QUALIPORT
Buying Into Market Value

By Maynard Paton (TMFMayn)
November 6, 2003

Few companies can better the buy and hold characteristics of the London Stock Exchange (LSE: LSE). It's a straightforward, predictable and visible operation, holds a near domestic monopoly and has genuine long-term growth prospects.

However, today's half-year results showed the Qualiport member failing to benefit from the FTSE's rebound, as well as revealing an Office of Fair Trading investigation. The LSE's shares slumped 8% in response, but for those investors prepared to take a longer-term view, great investment value is at hand.

(Refreshers on the LSE and its long-term shareholder attractions can be found here, here, here and here).

Interim figures

Here's a summary of the LSE's six-month profit and loss account:

Six months to Sept 30th          2003        2002

Turnover (£m)                   113.4       113.9
Operating profit (£m)            41.7        40.5
Pre-tax profit (£m)              45.4        45.1

Earnings per share (p)           10.8        10.5
Dividend per share (p)            1.4         1.3

A flat performance was achieved during what was described as 'difficult market conditions for the Exchange'. A lack of new issues (94 versus 128 last year) and fewer listed companies (2,692 versus 2,849) caused Issuer Services sales to slip 4% to £18m. Revenues from Broker Services were maintained at £44m, even though the value of all share trades fell 25% to £1.8 trillion. And turnover from Information Services was also maintained, at £50m, despite 4,000 fewer subscribers receiving the LSE's market data.

Still, operating margins remain as attractive as ever, this time coming in at 37% following minor cost reductions. And after a rather large £18m spent on fixed assets, the LSE managed to bump up its cash hoard to £222m (or 75p per share). Although the 8% dividend improvement looks impressive, the LSE's relatively low payout means the increase only involves distributing another £400,000 to shareholders.

For the current year, shareholders can expect the LSE to put in a 'resilient' performance in what will be a 'challenging' twelve months. Notably, new chairman Chris Gibson-Smith today claimed the LSE's financial performance was 'not directly linked to the level of the market', which contradicted his predecessor Don Cruickshank, who said this time last year 'the Exchange is however well positioned to benefit from any upturn'.

Whatever, it's hard to envisage the aggregate value of the stock market, new flotations, trading volumes, bargain sizes and demand for share price data declining over time. History has shown the stock market goes up over the long term and in five or ten years, it's fair to say all the key LSE revenue drivers will be at far greater levels than seen today.

Even so, the cautious short-term outlook helped drag the LSE's shares 31p lower to 338p. But over the twelve months ending September 2003, the LSE produced 19.8p of free cash. Adjusting for the cash pile, an attractive 7.5% historic free cash flow yield is on offer.

Competition

Today's share price wasn't helped either by the LSE admitting the Office of Fair Trading has been investigating its listing fees, which were raised significantly in April 2002. According to one broker, annual listing tariffs were hiked 30% and helped generate an extra £10m of revenues. A resolution is apparently being negotiated with the OFT and an outcome is due 'shortly'.

Though the market has taken fright, the OFT news should be seen as a positive. Simply put, investigations by a competition watchdog always imply abuse of a dominant market position and, of course, businesses with dominant market positions generally do well over the long haul. Indeed, considering the other providers of UK equity trading facilities, it's not surprising the OFT has begun taking an interest in the LSE.

Now owned by the SWX Swiss Stock Exchange, Virt-x is the LSE's main domestic rival. But going on the five most popular traded stocks on the Virt-x exchange during September, it has a long way to catch up:

September 2003

Share                Value of trades (£m)     Number of Trades
                       Virt-x     LSE           Virt-x   LSE

Vodafone (LSE: VOD)     228    10,743            351    97,601
HSBC (LSE: HSBA)        148     7,949            263    81,161
BP (LSE: BP.)           107     7,697            204    83,484
Lloyds TSB (LSE: LLOY)  107     5,500            316    96,246
Tesco (LSE: TESCO)       69     2,795            177    62,085

Another domestic rival is Ofex (LSE: OFX), the 'off exchange' bourse with 172 traded securities, full-year revenues of £1m and a listing of its own on the LSE's junior AIM market. There's also ShareMARK, which has just ten different listings and produces annual sales of £7m. In addition, there's been talk lately of reviving regional exchanges, which were last seen thirty years ago before being merged into the London market. So hardly a cutthroat industry, and no sign yet of the LSE losing its near monopoly.

Trading update

Within the next five trading days, the Qualiport will sell £2,000 worth of Carpetright (LSE: CPR) shares and reinvest the proceeds, plus the portfolio's cash balance, into the London Stock Exchange.

More: A Share For Bulls And Bears | LSE: A Shareholder's Dream

The author owns shares in Carpetright and London Stock Exchange.