Making Sense of the Cash & Investments at BSE Ltd

Caveat Lector - Since we are in the middle of the last quarter of the financial year the calculations shared below only accurately reflect the cash & investment position at BSE at the end of the year FY17 and somewhat accurately at the end of Q2FY18 when the balance sheet of the company was available. The figures below in no way reflect the current position of the unencumbered cash on BSE's balance sheet. For more precise figures please contact the management.

I have attached with this post an excel file with the calculations and the FY17 AR where I have highlighted the figures used. The excel sheet also contains the page numbers from which the adjustment figures have been taken.

Now, the reason why we are doing this exercise is that at first glance, the cash & investments on the balance sheet of BSE seems to greater than or equivalent to the current market capitalization (4376 cr) of the company.

Looking at the asset side of the balance sheet at the end of FY17 we have other non-current investments of 1491 cr, other financial assets of 253 cr, current investments of 502 cr, cash of 1163 cr and bank balances other than cash of 1262 cr. This cash and investments sum up to 4673 cr which would unbelievably seem to be more than the more than the market capitalization of the company.

Wow, what a bargain the markets are handing to us would be my first reaction. We have hit upon an undervalued gold mine at BSE where the margin of safety is so huge, that we are not only getting the cash & investments at a mild discount but the underlying oligopoly business, future growth, part of CDSL, some clearing businesses and optionality in the form of INX at GIFT city and upcoming universal commodity exchange in October.

Hold your horses, buddy, not so fast. We need to be sceptical and dig deeper, as the markets do not serve such feasts to investors during bull markets, they only do so when there is pessimism abound during bear markets.

Let us take a deeper look into the footnotes of this cash and investments to get a clearer picture.

Diving into the footnote 11 of the other non-current investments we find that there are 26 cr of funds that have been earmarked. What are earmarked funds you say?

Pg 127 of the AR defines these funds as, "representing deposits, margins etc held for the specific purpose." Deposits and margins from whom you say, let us wait a bit and visit this later.

Continuing with our dive into the footnotes for earmarked funds we find that other financial assets have 183 cr of funds earmarked, cash and equivalents have 926 cr and bank balances have 616 cr of funds earmarked. In total 1753 cr of funds on the assets side of the balance sheet has been earmarked.

Negating these earmarked funds from total cash and investments of 4673 cr we calculated earlier, we get 2919 cr of cash and investments which are probably unencumbered.

Not bad right, we still have 60+% of market capitalization as cash and investments with a stable regulated oligopoly business and other business vertical optionalities. Hold your pants on for a few minutes more mister, notice how I used, "probably unencumbered".

We still have not accounted for the liabilities side of the balance sheet. Looking at the liabilities we find, 1671 cr of other current financial liabilities and 257 cr of other current liabilities. Now one would say, why do we need to account for these liabilities from the above "probably unencumbered cash and investments."

In any other business model, you might be right, but this is a stock exchange which is a highly regulated space. It is a confidence based business where market participants need to be confident of the liquidity of the exchange to trade on it. That their dues will be honoured in case of a mishap.

 These are significant amounts at ~ 30% market capitalization, too big to ignore. Having a look into their footnotes, I found that these are mainly liabilities arising from clearing and settlement segment, namely, deposits from clearing banks, deposits and margins from members and settlement obligation payable.

Do you see the connection, earlier we discussed that some funds were earmarked for deposits and margins. That cash and investments on the asset side of the balance sheet have been generated from these deposits and margin liabilities and thus is not fully unencumbered.

I believe these deposits and margins collected are strictly regulated by SEBI, along with the maintenance of an SGF (settlement guarantee fund). These funds have to be invested as per the capital allocation regulations provided by SEBI.

Now a portion of these liabilities, 280 cr, has already been earmarked in investments and current accounts as the sub-footnotes mention. Therefore when calculating these liabilities I remove these earmarked funds so as to not double count these earmarked funds.

So we take the cash and investments left after earmarked funds have been accounted for, i.e., 2919 cr and subtract financial liabilities left after the earmarked funds have been accounted for,i.e., 1647 cr.

From these calculations, the unencumbered cash comes out to be 1271 cr & 1080 cr in FY17 and H2FY18 respectively.

Caveat Lector - Do be careful here that the latest balance sheet figures we have are from Q2FY18 but these do not contain the footnotes to balance sheet items which reveal the earmarked funds. Therefore, to calculate the H2FY18 unencumbered cash and investments figure I use the FY17 earmarked fund figures. Which is not entirely accurate, but we may get a ballpark figure.

Now here is the kicker in their business model, as I understand it, these liabilities may never come due. The past few year balance sheets reveal that these liabilities have been growing as the business on the exchange expands. The business model could be generating a float, as deposits and margin paying clients increase in both number and value.

Caveat Lector - This is a hunch, I am yet to check how much of these liabilities have been called due at once in the past 10+ years of the functioning of BSE.

These could be similar to the liabilities of an insurance firm, the premiums they receive to insure the risk, they keep this cash as investments on their books and earn returns on this float, I believe IRDAI mandates the asset allocation of such encumbered cash.

Similarly, BSE could also be generating a float, although on a smaller scale compared to insurance businesses.

If they are generating a float, the funds balancing these liabilities will have to remain on the balance sheet in the form of liquid securities as per SEBI regulations. The funds against these liabilities will stay on the B/S providing investment return for the foreseeable future.

Ultimately what matters is how the management views this situation as. I believe when Mr Ashish Chauhan in the Q3FY18 con call said we have 1600 cr of unencumbered cash he meant that is what can be used for operations, capital allocation etc. This would obviously mean they are not treating cash against these liabilities as unencumbered.

So if you are looking at BSE Ltd from an investment perspective please bear in mind that the unencumbered cash, as per management, as on Q3FY18 is 1600 cr. This is what will be used for operations, acquisitions, organic growth, dividends and buybacks. Rest of the cash and investments are encumbered but generating liquid investment returns for BSE and its shareholders.

We may agree to disagree here, it was a fun exercise to understand an exchange’s balance sheet.

If anyone cares to have a look/perform their own calculations, please do. Would be happy to be proved wrong.

Attachments:

1. Excel Sheet - BSE Cash


2. FY17 Annual Report with relevant figures highlighted -  https://www.dropbox.com/s/1r91z738aggv6h7/BSE_Annual_Report_2016_2017.pdf?dl=0

 Disclosures:

1. I am invested in this stock, and my views may be biased.


2. This is not a buy or sell recommendation, just an exercise in understanding the business model and balance sheet better.


3. Please do your own due diligence, the views expressed in this post are my own, and I reserve the right to be wrong.