TSX FACING ‘ PERFECT STORM.’
CANADA’S FLAGSHIP EXCHANGE FACES UNPRECEDENTED HEADWINDS
As many as 38 of the 240 companies listed on the S&P/ TSX composite index — the preeminent benchmark tracking the performance of Canada’s largest companies — were trading below $5 this week.
In other words, up to 15.8 per cent of this country’s dominant index, an import- ant symbol of the nation’s economic might, would be considered a penny stock on most major U. S. exchanges, according to rules set by the U.S. Securities and Exchange Commission.
Depressed values for commodities and the collapse in oil prices to 12- year lows have severely crimped the performance of the S&P/TSX composite and decimated the S& P/ TSX Venture composite index, which in mid-January sank to its lowest level ever.
Given its unfettered dom- i nant position at home, this is uncharted territory for TMX Group Inc., which owns and operates the Toronto Stock Exchange and the Venture and Alpha stock exchanges. Even before it became a for-profit company in 2000, its relevance and lon- gevity have never been seriously questioned or tested.
But ever since a consortium of 13 major Canadian financial institutions comprising the Maple Group Acquisition Corp. c ompleted the $ 3.8- billion purchase of TMX Group in September 2012, the country’s major exchange operator appears to have been a national institution in search of a strategy.
“The TMX finds itself in a perfect storm where commodity markets have collapsed and volumes have dried up on most exchanges,” said Ian Russell, chief executive of the Investment Industry Association of Canada. “It’s not so much an identity crisis as much as it may be a struggle for survival.”
TMX Group’s i dentity was forged in the aftermath of a failed proposed merger with the London Stock Exchange. After the merger was defeated in 2011 by Maple Group, sending the pesky foreigners packing with about $38 million in breakup fees, a made-in- Canada solution predictably ensued.
Essentially, its formula prescribed a continued focus on resource listings, with a few major blue- chip financials, such as the banks, telecommunications and transportation giants mixed in for balance — a formula some still believe in.
“We have a world-class exchange in this country,” said Richard Nesbitt, chief executive at the Global Risk Institute for Financial Services and former chief executive of TSX Group Inc., who was among those leading the campaign against selling out to the LSE.
Even now, almost eight years removed from the TSX, he maintains that the exchange, despite its challenges, is “the class of the field among the eight or 10 smaller exchanges in terms of servicing its customers, and in some industries, like mining and SME finance, it is world beating.”
“World beating,” however, is not how global investors would characterize any of the Canadian exchanges, which have l agged other exchanges since the 2008 financial crisis. As a result, inevitable questions about t he relevance of the Toronto Stock Exchange and its sidekick junior-- listing venue are now burbling.
“If the TSE went dark for a week, would it really matter?” asks a former Canadian regulator who spoke on the condition of anonymity. “In the past 10 years, the world has been populated with hundreds of smaller exchanges. It’s hard to say, but my sense is (the Toronto exchange) just isn’t as vital as it once was.”
That lack of vitality is reflected in TMX Group’s numbers. The company posted a $ 159- million loss in the fourth quarter of 2015, or $ 2.92 loss per share, according to results released Feb. 11. Meanwhile, its shares reached their nadir at the end of 2015, but have modestly started to rebound from last year’s 30-per-cent drop.
It’s also reflected in the lack of activity on its markets. Total financings on the Toronto Stock Exchange fell 33 per cent in January compared with the same month a year ago, while cash equity volumes declined 22 per cent.
The Venture Exchange, meanwhile, has fared much worse. Total financings plunged a whopping 74 per cent last month from the same period in 2015.
Overall, TMX Group’s revenue declined three per cent in the fourth quarter — with the only bright spot being market data sales, a big part of the company’s strategy going forward, which climbed nine per cent.
Accustomed to its insular view, competitive pressures are finally pushing the Canadian exchange operator out of its comfort zone.
For one, major exchanges such as the New York Stock Exchange, Nasdaq and the Tokyo Stock Exchange have already consolidated other smaller exchanges to create more heft to attract more listings. Many of Canada’s biggest companies are also interlisted on U. S. exchanges.
TMX Group is not in those big leagues now — and probably never was. “We claim to be a global financial centre, ( but) we’re really not. We’re more a parochial financial centre,” said the former regulator.
The Canadian exchange operator must also now compete with hundreds of smaller exchanges, such as dark pools, as well as local and regional exchanges rising in emerging markets that offer higher governance standards and other niche opportunities that attract investors.
Even in its own backyard, TMX Group’s dominance, which includes about 70 per cent of the country’s equity trading volume, is being challenged.
U. S. giant Nasdaq Inc., with former TMX chief executive Thomas Kloet now on its board of directors, has already arrived on TMX Group’s home turf through the purchase of Chi-X Canada, an alternative trading system that competes directly with the TSX Venture for small companies.
It is worth noting that Nasdaq’s main U.S. exchange is home to four of the biggest technology companies in the world — Apple Inc., Alphabet Inc., Microsoft Corp. and Facebook Inc. — which together have a market value of close to US$ 2 trillion, dwarfing Canada’s entire US$ 1.6trillion equity market.
At the same time, Aequitas Innovations Inc.’s Neo Exchange is challenging on the Canadian data front. The upstart filed a complaint with the federal Competition Bureau alleging TMX Group is using anti- competitive practices and its dominant market position to control pricing on data.
To be sure, TMX Group has been slow to respond to the challenges. The stocks of its global exchange peers — London Stock Exchange Group, Deutsche Borse AG and Spain’s Bolsas y Mercados Espanoles — all currently trade at a higher multiple, as much as 15 times earnings, than TMX Group.
But belatedly, if not reluctantly, the Canadian exchange operator has realized that it must navigate this new world of competition for investor interest in its listed companies, as well as for new listings.
“The TMX today is not the TMX of a year ago and the TMX next year will not be the same as the one today because the markets and our clients are changing,” said Lou Eccleston, the company’s American chief executive, who is leading the overhaul. “But at least we go into 2016 ready for the change, whereas last year, I couldn’t have said that.”
Eccleston, a former executive at Standard & Poor’s, Thomson Financial Corp. and Bloomberg LP, was hired in November 2014 to reverse the red tide. His major initiative has been to launch an unprecedented and sweeping overhaul dubbed “The Pillars for our Growth.”
Unveiled in late 2015, it is a blueprint that outlines how the exchange operator intends to shed the yoke of the old Maple Group model as an infrastructure provider and transform itself into a provider of client services, while investing in new products, such as data mining and analytics.
According to the plan, the future TMX Group will focus on commercializing its services, winning back some of its lost equity-trading market share, shedding non-core assets and, most notably, expanding the TSX Venture beyond its traditional focus on resources and into technology.
Even so, the TMX does not intend to shun its bread and butter. “The resource franchise in Canada is critical,” Eccleston said. “Technology is as important for the future as resources have been and continue to be for Canada and we have to do both going forward.”
Industry analysts are skeptical Eccleston can deliver on that ambitious blueprint.
“Finding the right direction in a choppy market is hard to do,” said Paul Holden, an analyst at Canadian Imperial Bank of Commerce, in a Feb. 15 note to clients. “We are not so clear about execution toward creating a digital company, a more efficient company and a more client-centric company.”
The analyst, who maintains a $ 50 price target on TMX Group shares, wants to see more specifics on things such as revenue diversification, as well as new revenue opportunities and growth prospects. Until then, “we don’t have enough confidence around new initiatives to recommend jumping into the stock today,” he said.
Others on Bay Street echo that sentiment. Shubha Khan at National Bank Financial on Feb. 15 reaffirmed his “constrained” outlook on TMX Group’s future prospects and his $40 target.
Khan said in a note that TMX Group’s current large valuation discount to its global peers “is unlikely to narrow” because of the collapse and continued weakness in the resource sector, the entry of Nasdaq into the Canadian marketplace and the added costs of the realignment. “We believe a narrowing of this discount appears rather unlikely in the near term.”
In the end, Eccleston may not have much wiggle room to build a strategic plan that is both compatible with a Canadian marketplace that relies on the commodities and energy sectors, and quickly delivers a profitable future in technology and data.
“In the short run, there isn’t a magic bullet to fix the TMX Group’s problem,” said the IIAC’s Russell. “He is proposing a long-term strategy that is going to take a long time to bear fruit. There’s no easy way out and shareholders will be stuck with it.”