As many as 38 from the 240 companies on the S&P/TSX composite index – the preeminent benchmark tracking the performance of Canada’s largest companies – were trading below $5 this week.
In other words, up to 15.8 percent of the country’s dominant index, an important symbol of the country’s economic might, could be considered a penny stock on most major U.S. exchanges, based on rules set through the U.S. Securities and Exchange Commission.
Depressed values for commodities and the collapse in oil prices to 12-year lows have severely crimped the performance of the S&P/TSX composite and decimated the S&P/TSX Venture composite index, which in mid-January sank to the minimum ever.
It’s less an identity crisis as much as it might be difficult for survival.
Given its unfettered dominant position at home, this is unchartered territory for TMX Group Inc., which owns and operates the Toronto Stock Exchange and also the Venture and Alpha stock markets. Before it became a for-profit company in 2000, its relevance and longevity haven’t been seriously questioned or tested.
But since a consortium of 13 major Canadian banking institutions comprising the Maple Group Acquisition Corp. completed the $3.8-billion purchase of TMX Group in September 2012, the country’s major exchange operator appears to have been a national institution looking for a method.
“The TMX finds itself inside a perfect storm where commodity markets have collapsed and volumes have dried out of all exchanges,” said Ian Russell, chief executive from the Investment Industry Association of Canada. “It’s less an identity crisis around it might be a struggle for survival.”
The TMX Group’s identity was forged as a direct consequence of a failed proposed merger using the London Stock Exchange. Following the merger was defeated in 2011 by the Maple Group, sending the pesky foreigners packing with about $38 million in break-up fees, a made-in-Canada solution predictably ensued.
Essentially, its formula prescribed an extended concentrate on resource listings, with some major blue-chip financials, like the banks, telecommunications and transportation giants included for balance – a formula some still believe in.
“We have a world-class exchange within this country,” said Richard Nesbitt, leader in the Global Risk Institute for Financial Services and former chief executive from the TSX Group Inc. who was the type of leading the campaign against selling to the LSE.
Even now, almost eight years taken off the TSX, he maintains that the exchange, despite its challenges, is “the category of the field among the eight or 10 smaller exchanges when it comes to servicing its customers, as well as in some industries, like mining and SME finance, it’s world beating.”
“World beating,” however, isn’t how global investors would characterize any of the Canadian exchanges, that have lagged other exchanges since the 2008 financial crisis. Consequently, inevitable questions regarding the relevance from the Toronto Stock market and its sidekick junior listing venue are now burbling.
“If the TSE went dark for a week, would it really matter?” asks a former Canadian regulator who spoke on the condition of anonymity. “In the past Ten years, the earth has been populated with hundreds of smaller exchanges. It’s hard to state, but my sense is (the Toronto exchange) is just not as vital as it was previously.”
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That lack of vitality is reflected in TMX Group’s numbers. The organization posted a $159-million loss in your fourth quarter of 2015, or $2.92 loss per share, based on results released Feb. 11. Meanwhile, its shares reached their nadir at the end of 2015, but have modestly started to rebound from last year’s 30-per-cent drop.
It’s also reflected in the insufficient activity on its markets. Total financings around the Toronto Stock market fell 33 per cent in January when compared to same month a year ago while cash equity volumes declined 22 percent.
The Venture Exchange, meanwhile, has fared much worse. Total financings plunged an astonishing 74 per cent recently in the same period in 2015.
Overall, TMX Group’s revenue declined three per cent within the fourth quarter – using the only bright spot being market data sales, many from the company’s strategy moving forward, which climbed nine per cent.
Accustomed to its insular view, competitive pressures are finally pushing the Canadian exchange operator out of its comfort zone.
For one, major exchanges like the Nyse, Nasdaq and the Tokyo Stock market have previously consolidated other smaller exchanges to produce more heft to draw in more listings. A lot of Canada’s biggest information mill also interlisted on U.S. exchanges.
The TMX Group isn’t in those big leagues now – and in all likelihood never was. “We tell you they are a global financial centre, (but) we’re really not. We’re more a parochial financial centre,” said the previous regulator.
The Canadian exchange operator should also now contend with countless smaller exchanges, for example dark pools, in addition to local and regional exchanges rising in emerging markets that provide higher governance standards and other niche opportunities that attract investors.
Even in the own backyard, TMX Group’s dominance, including about 70 per cent from the country’s equity trading volume, has been challenged.
U.S. giant Nasdaq Inc., with former TMX chief executive Thomas Kloet now on its board of directors, has arrived on TMX Group’s home turf with the acquisition of Chi-X Canada, an alternate trading system that competes directly using the Canadian exchanges for volume.
It is worth noting that Nasdaq’s main U.S. exchange is home to four of the most popular technology companies on the planet – Apple Inc., Alphabet Inc., Microsoft Corp. and Facebook Inc. – which together possess a market value of close to US$2 trillion, dwarfing Canada’s entire US$1.6-trillion equity market.
At the same time, Aequitas Innovations Inc.’s Neo Exchange is challenging around the Canadian data front. The upstart filed a complaint with the federal Competition Bureau alleging TMX Group is using anti-competitive practices and it is dominant market position to control pricing on data.
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To make sure, TMX Group continues to be slow to reply to the difficulties. The stocks of their global exchange peers – London Stock market Group, Deutsche Borse AG and Spain’s Bolsas y Mercados Espanoles – all currently trade at a higher multiple, around 15 times earnings, than the TMX Group.
But belatedly, otherwise reluctantly, the Canadian exchange operator has realized that it must navigate this new world of competition for investor curiosity about its listed companies and for new listings.
“The TMX today isn’t the TMX of the year ago and also the TMX the coming year won’t be the same as the one today since the markets and our clients are changing,” said Lou Eccleston, the business’s American leader who is leading the overhaul. “But at least we get into 2016 ready for the change, whereas this past year, I could not have asserted.”
Eccleston, an old executive at Standard & Poor’s, Thomson Financial Corp. and Bloomberg LP, was hired in November 2014 to reverse the red tide. His major initiative has been to launch an unprecedented and sweeping overhaul dubbed “The Pillars for the Growth.”
Finding the right direction inside a choppy market is hard to do.
Unveiled in late 2015, it is a blueprint that outlines the way the exchange operator intends to shed the yoke from the old Maple group model as an infrastructure provider and transform itself right into a provider of client services while purchasing services, for example data mining and analytics.
According towards the plan, the future TMX Group will concentrate on commercializing its services, winning back a number of its lost equity-trading market share, shedding non-core assets and, most notably, expanding the TSX Venture beyond its traditional focus on resources and into technology.
Even so, the TMX are not committed to shun its bread and butter. “The resource franchise in Canada is critical,” Eccleston said. “Technology is as essential for the near future as resources happen to be and continue to be for Canada and that we have to do both moving forward.”
Industry analysts are skeptical Eccleston can deliver on that ambitious blueprint.
“Finding the right direction in a choppy market is hard to do,” said Paul Holden, an analyst at Canadian Imperial Bank of Commerce, in a Feb. 15 note to clients. “We aren’t so clear about execution towards creating a digital company, a more efficient company and a more client centric company.”
The analyst, who maintains a $50 price target on TMX Group shares, really wants to see more specifics on items like revenue diversification, as well as new revenue opportunities and growth prospects. For now, “we do not have sufficient confidence around new initiatives to recommend jumping in to the stock today -,” he said.
Others on Bay Street echo that sentiment. Shubha Khan at National Bank Financial on Feb. 15 reaffirmed his “constrained” outlook on TMX Group’s potential customers and also the stock’s $40 target.
Khan said inside a note that TMX Group’s current large valuation discount to its global peers “is unlikely to narrow” because of the collapse and continued weakness within the resource sector, the entry of Nasdaq in to the Canadian marketplace and also the added costs from the realignment. “We believe a narrowing of the discount appears rather unlikely in the near term.”
In the end, Eccleston might not have much wiggle room to construct a strategic plan that is both compatible with a Canadian marketplace that relies on the commodities and sectors, and quickly offers a profitable future in technology and knowledge.
“In rapid run, there isn’t a quick fix to fix the TMX Group’s problem,” said the IIAC’s Russell. “He [Eccleston] is proposing a long-term strategy that is going to take a long time to bear fruit. There’s no smart way out and shareholders will be tied to it.”
ttedesco@nationalpost.com
