NSE Limited

[Unlisted price INR 1650; Implied valuation $11.3bn]

ABOUT
NSE is India’s dominant exchange platform, with leadership across most asset-classes. Within
equities (highest exchange-traded product), NSE commands a monopolistic position with 94%
market-share in cash & 100% market-share in equity-derivatives. Despite its late entry, NSE
garnered dominant market-share in cash-equities as it broke the region-wise trading barrier,
adopted a superior tech-platform (electronic-trading), which allowed for better pricing & for
investors to hold stocks electronically. Globally, NSE ranks among the top 10 exchanges in various
business segments.

NSE has a strong competitive moat, emanating from:

a) Sticky liquidity: Globally, once volumes gravitate to an exchange, very rarely do they migrate to a
different platform. Thus, liquidity creates ‘brand value’ for an exchange, creating strong natural
dominance and thus acts as an effective barrier to competition. With liquidity nearly impossible
to poach, NSE is a difficult-to-replicate business
b) Pricing power & annuity business : Owing to its oligopolistic nature, NSE commands very high
pricing power. Even during bear-markets or volatile-periods, it captures both sides of the
trade, protecting revenue from sharp decline. A large portion of its revenues are also annuity-
based, giving stability even during uncertain times

KEY GROWTH DRIVERS

a) Equity penetration
There exists significant potential for a shift in household savings to the capital market, benefiting
exchange turnover. Historically, a majority (~65%) of household savings were invested in physical
assets, with share of financial assets (~35%) being much lower than other countries. Even within
financial savings, bank-deposits have constituted a major share, while the share of equity-savings
stands at a very low ~5% (number of bank accounts in India is ~50x the number of demat accounts).

As India goes through the trend of increase in share of financial savings, and increase in the share of
equities within financial savings, exchange turnover can increase substantially. From a very low 5%
penetration of equities, there is potential for exchange equity-volumes to increase atleast 3-4x
from current levels. With NSE commanding dominant market-share in equity-trading, it is expected
to benefit significantly from this trend.

b) Triggers for equity turnover

There are a few other drivers that can drive secular growth in market-turnover:

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 - Indian exchanges have a low turnover velocity (capital market turnover/market cap) of ~0.6x
against significantly higher velocity of other markets such as China (~4x) and the US (~1.4x).
As Indian markets mature, turnover velocity can improve from the current low levels
- Government has proposed raising minimum public shareholding of listed companies from
25% to 35%, which is awaiting SEBI approval. An increase in the market free-float is a key
driver of cash-equities volume: as more companies increase float, velocity improves, driving
market turnover
- India’s market-cap to GDP is lower than world-averages, implying fewer corporates being
listed. As India witnesses more listings, market-cap will improve & benefit exchange
turnover. In the near-term, this could be driven by several large listings viz. LIC’s IPO, or
IPOs of several-large tech-firms (while there is worry of the tech-firms listing overseas, SEBI
is considering allowing dual-listings and will come out with a discussion paper soon)

c) NSE-SGX settlement at GIFT

NSE currently has a licensing agreement with SGX for trading NIFTY-backed equity-derivatives. With
the new structure proposed between NSE & SGX (NSE IFSC-SGX connect), Nifty contracts will be
traded on NSE’s platform at platform at GIFT City, with SGX members being able to access these
products. This will change a fixed-fee business for NSE to a revenue-sharing business (is expected to
commence from mid-FY22).

The value of NIFTY contracts that get traded on NSE & SGX is nearly equivalent (~$550-600bn a year
or ~25mn contracts annually yielding $0.8/contract, amounting to $40mn annual revenue). While
NSE currently makes $2mn (INR 15 cr) royalty on this, even if ~75% of the volume moves, NSE’s
annual revenue from this could be >INR 200cr (4-5% of FY21e revenue), and this should possibly
increase further over time.

d) Transactions: Other products

In India, products such as fx, commodity, interest-rates etc. tend to be largely OTC-traded, with <5%
of volumes transacted through exchanges, and consequently, the contribution of these products to
NSE’s revenue remains insignificant.

However, with measures aimed at deepening of bond markets, introduction of more forex-pairs
(apart from USDINR), standardized interest-rate & commodity contracts, there is potential for
exchange-traded volumes of these asset classes to increase. A lot of these products can become
meaningful as NSE’s international exchange in GIFT City (which will have a tax-free status) gains
more prominence and attracts more international participation.

e) Non-exchange business
For NSE, the contribution of non-exchange business has been lower at only ~10% of revenue
compared to 40-50% for some global exchanges like LSE. Over the next 5-6 years, NSE aims to
increase this to ~20% of revenues (it has an acquisition-led strategy to drive this). On a higher base
of transaction-revenue, this will imply a 3-4x growth in non-exchange businesses over the next 4-5
years.

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 - A growing ETF market in India can boost revenue for NSE’s Indices business. ETFs in India
have grown from 100k crores in 2018 to ~260k crores now, and can continue growing faster
as penetration of passive-investing increases. NSE Indices has ~77% market-share in the ETF
market and growth in ETFs can be a large contributor to growth of non-exchange business.
While NSE currently only charges on transactions (INR 200-400 for every 1cr of ETF
turnover), there is potential to start charging as a % of AUM (say 0.01 or 0.02% of AUM, i.e.
20-25 cr as of current AUM)
- Data business is only ~2% of group revenue (LSE at 30-35%) since NSE has been able to
provide largely India-specific plain-vanilla data (broad-data with limited analytics) for use by
B2B platform like Reuters, Bloomberg, etc. However, a focus going ahead will be to have a
B2C-offering through its recent acquisition Cogencis (acquired for 140cr in Jan’21), which has
distributed market-data/news terminals to market-participants

FINANCIALS
a) Revenue
Over FY15-20, revenue has grown at 15% CAGR, as this period witnessed high volume growth in
equity-options (27% CAGR). While the higher volatility resulted in 9M21 revenue growth at 49% YoY,
NSE’s secular revenue growth could continue to be at 15-16% annually.

b) Margins
NSE operates in a largely fixed-costs environment with staff + IT costs comprising 50-55% of costs.
Given the need to keep systems updated to handle growing volumes, IT costs have been growing at
13-14% CAGR over the last 5-6 years. However, despite the higher costs, NSE has structurally high-
margins of 65-70% & is amongst the most-profitable exchanges globally owing to lower operating-
costs (NSE’s profitability is lower than only HKEX, and ASX).

Analysis of NSE’s margins reveals that EBITDA margin increases (by ~500bps) in years with high-
volume growth (FY15, FY18, FY21), but normalizes to ~65% soon after. While something similar
might play out in FY22 (9M21 margin is +800bps to 73%), there is potential to expand margins as
volumes scale-up with operating leverage kicking-in, and increase in share of non-exchange
business.

NSE Turnover (INR bn) 2012 2013 2014 2015 2016 2017 2018 2019 2020 9M20 9M21

Cash Markets 28,109 27,083 28,085 43,297 42,370 50,559 72,348 79,490 89,988 63,905 109,221
Growth YoY (%) -21% -4% 4% 54% -2% 19% 43% 10% 13% 71%

Equity Futures 76,527 67,510 80,324 123,990 123,857 154,655 204,080 217,159 216,206
Growth YoY (%) -22% -12% 19% 54% 0% 25% 32% 6% 0% 22%

Equity Options 236,971 247,820 301,768 432,052 524,401 789,048 1,445,769 2,158,848 3,237,707
Growth YoY (%) 22% 5% 22% 43% 21% 50% 83% 49% 50% 61%

EBITDA Margin (%) 67.6% 61.8% 62.8% 67.2% 67.2% 63.6% 68.1% 64.6% 64.6% 65.4% 73.3%

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c) Cash balance & dividends
Liquidity 2016 2017 2018 2019 2020
a) Non-current investments 35,877 40,757 44,179 43,293 33,508
b) Current investments 32,336 28,681 28,739 - -
c) Cash and Bank 45,072 102,651 85,478 125,423 173,286
d) Cash & cash equivalents (a+b+c) 113,285 172,089 158,396 168,716 206,794

e) Settlement Obligation Payable 18,652 42,104 42,602 34,898 23,468

f) Margins from Members 8,635 32,962 12,868 25,868 63,560
g) Deposits from trading members 10,298 10,342 10,265 10,076 10,052
h) Security Deposit from Clearning Members 2,875 3,247 3,237 3,217 3,353
i) Deposits from clearing banks 2,236 2,931 3,771 3,941 4,260
j) Core SGF 9,659 19,755 24,336 30,576 34,267
k) Restricted cash (e+f+g+h+i+j) 52,355 111,341 97,080 108,576 138,960

l) Own cash (d-k) 60,930 60,748 61,316 60,140 67,834

m) Float cash (k-j) 42,696 91,586 72,743 78,000 104,693

As of FY20, while NSE’s cash balance is ~20k crores as of FY20, nearly 14k crores comprises
balances not belonging to NSE. Its interest income comprises: a) float-income on the 3 rd party
balances it holds (10.4k crores as of FY20) which comprises ~8% of operating income, and b) Interest
income on its own cash balance (part of other income, yields ~5.5-6%).

Despite its own cash balance being ~6.7k crores, ~5k crores of this is held in an escrow (in relation
to the colocation case) & is not free for use by NSE. Thus, NSE’s free cash holding as of FY20 is only
~1.7k crores. While dividend payout now is ~50-55% of PAT, there is potential for significant
increase in dividends as and when the colocation escrow money gets released (as of today, it could
result in release of atleast ~3800cr i.e. ~INR 75/share).

Despite higher margins, NSE’s RoE at 20-21% is lower than for SGX/HKEX (36%/24%), primarily
driven by low dividend payout (compared to 80% payout for these peers). A resolution of the
colocation escrow can also help boost RoEs significantly.

REGULATORY CASES
NSE primarily has 3 pending cases: co-location case, dark-fibre case, and another governance-related
case about data-sharing with outside agencies.

a) Co-location case
This matter is with the Securities Appellate Tribunal (SAT), which has concluded hearings in Mar’20 &
is awaiting the final order which is expected anytime soon. However, the matter will likely be
appealed at the Supreme Court regardless of the outcome. As per the order, NSE has already
deposited INR 627cr of penalty (already paid by NSE) & SEBI has claimed another 500cr as interest,
thus capping NSE’s exposure at ~1250cr. Since there has been no evidence of wrongdoing, it is very
likely that the penalty, if any, will itself be much lower. NSE continues to deposit all revenue from
colocation to an escrow a/c, which is 1500-1800cr annually, totalling ~5200cr balance currently.

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Given its liability may be limited to 1250cr, it is pursuing the discontinuance of depositing monies
into the escrow, and also refund of the surplus amount. NSE is in discussions with SEBI about de-
linking the IPO from the judicial progress on this case, which may happen once the SAT order comes
through over the next few months.

b) Other cases
NSE has already paid a fine of 68cr relating to the dark-fibre case, but hearing on this case and the 3 rd
case hasn’t yet started (there is no financial liability on the 3 rd case). NSE expects hearings on these 2
orders to heard faster, and in any case, there is no profitability impact from these cases.

KEY RISKS
 Colocation case: As discussed, SAT order on the colocation case is expected soon. While
NSE’s financial liability is likely to be limited to 1250cr, the case could witness appeal at the
Supreme Court, resulting in the matter getting protracted for long
 Technology disruption: The biggest threat facing exchanges is technology disruption, which
can lead in the entire liquidity moving within a short span of time. While still far away,
blockchain technology has potential to disrupt traditional exchanges

VALUATION & VIEWS

We like NSE because of the oligopolistic industry structure, competitive moats making it a difficult-
to-replicate business, with a significant medium-term growth potential, and fixed-cost structure
implying high operating leverage potential (when volumes scale up). Key growth drivers will be:

a) Commencement of SGX connect from FY22 can provide a 4-5% revenue boost & and will be
an important revenue driver for the medium-term
b) An increase in market-velocity, higher free-float, and dual-listing supported growth in new
IPOs can result in strong medium-term growth in market-turnover
c) NSE’s target of scaling up non-exchange business to 20% of total in the next 5 years implies
this could grow at ~30% CAGR (possibly through organic + inorganic growth)

At the price of 1650, the shares are available at 27x FY22e P/E, which is in-line with global exchanges
despite NSE’s higher growth potential.

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Annexure 1: NSE Key Financials & comps

NSE Key financials (INR mn) 2014 2015 2016 2017 2018 2019 2020 2021e 2022e 2023e 2024e 2025e
Revenue 13,618 17,231 18,635 21,043 26,091 30,278 35,079 49,650 57,149 65,878 76,041 87,879
Growth % 6% 27% 8% 13% 24% 16% 16% 42% 15% 15% 15% 16%

EBITDA 8,557 11,579 12,516 13,386 17,769 19,547 22,660 36,245 38,861 45,456 53,229 61,515
Growth % 7.9% 35.3% 8.1% 7.0% 32.7% 10.0% 15.9% 60.0% 7.2% 17.0% 17.1% 15.6%
Margin % 62.8% 67.2% 67.2% 63.6% 68.1% 64.6% 64.6% 73.0% 68.0% 69.0% 70.0% 70.0%

PAT 8,358 10,676 6,308 12,188 14,615 15,383 19,469 26,170 30,206 35,206 41,111 47,435
Growth % -2% 28% -41% 93% 20% 5% 27% 34% 15% 17% 17% 15%
Margin % 61% 62% 34% 58% 56% 51% 55% 53% 53% 53% 54% 54%
EPS 16.9 21.6 12.7 24.6 29.5 31.1 39.3 52.9 61.0 71.1 83.1 95.8

Cash Flows
CFO - - 19,792 61,786 (3,732) 20,796 40,519 38,582 35,688 41,377 48,100 55,396
FCF - - 18,459 60,326 (5,351) 18,776 37,628 30,582 32,688 38,377 45,100 52,396
Dividend/share 6.2 7.2 6.6 12.3 7.8 17.3 20.8 29.1 33.6 39.1 45.7 52.7
Dividend payout 37% 34% 52% 50% 26% 56% 53% 55% 55% 55% 55% 55%

RoE 17% 16% 23% 20% 20% 23% 23% 29% 30% 31% 31% 32%

P/E 31.2x 27.0x

P/B 8.8x 7.6x

M.Cap ($ P/E P/B RoE

Company
bn) FY21 FY22 FY21 FY22 FY21 FY22
BSE Limited 0.4 16.7 14.8 1.0 1.0 6% 7%
MCX Limited 1.1 34.8 31.3 5.8 5.5 17% 17%
CME Group Inc 72.7 30.5 27.9 2.7 2.7 9% 10%
Intercontinental Exchange 62.5 22.5 21.0 3.0 2.8 14% 13%
Hong Kong Exchange 75.3 39.4 34.4 11.2 10.5 30% 32%
Deutsche Boerse AG 29.8 20.9 19.0 3.6 3.3 18% 18%
London Stock Exchange* 57.5 25.4 22.5 2.0 1.9 13% 11%
Japan Exchange Group 12.5 27.9 26.0 15% 15%
ASX Limited 10.5 28.5 28.1 4.2 4.1 13% 13%
Singapore Exchange 7.9 23.3 22.6 7.8 7.2 35% 33%
NSE Limited 11.3 27.0 23.2 7.6 6.7 30% 31%