TMX Group has published disappointing 3rd quarter results. The Toronto, Vancouver and Montreal stock exchanges operator saw its revenues and profits fall 6% and 18% respectively. It would be easy to simply blame the recession, but it would obscure what appears to be the weakening competitive position of the company. Indeed, revenues from the Toronto Stock Exchange fell by 42% (from 26 million to 15 million) because of competition from new alternative trading system (ATS) such as Alpha, Chi-X and Pure Trading. This decrease was significantly higher than management had anticipated.
For years, the TMX Group ruled the canadian stock market as a quasi-monopoly. The company was highly profitable, since it could increase its revenue without large capital investments. The situation has radically changed since last year. The operator must now make significant investments in its technology infrastructure just to keep pace with the new ATS. To make matter worse, TMX group must also slash its prices to remain competitive. Needless to say that its profitability is taking a hit and the intensity of competition is not likely to diminish anytime soon …
The recent strategy of TMX group was to diversify by purchasing the Montreal Derivatives Exchange in 2007. In retrospect, it is clear that the TMX group probably pay too much for the Montreal Exchange. According to TMX Group CEO Thomas Kloet, the derivatives market in Canada is flawed. The lackluster earning of the Montreal Exchange seems to confirm his view. Again, the purchase of the Montreal Exchange seems to have been an (expensive) defensive maneuver in order to prevent the latter to make an alliance with a big U.S. exchange. Its 50% stake in the Boston Options Exchange (BOX) is not more exciting. The BOX seems doomed to be a second-rate exchange in the hyper-competitive options market in United States.
In conclusion, I must admit that the TMX Group is no longer the fortress surrounded by a wide moat that attracted me as an investor a few years ago. My feeling is that its moat is now filled with sand, the main gate is down and that enemies are inside the walls! Long-term investment in a stock like TMX Group could be rewarding provided we are able to identify in time the weakening of its competitive position. Which I was unfortunately unable to do !
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