DBOEY - Deutsche Börse: Diversified Play On The Global Exchange Value Chain

2023-03-06 06:56:10 ET

Summary

• Deutsche Borse looks poised to continue benefiting from rate-driven tailwinds.
• Secular growth drivers also remain intact and should support the mid to long-term targets.
• With the stock trading at a relative discount, there is re-rating potential here as well.

Deutsche Borse ( OTCPK:DBOEY ) remains one of the most diversified plays on the entire global exchange value chain, with key assets including the Eurex derivatives exchange and post-trade business (Clearstream), as well as EEX, the leading European power exchange. Thus, the stock offers investors the opportunity to capitalize on cyclical rate-driven tailwinds such as higher hedging activity via its derivatives business and interest income growth on its cash balances. Over the long term, there is plenty here for investors as well, with the company poised to ride the structural tailwinds in indices and data via Qontigo, as well as the shift toward European OTC clearing (vs. the prior reliance on third-country clearing). Net, the mid to long-term targets of 10% net revenue and EBITDA growth seem well within reach, and at ~18x fwd P/E (a wide discount to key peer London Stock Exchange Group ( OTCPK:LNSTY )), there remains re-rating potential as well.

Cyclical Strength Drives Near-Term Outperformance; Long-Term Developments Also Positive

2022 ended on a strong note for Deutsche Borse, with its Compass 2023 strategic targets achieved a year in advance on the back of stronger-than-expected cyclical tailwinds. The key drivers were the higher interest income on its cash balance and increased trading volumes amid the heightened volatility throughout Q4. In sum, the ongoing market volatility continues to benefit its core trading operations, and with recent jobs data providing fuel for the Fed to raise interest rates higher than previously anticipated, the runway could extend further into the next fiscal year. Looking past the cyclical benefits, the other business lines continue to grow structurally as well - the Data & Analytics business was the standout here, reporting an impressive new client pipeline on the back of the ESG-driven shift in asset management.

There were blemishes in the Q4 report, though, with the report noting fintech-related write-downs and a decline in equities derivatives revenue (on a per-contract basis). Also weighing on the P&L were elevated costs for the quarter, led by staff costs and other operating expenses, which will raise concerns about the path of the expense run-rate into FY23. Yet, the announcement of a ten-year strategic Google ( GOOGL ) Cloud partnership will come as good news, particularly following LSEG's Microsoft ( MSFT ) partnership . Not only will it ease the development cost burden related to the D7 digital securities platform, but by enabling the launch of crypto spot and derivatives products, Deutsche Borse also gains an accelerated path to unlocking lucrative new revenue streams. No specific synergy targets were disclosed, but the prospect of incorporating GOOGL know-how via "infrastructure" and a "data analytics layer" to D7 bodes well for the long-term outlook.

In-Line Guidance Update but Ample Room for Upside

There were no surprises with the FY23 guidance update, with net revenues falling in line with consensus at EUR4.5bn-4.7bn and EBITDA at EUR2.6bn-2.8bn. The rationale for the net revenue growth guidance hinted at some conservatism, though, with management stating that the guide depends "on expected continued secular growth," while the cyclical impact will be subject to "further development of interest rates as well as market volatility."

This leaves room for upside from the cyclical component. Net interest income will be key here - should rates remain higher for longer, expect a P&L boost from higher interest on cash balances. Meanwhile, trading revenues also stand to benefit in the likely event volatility stays high amid the rate uncertainty. For long-term-oriented investors, key segments to monitor include the Fund Services business, where management is targeting a pipeline-driven double-digit to mid-teens % revenue growth algorithm, as well as Data & Analytics, where the ESG shift continues to be a major driver.

Balance Sheet Flexibility Supports M&A Appetite

Building on the Google Cloud partnership, management hinted at more M&A in the pipeline should a deal make strategic and financial sense. Any acquisitions will likely focus on building capabilities in key growth areas like analytics or fund services; alternatively, a reasonably-priced bolt-on could also serve as a funnel for new customer acquisition.

Maintaining financial discipline will also be key - in particular, a focus on profitability and synergy potential to ensure minimal dilution to the group-level margin profile. As of Q4, the balance sheet is in great shape, with net debt to EBITDA at 1.2x, well below the 1.75x threshold required to maintain its AA investment-grade rating. Assuming a 1.75x floor, this implies >EUR1bn of incremental debt capacity, with more headroom available should management also tap into refinancing, equity raises, or joint ventures to fund its M&A efforts. Either way, the M&A optionality will be worth keeping an eye on.

Diversified Play on the Global Exchange Value Chain

Investors looking for exposure to growth across the core exchange value chain should look no further than Deutsche Borse, which remains poised to benefit from secular index & analytics growth via Qontigo, as well as robust pipeline-driven growth in fund services. With the higher rate environment likely to persist through the next year or so, Deutsche Borse offers cyclical benefits as well, not only from the added interest income but also from increased hedging activity via its derivatives operations. All in all, the 10% growth target seems achievable, and relative to the high-teens fwd P/E multiple (a relative discount to key peer LSEG), the risk/reward seems favorable.

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