By Ben Weiss
TEL AVIV (MarketWatch) — It seems the time is fast approaching for the Tokyo Stock Exchange, the bastion of the Japanese financial system, to enter life as a public company.
The 133-year-old TSE, operating what is still today the world’s fourth largest stock market with a market value of $3.6 trillion (trailing the NYSE/Euronext, Nasdaq and London), is rumored to be back in talks to merge with the Osaka Stock Exchange, creating a group that would control an eye-popping 96% of the Japanese exchange market. Read more.
Owning monopoly assets at this point in the economic cycle can be an investors’ dream — and what better way than to make a move prior to the IPO. How? Get out a bowl of edamame beans and a bottle of sake and read on below.
Own a monopoly asset
With its protected annuity-style incomes, stock exchanges are widely considered to be an attractive infrastructure asset and are very much in vogue, evidenced by the nearly $30 billion of mergers announced in the past year alone. This explains the serious attention paid to the Nikkei story that the TSE is in talks with the OSE /zigman2/quotes/201068873/delayed JP:8697 +0.56% to merge by September 2012 — perhaps in the form of a reverse listing into its smaller, but publicly listed partner.
While the finer details are still to be agreed by the boards and subject to shareholder approval, it does raise a unique investment opportunity for those investors still willing to chase the Japan story. Indeed, while Japan has a plethora of companies with dominant market shares (such as Toto /zigman2/quotes/207308983/delayed JP:5332 0.00% in toilets and Kikkoman /zigman2/quotes/200008494/delayed JP:2801 -0.56% in soya sauce), there is none like the combination of the TSE and OSE, which would be transformed overnight into a virtual monopoly.
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Although such a monopoly would still be tightly regulated, the TSE is in the enviable position to clip the ticket from transactions, listing fees and sales of information data — for which it has no serious competitor. And it also has assets. In June 2007, it acquired a 5% in the Singapore Stock Exchange /zigman2/quotes/204001956/delayed SPXCF -0.69% . Its 53.1 million shares are valued at $270 million, and the investment is spinning off an annual $11 million dividend for the TSE shareholders. As of September 2011, TSE also reported a healthy $810 million in cash and equivalents.
However, even the most beautiful rose has its thorns, and the TSE has been mired in a seemingly never-ending sales and earnings slump since 2007. It has also had its operational problems — no better evidence that the “fat finger” episode in 2005 where its systems inadvertently allowed a broker to sell 610,000 shares for ¥1 as opposed to 1 share for ¥610,000, a trade that led to the ongoing lawsuit against the TSE for $530 million in damages.
The merger in numbers
With major global securities exchanges globally trading at an average price-to-earnings ratio of 10 to 20, and price-to-book ratio of 1 to 2, the combined TSE/OSE group could be worth up to $3.4 billion. With profits of $231 million last year, and a book value of about $2.3 billion, a fair valuation of the combined companies would be about $3.4 billion.
In 2001, the TSE demutualized into a private company and converted the membership of its 115 market participants into an equal parcel of 20,000 shares (equivalent to a 0.87% stake). Since that time, through acquisitions of brokerages in Japan, the top shareholders now include Morgan Stanley /zigman2/quotes/209104354/composite MS -0.06% with 4.4% and Goldman Sachs /zigman2/quotes/209237603/composite GS -0.28% with 2.4%. No surprise there.
However, a little bit of reverse engineering from the TSE annual reports suggests there are still at least 86 of the original 115 shareholders left on its register, each of whom hold a stake worth on my calculations up to $20 million each. This list includes a number of diminutive brokers, some that are publicly traded. Because their TSE stake was effectively a “gift,” many record it on their balance sheets at nil value. This creates a potential windfall for these brokers at the time of any future TSE listing and an attractive arbitrage for investors who are quick into action.
First to move on this was the mid-size Japanese broker, Ace Securities, which acquired 47% in Maruhachi Securities in March this year — with Maruhachi’s stake in the TSE worth as much as its market value alone.
For those astute investors who want to enjoy the upside in any future IPO of Japan’s leading exchange, acquiring a basket of small positions in these broking houses may be just the way to go.