Deutsche Boerse – Fundamental Upside In This EU Stock Market Operator (OTCMKTS:DBOEF)
Deutsche Börse (OTCPK:DBOEY) (OTCPK:DBOEF) is what is called an “offering marketplace”, or stock exchange for the trading of shares and securities, as well as a transaction services provider.
Its task is to give investors and investment companies access to the global capital market. Its history goes back to 1992-1993 and the company is headquartered in Frankfurt, Germany.
In this article, I will show you why I own, and why I consider it a good idea to own shares in this operator.
Delving into the German stock market
So, numbers to begin, there are over a thousand companies listed with a combined stock market capitalization in the trillions.
The business has revenues in the billions, operates at appealing EBITDA/Operating margins of around 53-55% on an EBITDA basis, and unlike some of its peers, pays a dividend of over 2% at the current valuation.
The company has an AA credit rating, and its subsidiary has an AA credit rating. Some actually claim that Deutsche Börse goes back over 400 years, to 1585, but the clear roots are the “Frankfurter Wertpapierbörse AG”, which was a German LLC that changed its name in late 1992.
IPO was in 2001, and its competitive advantage was simple – digital/electronic trading as opposed to floor trading. This eventually went on to almost replace floor trading, and it was known as Xetra back in 1997 – a name that still sticks today.
Clearstream, the European leading supplier of post-trading services (including things like dividend payouts), is a wholly-owned subsidiary of Deutsche Börse. Its mission is to ensure effective cash and security delivery between parties and it manages/administers and safekeeps all of the securities it holds on behalf of its investor customers. So, that is also part of Deutsche Börse. This is also the subsidiary that I was referring to, with AA credit from S&P Global.
This combination of services gives it a distinct advantage over most of its competitors because its offerings are broad enough to cover the entire process chain. This means that European banks are customers of Deutsche Börse, as many of their operations for investors are routed through Deutsche.
The company’s focus has been the “Europeanization” of its operations. It sold the US subsidiary ISE to Nasdaq (NDAQ) and its stake in BATS Global back in 2016 and 2017 respectively. It’s done a few M&As, such as Axioma, a risk management software provider which was spun into its index (DAX/STOXX) operations back in 2019.
On a high level, Deutsche makes money/sales revenue from the following operations.
- Eurex (Financial Derivatives)
- Clearstream (Post-trading)
- Xetra (Cash Equities)
- IFS (Investment Fund Servicing)
- IIS (Institutional Services)
- 360T (Foreign Exchange)
- EEX (Commodities Trading)
- Qontigo (Index/Analytics)
As well as an “other/data” segment. The primary sales revenue generators are Eurex and Clearstream, which together account for more than 50% of sales, while 360T is less than 5% of revenue. Simplified, it can be said that a stock market company like this one can make money from Pre-Trading, Trading/Clearing, and Post-Trading services.
Deutsche does all of this.
The company’s highest FX exposures aside from Euros are the dollar, the British pound, and around 7% in emerging market currencies. (Source: Alpha Value)
A stock market operator such as Deutsche sits in an essential monopoly position, given that order flows go where liquidity is most prevalent. While low-cost trading platforms do compete with Deutsche, they also require post-trading services and other technologies, all of which Deutsche provides.
This does not mean that Deutsche cannot or should not improve its operations to stay competitive. The company has been initiating efficiency programs to reduce cost basis. I also see the future not being particularly kind to small players in this space in Europe, given the increased regulation and requirements which are coming under new infrastructure regulations, such as EMIR. As it has bought 360T, it now also owns its own Forex platform, and the company has proven that it can not only M&A well but also integrate new players while maintaining growth momentum not unlike to its start-up quality.
Brexit is another fundamental advantage for Deutsche. Given London’s previous importance as a financial gateway (and yes, I’ve heard the arguments for why it won’t change), business is likely to shift financial weighting to Frankfurt above London in the long term. Again, Deutsche is a winner of these trends.
Over a 15-year period, Deutsche has averaged YoY revenue growth of around 6-8% annually, interrupted only by the financial crisis, and sometimes as high as 30%. Gross margins have stayed between the 82-90% range during that timeframe, with pre-tax operating margins coming in around 37% on the low end and almost 50% on the high end, with an average of around 42%. Tendentially, numbers have been improving.
Dividend payouts haven’t been rock-solid, but they’ve mostly been appealing in terms of its YoY development, and the company hasn’t cut them for several years.
From a financial analytics perspective, Deutsche runs a very tight ship, and a profitable one, that over time has been a good investment. The company has averaged a 17-year annualized RoR of 11.8%, which is above most average indexes and market, to a total 17-year RoR of 586.9%.
Financials are somewhat complex to calculate, due to the exaggeration from assets from the clearing side of operations, such as collaterals and settlement requirements. On a historical basis, between 80-90% of the company’s balance sheet assets can only be classified as items that expand the sheet due to accounting requirements that have no/very little connection to actual funding or cash from the company.
Total equity for Deutsche is around €6.6 billion, with balance sheet assets of €158 billion, to give you a picture of this imbalance. Despite its relatively high non-current financial liabilities portion of just around €3.5 billion, it maintains its AA credit rating.
Overall, I don’t see that Deutsche needs to have Cash worries, and its credit rating makes borrowing funding at low cost a non-issue. The current cost of company debt is just around the 3% mark.
The company is excellent at hitting its targets and goals. 2020 targets have been achieved, with a 9% revenue growth and double-digit profit growth on a 2017-2020 CAGR basis. The next step for the company is its 2023 targets, with increased M&A contribution and continued secular growth, target double-digit revenue growth to the €4.3 billion markets, and a double-digit CAGR increase in 2023E EBITDA.
Drivers for these increases?
- A higher degree of OTC to on-exchange trading, both due to regulation and futurization.
- Brexit, and the post-Brexit weighting of the financed markets.
- Sell-side pressure due to regulatory and cost increase pressure.
- Buy-side importance with a shift to passive products, analytics, and ESG – all of which Deutsche does.
- The implications of COVID-19.
The European stock exchange market is an interesting one. Next to London, Deutsche with its subsidiaries is definitely the largest and what I would consider the most interesting player on the market. That doesn’t make Euronext bad or uninteresting (as we’ll see in later article portions), but I would consider Deutsche, due to its target markets and operations, to be much more appealing.
So – that is how Deutsche is as a company, how it makes its money, and some of the potential future for the company.
While I really view Deutsche as one of the safer businesses in all of Europe, every company has risks. Even this one.
While a successful M&A’er overall, Deutsche has also had failures. Before Brexit, Deutsche was shot down in its attempt to merge with the London Stock Exchange. Such an M&A would have created an EU stock market “superpower”. However, before Brexit, the European Commission straight up told the companies “No”. (Source: EC)
The reason was that such a merger would have moved the company from a “sort of” monopoly to a de-facto monopoly in the markets for clearing fixed-income instruments.
Because this no was before Brexit, I’m of the analyst camp that believes any sort of merger at this stage and following this failure would be absolutely unrealistic.
Aside from forward growth risks, I don’t see many risks to Deutsche in this market, and I believe recent earnings figures have sort of confirmed the upside in Deutsche. The only “problem” is one we get into in the next segment.
Let’s look at the valuation
Let me be perfectly clear from the get-go. Deutsche isn’t the most undervalued stock market exchange in Europe at this time – but I argue it’s the safest and most qualitative.
At a current price of €162/share, the company trades cheaper than London but substantially higher than Euronext. There is a quality and market cap difference between these, of course. But investors need to be aware of the fact that while I consider Deutsche to be attractive, I would be very specific about my expectations and targets here.
Let’s lay this out clearly.
Calling this company significantly undervalued can seem like a stretch on a 15-year basis, but if you’re willing to target a peer-equal multiple of 23-24X P/E, with LSE trading at around 26X, then there’s annualized upside of around 10-12% here. While these are based on somewhat optimistic growth rates, they also come at a substantial safety, given these firms’ credit rating, market position, and market share.
I own Deutsche – but I bought it significantly cheaper than it is today. There’s still a slight upside to my price target, but it’s no longer the double digits it once was.
I forecast Deutsche Börse at no more than a sub-GDP lower range growth rate, up to slightly above GDP of around 1.8-2.1% for the terminal period, with around 4-6% range for the 2021-2025 period. The company has a WACC of around 7.72%, reflecting high expectations for its equity growth. Again, risks for this company are very low – but they do exist in the form of “less growth” than expected. If this happens, you might maintain your capital, but you’ll have missed out on opportunity growth.
Based on these relatively conservative growth range estimates, the implied equity value on a per-share basis for Deutsche comes in between €178-€192.
What you have in Deutsche Börse is significant advantages, including:
- Its market size
- Its returns/margins, beating comps and peers
- Better coverage than any of its peers in terms of its pre-market, market, and post-market services
- Future growth plans
So there is an upside here. It’s just that the upside is perhaps somewhat smaller than most investors would like. At current dividend levels, however, Deutsche provides a better yield and a better forward DGR than its peers, and I consider its overall upsides to being well worth a second look and consideration.
Remember, rotation brings with it a lot of boons for companies such as Deutsche – and the recent moves have been no different.
If the rotation continues, we should see similar positive momentum for Deutsche going forward. The company has outperformed its sector index, and should it drop down, I will most certainly start pushing capital to work here. However, even today, there’s a case to be made for investing in Deutsche Börse.
Concluding Deutsche Börse as a conservative investment
This article is the shortened version of the analysis posted to subscribers on our marketplace, iREIT on Alpha. The full article was published in January of 2022 and has a deeper survey of public comps, more detailed valuation, risks, downsides, and forecasts as well as a look at the ADR.
The recent stock market action has really confirmed to me the stability and resilience of my approach.
Signs which I saw in 2020-2021, of my portfolio seeing far less downward volatility due to investments in high-valued companies have been quadrupled here, with Tech-heavy indexes down more than 10% for the year.
My own core portfolio is up almost 3% for the year. This is what I want. Good, safe growth, safe, conservative but high (4-5% average) dividends, with a whole lot of “Sleep-well-at-night” sort of feeling – and that’s exactly what I’m getting.
There isn’t a single holding in my core portfolio that I’m worried about in a downturn. This is derived from expertise as well as conservative investing – many of the things we practice here at iREIT on Alpha.
Some conservative investors allowed themselves, through these past few years, to be spellbound by tech and the prospect of triple/quadruple-digit growth rates based on flimsy justification. I have never felt any calling towards these sorts of investments.
I may be an old dinosaur here – but I won’t change this, as things are looking now. This means that if you are, or want to be a tech-heavy or tech-focused investor, you don’t really need to take after me for those investments. They’re not my cup of tea.
I will never leave behind the core tenets of value investing. Valuations matter. Fundamentals matter. History matters. They matter far more than thinly-based expectations of what “might” grow.
My core is this:
I’m happy to pay the opportunity cost and lower returns of investing in safer stocks at lower multiples, as opposed to taking the risks some are taking here (and paying for). The whole notion of “Just go 5% crypto” or “just try X% this” is illogical to me. Is the implication that 5% or whatever percentage of my TPV isn’t valuable, or somehow an acceptable risk in terms of a pure spec play? I don’t “play” or “gamble” with my capital – the notion is insulting to the effort it took to earn it, and I firmly believe that anyone who’s ever worked their way from rags to riches would agree.
The result is potentially lower returns in a pro-tech/spec market, but higher safety in the opposite sort of climate.
I find that many investors, particularly of the older/traditional generation (which are most of my clients), agree with this view.
For those, investments such as Deutsche Börse might be just what the doctor ordered.
I’m a “BUY” here, with a slim upside – but still an upside.