Business | Investment
Take a peek at the Saudi bourse
Robust economy and an expanding capital market promise volume growth.
- By Farhan Mahmoud, Special to Gulf News
- Published: 00:34 December 29, 2007
- Image Credit: AP
- Robust economy and an expanding capital market promise volume growth.
A few weeks ago Dr. Abdul Rahman Al Tuwaijeri, chairman of Capital Market Authority (CMA), announced plans to transform Tadawul, the Saudi stock exchange, into a joint stock company. Furthermore, there are plans to sell part of its shares to the public through an IPO next year.
The CMA recently announced the formation of Tadawul's board of directors, approved by the Council of Ministers.
These are steps in the right direction as the government liberalises the Kingdom's capital market and provides a platform to the investing public to participate in economic growth.
Today, Tadawul is at a defining moment in its history. Its current market capitalisation of over $430 billion makes it one of the largest emerging market exchanges in the world.
There are 107 companies listed on the bourse and the average value of shares traded this year currently stands at over 11 billion Saudi riyals per day.
Now, as the bourse nears its transformation, the opportunity is ripe for Tadawul's management to build on its success so far and take the exchange business to a new level that is scaleable, profitable and div-ersified.
Globally, exchanges have either changed or are changing their traditional business models. Until a few years ago, most of them were organised as "mutuals" or cooperatives of members.
Now, after a listing of 22 exchanges, with the likes of London, New York, Toronto and Singapore bourses to name a few, a new structure has evolved which facilitates greater business and operational efficiencies, transparency and the transition to new electronic trading platforms.
Under the new business model, exchanges have gone public and have listed themselves in the stock market. This model is not without its weakness.
Demutualisation of exchanges has created a conflict of interest between market participants (brokers, as well as investors) and the operator of the exchange, which now attempts to maximise returns to shareholders.
Tadawul is a regulated entity, overseen by the CMA. Globally, regulatory rules are far from uniform across different jurisdictions, and the involvement and goals of regulators also differ.
However, in most cases, regulators have the function of market oversight, with the objective of providing a framework of rules or laws, and the power to enforce or even prosecute for the orderly functioning of financial markets (for example, ensuring fairness among market participants).
Retail involvement
Furthermore, in particular for cash markets such as Saudi Arabia, with a high degree of retail involvement, there is an additional objective of protecting the consumer, the small investor.
An analysis of the listed global exchange business reveals that currently there are 22 exchanges listed with an aggregate market capitalisation of $154 billion (as of early June 2007). Of the listed exchanges, nine are in North America, seven in Europe and six in Asia.
Exchanges are scaleable businesses and the majority of the cost base tends to be largely fixed. The exchange business is characterised by dominant market positions, solid financials, strong cash generation and above-average earnings growth.
Over the past five years, valuation multiples have expanded and currently, global exchanges trade at 25 times forward earnings.
The exchange business is a profitable one if managed efficiently along the pillars of cost rationalisation, revenue growth through product development and strategic acquisitions.
It is a volume-driven business where economies of scale matter and there is usually scope for further efficiency gains to support earnings growth.
On a global average, the exchange business has a return on equity of over 24 per cent. Last year, global exchanges generated a profit of $3.80 billion on a revenue base of over $12.20 billion, a margin of over 30 per cent.
The 22 listed exchanges have witnessed a revenue growth of over 17 per cent in the past five years while costs have increased by a shade over eight per cent.
The profitability of the exchange business shows that there is great opportunity ahead for Tadawul, which has the potential to grow aggressively in the next five years and be a dominant, highly profitable regional exchange.
For Tadawul, revenue diversification will become increasingly important if it wants to be a major player in Mena (Middle East and North Africa). It appears that the Saudi exchange is well-positioned to develop an "integrated" offering for traditional market opportunities.
Going forward, Tadawul must target revenue diversification through aggressive product development, strategic stakes in regional exchanges with strong product portfolios and acquisition of fast growing niche exchanges or trading platforms that trade products with little or no correlation to the existing portfolio (e.g. energy, commodities, weather, etc.).
As well, Tadawul will need to identify and implement sources of incremental revenue. Its product portfolio needs to be enhanced to include derivatives, fixed income, exchange traded funds, real estate investment trusts, an Islamic securities platform, and new investment benchmarks.
For Tadawul, structural drivers for volume growth are in place in the form of a robust economy, a growing capital market and increased demand for capital from new issuers and listed companies.
Over the years, the Exchange has deployed substantial resources towards development of IT infrastructure, a new trading platform and risk management system.
However, continued strong volume growth may come in conjunction with higher fee attrition than currently anticipated as the participants put pressure on pricing.
New technology
Historically, most exchanges have had dominant positions in their respective markets. In today's financial markets characterised by rapidly developing technology and a diverse client base, lower marginal costs have become increasingly important.
In such a scenario, when exchanges, like Tadawul, offer new products and expand into different geographies, a strong and innovative management team can make a difference on earnings growth of an exchange.
Tadawul must offer a comprehensive and efficient infrastructure to issuers for raising capital and to investors for transacting and clearing financial products.
As a leading marketplace, it must strive to continually innovate and provide its customers (issuers, investors, broker-dealers) with convenient access to quality products and the best price discovery and liquidity at a competitive cost while seeking to create value for its shareholders.
The time has now come for Tadawul to reposition itself and restructure its business model for the next phase of its growth.
(The opinion expressed is that of the author himself and does not necessarily reflect that of the organisation he represents.)
The writer is head of asset management at FALCOM Financial Services in Riyadh.
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