Betting on SGX? Better metrics than many listed gaming peers

SIR, would you like to make a wager - or hedge, as professional investors like to call it - on Singapore?

That may be quite a bet to make. Singapore's equity market and economy are a tad too small, with growth maturing.

Not to worry, sir! We can offer you China, India, Japan, Indonesia, Taiwan, the US dollar, Chinese yuan, Indian rupee and much more. If that still does not cater to your tastes, we can extend to you more exotic offerings: iron ore, coal, shipping freight, petrochemicals and rubber. You need not be bullish, you can even be bearish. You can participate in this suite of products at the convenience of a single deposit - or margin. So, come on in and place your... hedge.

The Singapore Exchange (SGX) introduced derivatives in 1986 with its successful Nikkei 225 Index Futures. From equity indices, it has expanded into commodities, foreign exchange, interest rates and customised equity indices. The business is booming.

As our chart suggests, derivative volumes, as marked by their 6-month moving average daily volume, have more than doubled over the past five years. To be exact, volumes have compounded by an average 17 per cent per year. Derivatives now account for some 50 per cent of SGX's revenue.

In part, this has been due to weaker equity volumes in Singapore, but standalone derivative revenue is up a compounded annual growth rate of 12 per cent in those five years. It is through derivatives that SGX can now capture not only the domestic but also global money flows, especially into Asia.

The typical definition of betting is to express a view on an unpredictable event. If we extend this concept into derivatives, where participants make predictions (or guesses) on the direction of prices, we can even loosely classify SGX as a gaming stock. However, it possesses far better metrics than many listed gaming peers. Its return on equity (ROE) stands at 34 per cent, without any leverage. This compares with an estimated 35 per cent for Las Vegas Sands (LVS) and 8 per cent for Genting Singapore (GENS). What's more, both need to gear up their balance sheets to around 35 per cent and 100 per cent respectively.

SGX's business model enjoys two superior features over gaming stocks, in our view. First, the capital required for its business is limited. There is no need for major capital expenditure. LVS and GENS had to spend S$6-7 billion each just to kick-start their Singapore integrated resorts. SGX has fixed assets of S$242 million, including software, on its balance sheet.

Second, SGX is a platform. Which means it requires minimal capital to accept bets from players. It does not need to grant credit to VIP rollers. As a platform, scale and network effect are its primary barriers to entry. As more buyers enter the platform to trade the variety of derivative products, it will be able to attract the other side, comprised of sellers. And vice versa. This creates a virtuous loop of value creation through the network effect.

Some of the largest companies in the world are platforms. Their challenge is always to build volume and resolve that perennial chicken-or-egg dilemma. If there are not enough buyers, sellers will not be attracted to the platform. This is a difficult obstacle SGX has managed to overcome through engagement with customers and piling up new products.

The average daily derivatives volumes at SGX of around 900,000 contracts per day is dwarfed by the Chicago Board of Trade's 16 million per day for futures. While Initial Public Offerings and equity volumes may grab all the headlines, the bigger prize for SGX is actually derivatives. So please, place your… hedge.

  • The writer is head of research at PhillipCapital.

Disclaimer: Chartpoint is provided by Phillip Securities Research for information only, and should not be construed as investment advice.

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