIL nominee) started selling in Dec-2012 and sold over 90% of his holdings in a span of 4 months! He now holds only about 50000 shares. Further news searches indicate that he has made more money by exiting his ESOPs post IPO

      b. Joseph Massay has sold over 8000 shares, again he sold in Feb – April 2012 also, post IPO.
      I could not find any news where Mr. Paras Ajmera is involved in a wrong doing. It is however surprising that why a non-director is given such a large number of ESOPs.

      In summary, yes, there’s risk that insiders are selling, but it could be true that they’re just liquidating their ESOPs when prices went quite high, during the market bounce back in end of 2013, and they probably knew that CTT was coming (

      2. Does MCX revenue depend on commodities cycle? If commodities get cheaper across the board, will it reduce transaction amount and hence the commission revenues for MCX? In other words, is MCX business cyclical and has strong dependence on commodity cycles?

      To some extent, as the Bull Run in bullion has receded, the volumes have taken a hit. Hence, to some extent, there’s a commodity like nature. However, since there’re many types of commodities traded, and that the company is diversifying into agricultural based commodities, decrease in volumes in one will at least be partly offset by increase in another, and hence, as such, we can say that MCX will not be hugely impacted by commodity cycles. Yes, there’s a moderate risk due to a steep slowdown in worldwide commodities, but again, since Indian commodity market is growing fast, there’s scope of de-growth getting offset again.

      3. Do software charges increase with increasing contracts volume, and if so, will it mean a nearly fixed operating margin for MCX, contrary to what was originally perceived to be a “grow revenue, grow margin” equation?

      It appears that FTIL’s business model is revenue sharing with exchanges it supports technically. This means that our assumption of “near constant software charges” is wrong – and this implies that MCX’s operating margin may not continue to grow with size – though it may remain constant, or grow very slowly as it may still not need to scale employee spending as volumes grow.

      4. Is MCX playing with financial numbers and accounting investor margin money as “profit and loss”, as highlighted by Ravi above in a comment? Are there any further financial shenanigans done by MCX in its financial statements?

      Some of the things from studying notes to financial statements are as follows:
      a. MCX-SX is shown as associate company, and MCX holds 27 million shares at a cost of Rs 1 each
      b. 634 million warrants of MCX-SX, worth Rs. 1284 million. This was one reason of contention between MCX-SX and SEBI, which seems to have been resolved by court decision in favour of MCX-SX.
      c. Found a link that relates to MCX-SX and might have financial bearing indirectly on MCX
      d. We’ve not accounted for the value due to large amount of investments that MCX holds. If they generate any large cash inflow (capital gains), they’ll be a bonus to the investor.
      e. On the point raised by Ravi, trading margin from members is reported as current liability in the tune of Rs. 624 crores, which has increased by about Rs. 80 crores in FY2011-12, and this is properly accounted in cash flow statement. Hence, looking at cash flow, this is eliminated and our valuation would not be impacted, even if EPS is impacted.
      f. I had a further glance at all the notes to financial statements, and did not find anything majorly concerning.
      Overall, MCX financial don’t show any major concerns, and as our valuation is mainly based on ‘free cash flow’, the risk is reduced.

      5. Study if FTIL is in deep waters, and could something go seriously wrong with it in next 2-3 years, such that the technology for MCX gets at a significant risk and hamper continued operations?

      A quick look at FTIL financials tells that it is indeed in deep waters. Let us see if revenues from MCX can help them sustain operations and pay debt interest, such that FTIL can avoid a shutdown:
      • Total long term debt of Rs 590 crores, and a total debt of over Rs 600 crores.
      • Non current investments are reported with a book value of over Rs. 800 crores, apart from fixed assets of Rs. 450 crores. This gives a confidence that a rough liquidation value of firm is not negative (keeping positive value as a cushion for foreign currency volatility, since most of the borrowing is in form of FCCBs). Even if one assumes that most of these non current investments being in subsidiary companies whose worth is ZERO, we have current investments in mutual funds which are not counted, and they’re significant, of the tune of over Rs. 900 crores.
      • Interest cost for the company in FY11-12 was less than Rs. 31 crores.
      • Total operating expense for FTIL was Rs. 265 crores. Compare this to Rs. 77 crores as software charges paid by MCX to FTIL. If in the worst case, FTIL were to depend on MCX to support its operations, MCX will need to spend Rs. 190 crores additionally (this is an unlikely scenario, but let’s pre-mortem the dead FTIL), which will significantly impact operating profits for MCX. On the other hand, if FTIL were to close down, and MCX retain / buy only the part of FTIL needed to support MCX / MCX-SX operations, the operational costs will be lower and it won’t be a major hit…in case FTIL ceases operations, it’d be in interest of promoters of FTIL and MCX to let MCX continue operations as that’s what is the only and big positive in FTIL group
      Overall, I think that while the risk of FTIL closing down and causing a severe impact on MCX is present, it is quite low, and management / promoters of both FTIL and MCX will find in their personal and professional benefit to keep FTIL profitable and afloat (possibly through trimming down loss making ventures)

      6. Why need to launch MCX-SX so desperately? Does MCX and FTIL see risks ahead in further growth of commodities trading, and they want to diversify? Or it is just institutional imperative to go and try to grab share from NSE?

      MCX-SX looks to me an attempt to extend the success of MCX and generate strong revenues for FTIL, which is ailing in all of its other investments. As of June 2013, MCX-SX has commenced operations, and MCX and FTIL own an indirect majority stake through convertible warrants issued to financial institutions

      MCX-SX has commenced operations, and is generating some traction. However, the very network effect which gives a strong competitive advantage to MCX can work against MCX-SX, and hence, I’ll not bank a lot on the success of MCX-SX. On the other hand, it doesn’t impact MCX directly, as it is just an investment in the tune of Rs. 132 crores, which is less than 10% of total investments. However, MCX-SX’s success plays a good role for FTIL’s struggle to sustain. In summary, I don’t think MCX should invest a lot of time and energy in getting MCX-SX grow and focus on MCX core operations.

  13. I had done some back of the envelope calculation for MCX a few months back:

    MCX’s more than half turnover is from precious metals.
    Energy, which should be more is only 20%
    Agri is mere 1%

    So the current measures by govt to curb precious metal import will adversely affect the company.
    6th largest commodities derivatives exchange, largest is 4.5 times bigger, 2nd is 3 times bigger, 3rd is 2.5 times bigger, 4th is 2 times bigger, 5th is 1.1 times bigger

    Banks, MFs and FIIs not allowed to trade on India’s commodity futures so less market- potential for a big gain.

    The company is rightly focused on technology upgrade. Exchanges are nothing but powerful technology hubs providing process and technology for people to trade.

    If the company was so successful, what was the need to enlist it. It means that fin players (who are savvy promoters) wanted an exit. They could have listed for transparency but that is a remote possibility in an immature market like India. FIIs are not allowed to trade so there is no immediate need to show that transparency.
    Also, since the company model is to be a technology hub, there wasn’t much need of funds for growth and expansion.
    It looks that the company is likely to grow slowly, having captured a couple of critical commodities market in India. Though that is a positive, it seems there are less avenues for rapid growth.
    It certainly doesn’t looks great to buy at eps of more than 10, given the sitting duck and attack like cat when attacked kind of business model situation in this case.

    • Understand your conservatism, Saket. Yes, the company would grow slower, and there’re risks due to concentrated revenues. For the VCs like fin companies, returns from holding MCX stake would not be so great, than what they can get by reallocating this capital into high risk, new startups…simply saying, they play into high risk, and have high hurdle rates on their investments.

      For an investor like me, I’ll be content if this stock can deliver 12% annual returns during my holding period, anything better being a bonus, and in my opinion, the risks mentioned are already discounted in price, and after I answer all the questions pending this weekend, and if all remains fine, I’ll start buying slowly, in small quantities now that price has become even more favorable below Rs 800 due to recent fall.

      Bottom line is, expected returns for different investors are different, and their risk appetite is also different accordingly.

  14. Krishna says:


    A really nice analysis.

    1. I personally don’t think IT/ODIN is such a major issue as there are many options available in India.

    2. And given the comment from saket showing that MCX in its nascent stage has already covered most of the market, the competition is non-existent.

    3. Regarding Remuneration to FTIL for their services. This is actually in ratio to the turnover. This is mentioned in the link given by you. Pls read the paragraph below.

    “Q3 FY 12 reveals that the average Daily Turnover of MCX in the Oct-Dec 2011 Qtr was Rs 48627 crs,an increase of 52% over the corresponding period in Q3 FY 11…the highest recorded in a single day was Rs 92910 crs…This is interesting as FTIL gets a royalty based on MCX turnover while MCX itself had the highest at 81.5% of total revenues,Rs 386 crs of Rs 475 crs, as Transaction Fees for the Nine Months at December 31,2011…so higher the turnover,higher the fees !”

    4. In this link given by you, it is mentioned that promoters are asked to reduce their exposure to 5%.

    “The SEBI’s approval is based on MCX’s submissions that backers MCX and Financial Technologies will cut their combined current stake to 5 percent from 70 percent today, including warrants.”

    Now I dont understand this ruling completely. If you make promoters own just 5% of a company, how will they run it? Also why would a court give such a ruling? But it is quite possible that massive selling as mentioned here is due to this factor?

    Given the down trend market is in, a investor might be prudent and wait the price to go above 200MA to start a SIP or wait for a fixed MOS of say 50% – 60% to start nibbling in.

    • Thanks Krishna

      Indeed, looks like I missed reading about software charges, thanks for pointing, will dig deeper and present a summary later today.

      On the reduction of stake to 5%, seems that’s about MCX-SX – a new venture backed by MCX and FTIL, and for some unknown reasons, SEBI doesn’t want MCX and FTIL to hold more than 5% each in MCX-SX…nevertheless, another question that deserves answer is what’s it all about MCX-SX, added to the list

      I’ll post further analysis as a comment later tonight or tomorrow morning

  15. karthik says:


    Thanks for the Excellent Analysis..

    Vishal.. Thanx for the plan on Stock Talk..

    Just 2 Thougts…

    NSE and its lobby…

    How well NSE will allow MCX-SX to perform.. NSE/BSE are basically crushing competition….
    Impact of MCX-SX on MCX balance Sheet…

    Impact of bullion prices and govt’s intervention… Yes we can factor in our prices…
    Volumes on commodity markets… with most of retail investors out in equity/commodity markets .. not sure of the impact…

    • Thanks Karthik, Indeed, we must analyze MCX-SX impact and I’ve added that as 6th question, to be answered by tomorrow positively.

      • Dhanesh says:

        Recently SEBI approved seperate trading platform for Debt instruments . BSE , NSE and MCX-SX established seperate platform for debt trading.
        This is very much a new business for all three exchanges. Also there is huge demand for debt instrument trading. Some reports say the business opportunity in debt trading is 3 times equity trading business

        • Thanks Dhanesh, yes that can be a different perspective to look at MCX-SX – maybe MCX-SX can “win the battle” in debt instrument trading and that can be super beneficial for both MCX and FTIL…

      • Anindya says:

        Thanks for the great analysis.did you post these already somewhere else in website or still working on it?

        • Thanks Anindya, no I’ve posted it here only (though I posted an earlier version on my blog, some time back but then removed it as I planned to post here.

  16. Excellent Analysis ,

    Please find the link from Business Standard on ESOPs given to MCX Employees .

    • Thanks Balaji, indeed a lot of people benefit from ESOPs. I hear how my seniors in Freescale made huge money when the company was taken private in LBO by Blackstone group – they had got ESOPs which were bought at $40 a piece, and people with less than 10 years industry experience, senior engineers made thousands of dollars.

      I don’t think this is a bad thing for an employee to sell and liquidate part of his ESOPs – after all, he at some point in time agreed to get ESOPs instead of cash as his compensation, and he did that because he believed in the company’s growth and thereby growth in his “fortune” 🙂

  17. Narayanan says:

    Good research Sunny. Please refer motilal Oswald research. It has some interesting points regarding software charges increasing and other aspects.

    • Thanks for sharing this, Narayanan, I’ll study and post an incremental review summary tomorrow morning, and hopefully have answers to all 5+1 questions.

  18. superb analysis sir..
    mcx is penetrating big time into agri ,but not sure whether it can compete with other exchanges .
    it has already taken on its pay roll some of the employes from agri dominated exchanges.

  19. Karthikraja says:

    Presently it trades at Rs 721. Hope now the safety of margin is huge. do you want to revisit your Reco or valuation based on the discussion at ” Speak your mind”.
    Kindly assess if necessary. It is really sad that from 1600 level to 720 level? something must be cooking. CARE also fell from 975 to 595.

    • Hi Kathik, I do not know why it is falling, possibly because of CTT imposition, insider selling, general market sentiments etc, but yes, I’ll be more comfortable buying as prices slide given high margin of safety, and the fact that the business fundamentals are strong and in long term, the business should do quite well

  20. Prashant says:

    Hi Sunny,

    Informative article which provokes correct line of thought to analyze MCX.

    Regarding the point ‘”Risk of new entrant”, I don’t think that it will be easy for anyone to start an exchange. There are regulators such as SEBI and FMC which will not allow ‘thousands of exchanges in the country. This means that the no of exchanges will be limited in future and the exchanges with good liquidity will be able to attract dealers/traders interest. On this point i feel that the entry barriers are high from the regulatory framework perspective.

    Besides, the article doesn’t mention anything regarding the high return on equity (ROCE) that MCX can generate. Given the nature of business it will not have any need to dilute its equity in future. This will translate into high ROCE If we couple it with 15% avg CAGR in revenues/profits.

    In nutshell, high ROCE, decent dividend yield, 15% CAGR (conservative), minimum need of Capex, reasonable market price and a very vast customer base. All this should translate into a extremely good investment.


    • Thanks Prashant, agree with you, yes, I initially did not realize the SEBI regulation and network effect which will give a strong barrier to entry protection and hence some durability to business moat of MCX.

      I did talk about ROE / ROIC in financial health section, and showed how it actually has a great return on used capital, and must of it’s book value is not used for business and is into mutual fund / subsidiary shareholding investments.

      Indeed, MCX is a great investment opportunity, barring the concerns about regulation and why such a great degree of insider selling in recent past, and more the share prices fall, the higher our margin of safety becomes.

  21. MCX-Sx beats NSE in currency segment. Since NSE was reliant on Banks for currency trading, ban on bank prop trading has allowed MCX-Sx to beat NSE.

    Volume has been impacted by close to 40 pc after CTT imposition.

    Ambiguity regarding payment of LES of MCX-SX

  22. Rohan Advant says:

    I wanted to understand one thing in MCX. Can you analyze/ break-down the costs into Fixed and Variable. The point is that with 40% drop in volume post implementation of CTT, what could be the likely drop in profits. I suspect it would be much more than 40%, given operating leverage would play adversely. Are the software support charges fixed or variable? So, what could be the PAT for MCX if the average daily volume is more like INR 30,000 crs (as shown in the last month post CTT implementation).

    • Hello Rohan, yes tha’s a good concern. As we found during discussions in comments section, we found that software charges are proportional to commodity trading volume, as this is the business model of FTIL Of course, it may not be linear and may have some discrete levels in which software charges increase. Yes, there’ll be some operating leverage due to employees cost, but that’s a smaller portion.

      Finally, MCX is cognizant that they can’t just rely on precious metals and are trying to expand in agricultural commodities also, so there won’t be a direct 40% reduction in volumes, and hence I believe analysis above should hold fairly OK.

  23. I analyzed the Q1 FY2013-14 results as well as monthly contract data and find the following

    – About 40% reduction in contract volumes from June to July, showing the impact of CTT imposition is quite severe. However, just one month of data will be too pessimistic to extrapolate. In my opinion this is a knee jerk reaction and things should stabilize to better values in months to come. Of course, not to mention that stock price is fallen further and discounting the large reduction in volumes, and if some regulatory improvements occur on CTT front, it’d be a huge positive black swan event.

    – Increase in operating costs relative to revenue which is nearly flat. We need to wait for annual report for FY2012-13 for details on why there’s an increase.

    Yes, it is time of patience and important to slowly catch the falling knife. It might take a while before MCX will resume growth trajectory and one should invest only if he has conviction to hold the stock for many years before it reaps rewards.

    Happy Investing 🙂

  24. Hi Vishal,

    Please comment on the current MCX FT crisis.


    • Hi Sujit, thanks for asking this question. I’ve just looked into the “exposure of MCX and FTIL” to NSEL (NSEL is a wholy owned subsidary of FTIL, and FTIL has 24% stake in MCX, but MCX doesn’t have any direct exposure to NSEL, and BTW, we chose NSEL due to the recent news of trading halt due to regulations at NSEL, refer the following news items for details: )

      Disregarding what management says, I looked at the amount of revenue FTIL generated from NSEL in FY2011-12, and it is less than 2-4% of their total operating revenue. Further, related party transactions indicate no major loans provided (in fact, NSEL returned the prior loan to FTIL during the fiscal).

      What remains to be seen is, even though management clarified the situation, that if NSEL were to compensate for the losses of investors due to regulatory pressure, can it close down NSEL, which in turn can put liability on FTIL and force FTIL to go into deep financial trouble such that it can no longer operate, which in turn can be a huge concern to MCX’s continuing operations.

      I searched on internet since i don’t understand spot exchange operations, but it appears that NSEL has sufficient backup / insurance to cover for mismatch in liquidity, since rollovers did not success and the demand for funds is more than the settled payments for contracts (the biggest risk for any exchange, as we also mentioned for MCX during the analysis, and found that there’re sufficient security measures and deposits to avoid a solvency issue). Refer to the following links:

      Eventually, since it was an illegal form of forwards contract and FMC has indicated to take action against NSEL, in the worst case, NSEL’s license may be cancelled and they’ll have to shut down shop. However, I don’t think NSEL is a major revenue generator for FTIL to force FTIL’s and hence MCX’s operations to get impacted.

      Finally, I think the market has over-reacted to the news and it’s an opportunity to buy MCX share at an even better price (only for brave hearted who would have bought Satyam Computers when it crashed over 80% when Mr. Raju spoke about his mis-deeds in public). However, as we’ve seen in the past, such news driven stock crashes can last for a prolonged time, and since the stocks of MCX and FTIL have been falling for quite some time now, we should be very cautious and patient in many any investments, and even if you do, it should be slow and staggered. Note that this is solely my personal opinion and in no way an advise to invest in MCX stock, as well as the fact that every person has his own risk appetite, viewpoint about a business future prospects and the risk capacity, so please perform your own analysis of the business and the prevailing situations before getting carried away and taking any investment calls.

  25. Ashwini Damani says:

    Can we make a list of reviews done at Safal Niveshak and their performance.
    For eg. MCX is down almost 40% from Safal Niveshak’s reccomended price after 30% Margin of Safety.
    Opto Circuit is also well known
    TCS is up 20% after Safal Niveshak recommended not to buy it.
    We should be honest and do a course correction

    This can be done for all future reccos too

    • Hi Ashwini, you have already reviewed the performance! 🙂

      Anyways, I would just reiterate here that stocks reviewed on Safal Niveshak are not recommendations, and the entire effort is just as a way to explain how a particular business runs etc. So please don’t anchor your review on the IV calculations.

      As far as business analyses are concerned, we are already on the right course I believe. 🙂

    • Hi Ashwini,

      You are right about the performance of Safal Niveshak but as Vishal Pointed it out, its a educational blog not Stock recommendations website.

      Aur rahi Interinsic Values (IV) ki baat , yha jo bhi analysis kar rhe hai they are going in deep and are Very Good but are forgetting one thing which is the top most priority of any investment… ‘ U need to learn dhandha of markets to be a Value investor which needs lots of market experience FIRST HAND’
      as in words of Value Gurus ” Investment is best when it is run Business like & Business are best when it is run Investment like 🙂 .

      Safal Niveshak is a good start point to protect your capital but to Create Wealth you need solid experience or a Fund Manager.

      By reading couple of books on Value investing or Listening to publicity of Warren Buffet only gives illusions of becoming smart.

      Finance is long journey and Value investment is a vehicle and it needs lot of reading as well as competence to understand businesses.

      Regarding execution part a person needs the personality of Valuer which comes by you Habits. ” Insaan apni values se satisfied hota hai… Paisa to sirf mode of satifaction hai ”

      PS : Vishal , I love your initiative and they way you are handling the subject of imparting to public . Total Blue ocean is what you are tapping here, would love to meet you sometime 🙂

      • Hello Jasmeet

        I think you’ve summarized it very well, but just few points that I’d like to clarify:

        1. If you read an analysis and believe in it, perform your own “verification” and then decide to take an investment call (say people bought MCX around Rs. 800 when this post came in), are they doing it with a time horizon of few weeks? If so, I’m sorry but it is the single biggest mistake to do so – the foremost principle of value investing is to NOT put in money that you’d need in next 5 years – at least I follow this, and hope everyone would agree to it in good spirits on this forum

        2. As Mr. Munger said, don’t go where you may die – we still don’t know what would happen to FTIL and group post this disaster at NSEL, but if the group were to collapse and go bankrupt (I’ll talk about it in next comment), I think it was a mistake on our part to have “not known” enough about Financial technology group and its problems. I don’t think the stocks have crashed because of any of the points discussed so far on this forum, related to MCX – yes, I identified defaults by clients as a risk in the post, but whether all of the liabilities due to “naked” contracts as is being discussed today will come true or not is still to be seen.

        Value Investors lose, and often do so in their stocks due to what they don’t know – we took risk of investing even when directors of company were buying, I still don’t know if it was a mistake and I’m performing a “post-mortem” (probably I didn’t do enough pre-mortem in this case), but I think we should learn from this example and avoid such mistakes in the future.

  26. Nitin Sharma says:

    I think just putting the disclaimer is not doing the trick and we need to do some course correction as a team. I seriously think that we should not price targets and when we put a IV calculation it should be dynamic(with forms/latest results based) and conservative. Reading an year old post on BHEL would always confuse the readers.

    Opto Circuits, Engineers India and now MCX, they have some thing in common wrong Promoters/Governance. No number crunching can predict these and Markets always pays premium to Good Managements be it TCS, Titan or Hawkins.

    Said that, readers should not hold anyone else for their decisions. Who held them for doing the dirty(hard) work themselves.

    • Very well said, Nitin. Indeed management quality is something for which we need much more checks and we should be even more conservative about them.

  27. Nitin Sharma says:

    A bit of personal experience, I entered MCX @780 and exited @700 (later in went up till 740). My wife(who is a true long term investor) was baffled and wondered why did I entered in the first place when you were not sure that this is a long term bet. My answer was that though i still see it as long term stock but at this time it is falling for reasons not known to me so let me watch from the sidelines till I get more clarity.

    Lots of people (including me) are thinking it has already fallen 75%(from Jan 2013 high) how much can it fall more. A bit of Gyan from Sanjay Sir.

    My personal feeling is that most of the risk is already priced in
    – Operationally MCX should do more than 200 Cr (Q1-60, Q2-54, Q3-49, Q4-45) this year after assuming the 10% de-growth QoQ. This is very conservative in my opinion.
    – Stock trades currently at around 2000Cr so current valuation should are fine for a business like MCX

    The biggest risk that I see is that public(8%) and promoters(26%) combined holding is 34% and more than 65% is held by Banks, DII, FIIs, Corporates. Most of them(especially FIIs) would like to dump the stock at any rise. So definitely time is not correct for bottom-fishing.

    Still, I see this as an opportunity (unless someone thinks that MCX would shut shop) and buy in phased manner.

    Sorry if I have confused you more than providing clarity. But that’s investing, one has to take their own calls (indecision are worse than bad decisions). Happy Investing.

    • Hi , Whatever happens will NSEL , will happen , but i will never buy MCX or FT because of only one reason ‘Management Quality ‘ ,” Once a thief ,always a thief ” , When prices of company like BHEL or TATA STEEL goes down , its a different case and it can be a good bargain , they are down not because of fraud or anyting , its just the sector specifil problems but when MCX ,FT , GITANJALI GEMS , OPTO CIRCUITS goes down ..its a different case , these company goes down because of greedy promotors , when i read about the scams and frauds these compnies made , it made me sick , i cant believe that NSEL still used to do badla type of trading . So my point is please dont say MCX is a bargain just by looking at numbers , the people who can commit 6000 crore scam , can falsify any numbers too .

  28. I think we have overlooked the power of domino effect in this analysis.

  29. Hi,

    Quick Questions on MCX financial statements:
    1) The dividend outflow for FY13 and and FY12 is the same (24Rs per share). However, the treatment of this line item of dividend is different in the cash flow statement (Financing Activities)?
    2)Why there is a sudden drop in cash flow from operating activities.



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