Exchange business models are almost universal, and a relatively high proportion of exchange costs are IT-related.

By Jakob Håkanson Vice President, Head of Investor Relations, OMX

Changing market structures and technological demands are driving exchanges globally to become publicly listed companies. More than 15 exchanges in Europe, Asia-Pacific and the US have recently gone down this road, with the venerable NYSE being one of the latest exchanges to list on its own market. Today, there is a global sector of listed exchanges that is attracting investors like magnets.

During the past 12 months, the average share price of exchanges worldwide has more than doubled. And, looking at valuation multiples, using a price/earnings ratio, North American exchanges are valued at 27 times expected 2007 earnings while the comparable ratio for European exchanges is 19. These multiples are substantially higher than the stock market on average.

Exchanges’ business models in combination with strong growth prospects are supporting these high valuations. Over the next few years, analysts expect securities trading volumes to continue to grow at a rapid pace. This growth is considered partly cyclical but, to a large degree, also structural and, thus, independent of the general economic climate. And since most exchange costs are fixed, a lot of that top line growth can be converted into cash and bottom line profit. Assuming an exchange has a flexible trading model and platform, the direct marginal costs of additional trades being executed on that exchange can be virtually zero. In addition, there have been several mergers and takeover attempts among exchanges over the past couple of years, and many investors expect this consolidation trend to continue. Exchange business models are quite universal, and a relatively high proportion of an exchange’s cost base is IT related.

With the demanding valuations of the dotcom boom and bust still fresh on investors’ minds, some may question whether exchange share prices will continue to rise over the long haul. Admittedly, a recession or cyclical downturn could have a significant negative impact on these companies, with their high operational leverage.

But for now the economy remains strong in North America and most parts of Europe even though, at the time of this writing, the bears seem to be ending their hibernation. It is also evident that financial market growth is now being driven by structural market shifts, such as cross border investing, automated trading and increasingly active hedge funds. In addition, the consolidation play still has a long course to run in the exchange sector.

As long as these fundamentals exist, there is probably scope for valuation multiples to be kept at high levels and for exchange share prices to trend even higher on the back of their rising profits and steady cash flows.

MarketView 2006:2