Description

The stock exchange operators of Colombia (Bloomberg ticker BVC:CB), Peru (GBVLAC1:PE), and Chile (BOLSASTG:CI) are engaging in a three-way merger to form a regional exchange (no Bloomberg ticker yet but referred to in this writeup as HOLDCO). HOLDCO will be headquartered in Chile and the merger is expected to be completed by the middle of October 2023. The current CEO of BVC:CB, Juan Pablo Cordoba, will transition to CEO of HOLDCO. The three predecessor exchanges own or have a substantial interest in trading, settlement, depository, custody, and other services.

Existing shareholders of BVC:CB will own 40% of HOLDCO, shareholders of GBVLAC1:PE will own 20%, and shareholders of BOLSASTG:CI will own 40%. BVC:CB is the way that is most attractive and feasible to buy into HOLDCO before the completion of the merger in October 2023. At a price of 9,470 COP, buying shares of BVC:CB implies a 339M USD market cap for HOLDCO which is equal to 11.5x trailing earnings.

To varying extents, each of the three has been sub-scale. Without a large investor base, there has been little incentive for companies to list. And with a small number of listings, there is little incentive for investors (especially foreign ones) to set up to trade and search for investment opportunities. A relatively small single-country market means that each exchange has not been able to launch certain financial products, because the resulting transactions and profits would not provide sufficient return. The merger is happening because the three exchanges realized they had to join forces to acquire scale and become relevant globally.

We have been following the exchanges for years and believe that the combined entity will have a critical mass that will enable it to develop to a new level. The combined population of the three countries is 105M and combined GDP is 850B USD. These figures are about half of Brazil’s comparable population of 214M and GDP of 1.6T USD. Whereas via BVC:CB we can buy into HOLDCO at a 339M USD market cap, the stock exchange operator of Brazil (B3SA3:BZ) has a market cap of 13.3B USD, 46x greater. This shows how underpenetrated the HOLDCO exchange is and the growth potential it has going forward. The business case put together by the three exchanges for the merger read, “… integrating the Chilean, Colombian, and Peruvian markets will create a market similar in scale and liquidity to Mexico in the short term, and close to Brazil in the medium to long term …” The three combined exchanges will “be equivalent to 45% of Brazil’s free-float capitalization and 85% of its market capitalization, but just 15% of its traded volume,” showing the potential to increase trading in HOLDCO markets.

The merger of the three entities should result in significant synergies and value increase. The exchanges hired Bain and Rothschild to analyze this. Bain and Rothschild concluded that HOLDCO should be worth 764M USD in a base case, equal to 2.2x the 339M USD valuation when we buy in through BVC:CB today. The consultants believed that 17% of expenses can be eliminated, mainly in IT (running a single trading platform) and labor. Bain is working with the three exchanges to achieve these synergies. Moreover, the consultants believe there will be income synergies from the attraction of new market participants, volume increases, and the distribution of products in new markets.

Note that Bain and Rothschild left out possible additional sources of upside value to HOLDCO. For example, they noted that “additional income could be captured by increasing the range of digital post-trade products. This long-term income has not been included in the totals, but could represent ~20M USD in additional income.”

Recall that today one can buy into HOLDCO at 11.5x trailing PE and this is before considering all of the revenue and cost synergies that will come. Pro forma, the multiple will go down significantly. Compared to the comp list, it is safe to say that HOLDCO will be the exchange globally having undergone the most dramatic transformation. Median multiples for exchanges are 23.7x trailing PE globally, and 21.9x trailing PE for EM / FM (those multiples are for companies with no expected synergies and no special catalysts):

(Note that the above numbers, which are all pulled from Bloomberg, are innacurate for BVC specifically as they contain a large one-time tax hit in trailing earnings. In addition, they reflect only standalone BVC whereas this writeup focuses on the coming consolidated entity)

BOLSASTG:CI, the existing standalone Chilean market operator, traded 22 thousand dollars’ worth of shares in 2022, which is an irrelevant amount of liquidity. GBVLAC1:PE, the Peruvian predecessor, traded 1.5M USD worth in all of 2022 and around 6M USD so far in 2023. Somewhat amazingly, GBVLAC1:PE traded 6M USD in 2023 at a price that implies a 673M USD market cap for HOLDCO—double the implied valuation with BVC:CB, even though it has been clear all year that GBVLAC1:PE and BVC:CB are converting into the same HOLDCO. So much for the efficient market hypothesis! BVC:CB traded 5M USD in 2022 and more than 10M USD so far in 2023. Buying BVC:CB right now and converting into the merged entity is an attractive option for investors who do not require large liquidity. For larger investors, they can wait to see where HOLDCO trades and buy in October 2023, although we cannot rule out that HOLDCO will be priced off the bat at something like a 22x PE, in line with EM comps. The business case put together by the three exchanges for the merger predicts that “the [combined] company will be attractive internationally, its intrinsic value will increase, as will its share price, and the unified company’s share liquidity will be greater.”

After the three exchanges merge into HOLDCO, there is potential for further industry consolidation. Note that the Brazilian exchange with a 13.3B market cap owns around 10% of the Chilean exchange, 8% of the Peruvian exchange, and 6% of the Colombian exchange. A representative of the Brazilian exchange has been on the board of the Colombia, Peruvian, and Chilean exchanges. An attempt by the Brazilian exchange to acquire HOLDCO is possible. HOLDCO will start trading with a 10% ownership limit in its bylaws, but bylaws can be changed.

At the same time, HOLDCO could stay independent and add other countries itself. Note that the central securities depository of Peru (which will be part of HOLDCO) currently owns 28% of the CSD of Bolivia. The Chilean exchange owns a little more than 6% of the exchange of the Dominican Republic. Bolivia and the Dominican Republic and several countries in Latin America, that do not have the scale to support capital markets on their own, would be natural additions to HOLDCO over time.

There is ample precedent globally for the consolidation of national exchanges. For example, many European countries gave up their individual exchanges and formed a consolidated Euronext. In 2017, two professors studied the impact of the combination on liquidity. They wrote (link):

We find that traded volume in the Paris, Brussels, Amsterdam, and Lisbon exchanges increased as a result of the creation of Euronext. The effect is statistically significant. It is also material from an economic viewpoint. According to the estimations in columns 5 and 6, which are the ones that we prefer given they include all relevant controls, volume increased by approximately 25% in the period after the integration. A thicker market (i.e. a market with more traders and greater traded volume) is a more liquid market. Therefore, our findings on the effect of the Euronext mergers on traded volume confirm our previous results on bid-ask spreads and volatility: the Euronext mergers increased liquidity.

An increase in traded volume on the order of 25% means a significant increase in revenues for the stock exchange operator. This largely drops to the bottom line as it carries no associated costs, boosting profits by significantly more than 25%.

Catalyst

Completion of three-way merger and listing of consolidated entity in ~3 months