The ASX guided to operating expenses growing by 13%-16% in fiscal 2027 and lifted capital expenditure guidance by a little over 10%. Shares fell more than 10% following the announcement.

Why it matters: We expected the exchange to be closer to cycling its large investment cycle, which kicked off in fiscal 2023 as the botched replacement project for the Clearing House Electronic Subregister System was replaced by a different solution.

  • Guidance is for fiscal 2028 capital expenditure to fall 5% on fiscal 2027, supporting our view that the investment cycle will likely peak in 2027.
  • The exchange cited technology cost inflation and new product development costs as the drivers for higher costs. We struggle to reconcile this with artificial intelligence driving down the cost of technology development. We expect regulator-induced self-flagellation and appeasement to play a part as well.

The bottom line: We lower our fair value estimate for wide-moat ASX by 5% to $67 per share. We update near-term expense forecasts and lower our expectations for terminal margins. Shares screen as materially undervalued.

  • We now expect steady state operating margins for the exchange to be in the mid-50s percent from high-50s previously. We expect margins to be in the mid-40s in fiscal 2027-2029 as the exchange grows into new cost levels.
  • We expect the incoming CEO, Anthony Attia, former CEO of Euronext Paris, to provide an opportunity for a reset of relations with market participants and, crucially, regulators.

Big picture: Operating expenses in fiscal 2027 are guided to be more than twice what they were in the highly volatile years of fiscal 2020 and fiscal 2021. Even with inflation, we believe this expense level is elevated, enforcing our belief that the exchange will be able to return to higher operating margins.

ASX expense guidance suggests spending to remain elevated for longer

We expect the Australian Securities Exchange’s near- and medium-term strategic focus to be on protecting its economic moat in cash equity clearing and settlement. ASX has long been protected from competition through various exclusive licenses to clearing and settlement, which we consider a source of its economic moat, based on intangibles. However, over the past decade, ASX has faced increasing calls from the federal government, regulators, and industry bodies for more competition.

In response to these calls, ASX attempted to deliver a world-leading new clearing system based on blockchain. But after several years of delays and cost overruns, this project has been binned, which has renewed discussion on opening up the clearing and settlement market to more competition. We expect ASX to therefore focus on trying to demonstrate to the federal government, regulators, and industry bodies that it is capable of maintaining smooth operations of Australia’s financial infrastructure, including by increasing spending on its various systems.

Regardless of the potential regulatory outcome, cash equity clearing and settlement make up only around 15% of ASX’s revenue. Moreover, we believe that even if cash equity clearing and settlement were opened up to competition, ASX’s business would remain well protected due to the network effects inherent in its clearing business. We therefore do not expect significant changes to ASX’s cash equity clearing and settlement market share or margins in the foreseeable future.

Bulls say

  • ASX is a vertically integrated exchange with a wide moat based on network effects and intangibles.
  • ASX benefits from exposure to Australia’s outsize natural resources sector, and the energy transition will continue to fuel demand for ASX’s listing services.
  • Volatility will increase demand for ASX’s trading and clearing services, especially for companies in the highly volatile materials and energy sectors, which make up around half of total listings.

Bears say

  • ASX has failed to adequately secure its economic moat based on regulation and now risks increased competition and costs.
  • ASX has not yet presented a credible plan to replace its aging clearing system.
  • Uncertainty in financial markets may negatively affect ASX’s listings business, which is disproportionately large compared with peer exchanges.