To own stock in TMX Group is to own a piece of a mighty franchise that pays you 5 per cent for your troubles. In a world of minuscule interest rates and even more minuscule optimism, that seems like a good deal. And it would be except for that hair in the soup called "sentiment."
Sentiment is underrated. Sentiment can turn a 5-per-cent yield into a 6-per-cent yield in short order, with no warning but with painful consequences. And sentiment is not with TMX Group, for understandable reasons.
What turned sentiment against TMX is competition, primarily, but not only, from Alpha Group, an alternative market where big investors can buy and sell the very same shares that TMX quotes every day. Not long ago - three years - TMX was a monopoly, and it priced its services accordingly - gouged accordingly, some might say.
Then some of its biggest customers - the big six Canadian banks, the CPP Investment Board and a couple of mid-tier brokerage firms - started Alpha. Today, TMX's market share in the trading business is about 70 per cent. Most of that 30-point loss went to Alpha, and there's probably more gains for Alpha to come.
Now the upstart wants into the listing business. Listing fees are a lucrative annuity. All of this is making investors blanch.
As far as competitors go, Alpha is a force. It's run by a shrewd and experienced chief executive officer named Jos Schmitt.
Alpha says it got into the business to lower fees and make money, and in truth the fees were high. Trading fees have come down, thanks to competition. TMX still has the incredibly profitable market data business to itself, although it's vulnerable.
And finally, TMX's derivatives business, growing nicely and highly profitable, will eventually be another battle front.
To sum up, sentiment has gone cold on TMX.
Fair enough, but is it overdone? Talk to average investors about TMX and most dismiss you with a weary wave of the hand, "Competition," they mumble and get back to trying to pick a bottom on RIM.
Competition to be sure. But as Mr. Schmitt told me, when it comes to trading market share "the sky is not the limit." In other words, even he acknowledges that TMX will never lose all of the market. He thinks Alpha will peak at between 40 and 50 per cent. Maybe, maybe not. He's taken a lot of share quickly, but there was a lot of low-hanging fruit to pick. A lot of the gains have come from so-called high-frequency traders - computer driven systems, mostly south of the border. In fact, some of this business exists not to make money from buying and selling stocks but rather from the rebates that the competing exchanges pay. That's not sustainable.
Furthermore, while TMX has lost share and been forced to cut fees, its trading revenues are still growing because there's more business.
As for listings, if you're the CEO of a company you've always dreamed of being on the Toronto Stock Exchange. It's what you brag about to family and friends. "We just went public on Alpha" doesn't quite have the same vaunted ring to it. It's kind of like saying: "I just got into Devry."
Alpha has attacked TMX where it was most vulnerable. And the group's other sources of revenues are at some risk. But the company has been around for more than a century. The business it transacts in is not going away. And it has time to react to threats - assuming it does it right, which isn't a given (If it had cut fees aggressively three years ago, TMX would have made life hell for Alpha.) It's hard to wake up and discover you're not a monopoly any more. But a powerful franchise will survive.
So about that dividend: In the latest six months the group's cash flow was $145-million. The dividend payment was $56-million. It's easily covered. The group's costs also look high; there's room for improvement.
The stock could fall, or it could be dead money for a long time, like BCE was until recently. But TMX isn't going out of business and that dividend looks very reliable.