June 21, 2009 Fair Value Estimate: AED 2.04 Recommendation:: Hold Executive Summary DFM posted a weak operating result in Q1 2009. Total revenue fell 24.7% q-o-q to AED 68.6mn due to lower trading commission fee as a result of the exchange s weaker total traded value. While first quarter market data suggested investors were becoming cautiously optimistic, April-May figures show that the market has rebounded and investor confidence improved. As a result, we forecast a 97.6% q-o-q increase in Q2 2009 trading commission fee and an EBIT of AED 91.3mn. The Q1 2009 net profit improved to AED 68.2mn, from a loss of AED 175.7mn in Q4 2008. However after adjusting for impairment losses in Q4 2008, profit for Q1 2009 decreased by 8.2%. For Q2 2009 we expect net profit to increase by 61.7% q-o-q to AED 110.3mn resulting from higher trading commission fee. Market data for April-May 2009 indicates a significant increase in the exchange s total traded value based on greater investor confidence; supported by the recent rally in oil prices and hopes that the economic slowdown is bottoming-out. As we expect this uptrend to continue, we have upgraded our key market capitalisation/gdp and market-velocity estimates. Valuation: Based on our increased key estimates, our weighted average SOTP and peer group multiple valuation yields a fair value estimate of AED 2.04, indicating a possible upside of 12.6% from current levels. However, we believe that the 46% increase in DFM s share price over Q1 2009 largely factors-in the potential near-to-medium term positives. We don t expect any significant upside from current levels, therefore, we downgrade our rating to Hold. RESULT UPDATE Share Data Market Cap Price AED 14.4 bn AED 1.81 DFM General Index 2,014.09 Reuters DFM.DU Bloomberg DFM UH Avg. Volume (52 Week) 44.7 mn 52-Week High/Low Shares Outstanding AED 5.5 / 0.76 7,944 mn Fair Value Estimate AED 2.04 Key Figures Year to 31 Dec 2008A 2009E Revenue (mn) 688.9 447.1 EBITDA (mn) 619.4 384.7 Investment income (mn) 74.3 102.2 Net Profit (mn) 605.0 403.5 Adj. EPS (AED) 0.08 0.05 +/- (%) (37.7)% (33.3)% RoA (%) 6.4% 4.7% RoE (%) 6.8% 4.9% P / E (x) 16.4x 35.6x EV / EBITDA (x) 14.2x 33.4x P / BV (x) 1.2x 1.7x Shareholding Pattern (%) Borse Dubai 80% Public & Others 20% Relative Performance 7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0 Jun-08 Jul-08 Aug-08 Sep-08 Oct-08 Nov-08 Dec-08 Jan-09 Feb-09 Mar-09 Apr-09 May-09 Jun-09 DFM Rebased Index ADCB Wealth Management Group I Research I +97126973525 ADCBresearch@adcb.com 1
Investment Rationale DFM reported a weak operating result for Q1 2009, due to weaker trading commission fee income, following a decline in the exchange traded value. While the net income for the quarter increased from a loss of AED 175.7mn in Q4 2008 to a profit AED 68.2mn, it was mainly driven by the absence of impairment losses on the AFS portfolio. The DFM General Index has increased by approximately 30% since the end of the first quarter, showing early signs of recovery. While Q1 2009 indicated sluggish trading activity, market data in April-May 2009 suggests an upsurge in total traded value on the exchange. Consequently, we have revised upward our near-term assumptions regarding market capitalisation and market velocity. Further, in view of rising oil prices, and improving risk appetite, especially for the UAE region, we raise our long-term market capitalisation/gdp and market velocity forecasts, resulting in an increase in our fair value estimate to AED 2.04. We believe the current share price largely discounts the near-term positives, and see no significant upside possibilities from present levels. Hence, we regard the share as fairly-valued and downgrade our rating to Hold. Weak operating performance; likely to improve DFM reported a 25.5% q-o-q fall in the chief constituent of its total revenue trading commission fee, which fell from AED 82.8mn to AED 61.7mn. This was due to lower exchange traded values, which went down from AED 37.6bn in Q4 2008 to AED 27.6bn in Q1 2009. First quarter EBIT fell 35.9% q-o-q to AED 31.7mn. Operating costs remained under control with selling, general, and administrative expenses down 23.3% q-o-q. For Q2 2009, we expect total revenues to increase by 88% q-o-q to AED 128.9mn, following an increase in traded values. Exchange data for April and May 2009 indicates a significantly higher total traded value on the exchange. We expect DFM s revenues to improve steadily in 2009, as market activity increases further. In our view, the pessimism prevailing until Q1 2009 is being replaced by cautious optimism with markets showing early signs of recovery. Long-term outlook on trading activity remains bullish Despite short-term market weakness in Q1 2009, we remain bullish on DFM s long-term prospects. Total traded value, the key driver of the company s income increased from an average of AED 9.2 billion per month in Q1 2009 to AED 13.9bn in April, and AED 14.9bn in May. Higher values indicate increasing turnover velocity, reflecting improved investor sentiment. In our view, this development is supported by visible signs of economic recovery and rising oil prices which should benefit the region. In addition, the net investment by foreign investors has improved in recent months. Through Q1 2009, foreign investors were net sellers to the tune of AED 338.9mn, whereas in April and May alone they have been net buyers of AED 792.1mn. This has resulted in further increases in values and better investor confidence. ADCB Wealth Management Group I Research I +97126973525 ADCBresearch@adcb.com 2
Trade Value on DFM 24 21.8 20 AED bn 16 12 11.6 10.9 11.2 13.9 14.9 8 4 4.2 5.5 0 Oct Nov Dec Jan Feb Mar April May Source: DFM Monthly Bulletins The DFM General Index is currently trading at ~6x 2009E earnings, compared with 5.2x in April 2009, providing further evidence of the recovery in investor confidence. We believe PE multiples are likely to revert to their long-run historical averages. Consequently, we increase our market capitalisation/gdp ratio to 110-130% for 2011-12 and to 160% on a terminal year basis. We have also revised our trading velocity forecast upward to 85-100% for 2011-12, maintaining it at 135% for the terminal year. As a result, our fair value increases significantly to AED 2.04. Reforms in full swing DFM has intensified its efforts to improve its functional and regulatory framework to bring itself more in line with international standards. The most important of the company s recent initiatives was the publication of its "Guide to Going Public" intended to support private and family businesses planning to seek a public listing. In this regard, the Emirates Securities and Commodities Authority (ESCA) is now seeking to develop laws and regulations to lower the minimum free float requirement to 30%, allow book building, and adopt relevant valuation mechanisms. These initiatives should help improve IPO market activity and increase trading income. At the same time, other developments being considered include allowing trading of rights issue listings, and permitting short selling. In addition, the exchange is currently introducing a Delivery Versus Payment (DVP) system, intended to abolish present T+2 settlement arrangements. Overall, these new proposals should help improve market efficiency and support investor efforts to diversify their investment options. ADCB Wealth Management Group I Research I +97126973525 ADCBresearch@adcb.com 3
Valuation We have valued using a combination of SOTP and Peer-Based Multiples. Within the SOTP, we have valued the exchange using DCF valuation and its portfolio of AFS investments at current value, based on the QTD movement in the DFM General Index. We have assigned subjective weights of 90% to our SOTP and 10% to our Peer-based Multiples Valuation to calculate our fair value estimate. Our SOTP valuation has been assigned a higher weight as it discounts firm-specific cash flows and assets. We arrive at a weighted average fair value estimate of AED 2.04, which implies a 12.6% upside from the current market price of AED 1.81. Therefore, we downgrade our rating to Hold. Weighted average table: Weighted Average Value per Share Valuation Method Value (AED) Weight (%) Discounted Cash Flow (DCF) 1.99 Value of AFS Investments 0.15 Total SOTP Value 2.14 90% Peer-based multiple valuation 1.13 10% Weighted Average Fair Value 2.04 Source: ADCB research SOTP Valuation We have valued the core exchange business using a two-stage DCF model with explicit forecasts to 2016. Based on our forecasts, we have calculated free cash flows to equity holders which have then been discounted in order to estimate the fair value of the Company. We have estimated the Cost of Equity using the Capital Asset Pricing Model. The key assumptions underlying our model are as follows: Risk free rate: 4.2% Equity Risk Premium: 6.0% Country Risk Premium: 2.9% Beta: 1.16 Cost of equity: 14.06% Terminal growth rate: 3.5% Based on these assumptions, our estimate of the fair value of equity for DFM is AED 15.8bn. There are 7.9 billion fully diluted shares currently outstanding. On this basis, our DCF model yields a fair value of the core exchange business of AED 1.99per share. In addition, DFM had AFS portfolio of AED 954.1mn as of March 31, 2009. This portfolio consists of actively traded equity shares. We have estimated current value of the AFS portfolio based on the change in the DFM General Index since March 31, 2009. DFM General Index value has since increased 28.8% and we have accordingly increased the book value of AFS portfolio (as of March 31, 2009), indicating a fair value of AFS portfolio of AED 0.15 per share. Consequently, our SOTP methodology yields a fair value estimate of AED 2.14 per share. ADCB Wealth Management Group I Research I +97126973525 ADCBresearch@adcb.com 4
Sensitivity of the SOTP fair-value estimate, using different rates for terminal cost of capital and terminal growth rates: Terminal growth Source: ADCB research Terminal Cost of Capital 2.14 13.1% 13.6% 14.1% 14.6% 15.1% 2.5% 2.21 2.11 2.02 1.94 1.87 3.0% 2.28 2.17 2.07 1.99 1.91 3.5% 2.36 2.24 2.14 2.04 1.96 4.0% 2.44 2.32 2.20 2.10 2.01 4.5% 2.54 2.40 2.28 2.16 2.07 Sensitivity of DCF based fair value to changes in value of shares traded in the terminal year (2016) Sensitivity of DCF Derived Valuation to Value Traded Shares -40% -30% -20% -10% Base Case +10% +20% +30% +40% Value of Traded Shares (in AED Bn) Fair Value Estimate 695 810 926 1,042 1,158 1,273 1,389 1,505 1,621 1.51 1.63 1.75 1.87 1.99 2.10 2.22 2.34 2.46 Using our peer-based multiples valuation, our analysis yields a fair value per share of AED 1.13. Company Comparable Company Trading Analysis Mcap MCap Index co./mcap 31-Mar-09/ P/E ROE index Total GDP 31-Mar-09 2008 2008A 2009E 2010E 2008A 2009E 2010E Deutsche Bourse 1.7% 19.7% 10.7x 13.5x 12.0x 41.1% 27.5% 28.2% New Zealand Exchange 0.1% 116.0% 20.1x 17.2x 15.8x 32.1% 14.3% 10.8% Australian Stock Exchange 0.6% 76.1% 16.8x 19.1x 20.0x 13.3% 11.8% 11.2% Bovespa Brazil 1.5% 32.9% 36.2x 20.6x 16.0x 2.4% 5.8% 10.6% Hong kong Stock Exchange 1.2% 385.5% 25.4x 28.9x 25.1x 65.5% 58.1% 61.9% Bursa Malaysia 0.7% 58.6% 36.9x 39.8x 32.5x 13.8% 13.2% 15.4% Singapore Exchange N/A N/A 15.8x 25.7x 21.9x 55.5% 35.0% 41.0% Johannesburg Stock Exchange 0.1% 118.0% 11.3x 13.0x 11.5x 30.2% 23.1% 21.3% Mean 0.8% 115.2% 21.7x 22.2x 19.4x 31.7% 23.6% 25.0% Median 0.7% 76.1% 18.4x 19.8x 18.0x 31.1% 18.7% 18.3% P/E multiple (Peer-group Avg) 22.2x EPS09E 0.05 Equity Value 1.13 Source: ADCB research, Reuters ADCB Wealth Management Group I Research I +97126973525 ADCBresearch@adcb.com 5
Balance Sheet Income Statement (AED M,Yr. ending Dec. 31) Q109A Q209E Q309E Q409E Q109A Q209E Q309E Q409E Cash and cash equivalents 670 1,600 1,705 1,517 Revenue 69 129 111 139 Investment deposits 262 275 289 303 Operating Cost 37 38 38 39 Receivables and other current assets 855 6 6 7 EBIT 32 91 73 100 Property, plant and equipment - net 307 308 309 309 EBITDA 54 114 95 122 Other financial assets - non current 954 954 954 954 Depreciation & Amortization 22 22 22 22 Goodwill & other intangible assets-net 5,659 5,640 5,621 5,602 Non-operating income (expense) 31 19 26 26 Total Assets 8,707 8,784 8,883 8,692 Interest expense - - - - Investment Revenue 21 19 26 26 Payables and other current liabilities 105 72 72 73 Gain from revaluation of HFT securities 10 - - - Bank Loan - - - - Impairment Loss on AFS Investments - - - - Other long term liabilities 283 283 283 283 Profit Before Tax 63 110 99 126 Share capital and reserves & surplus 8,589 8,589 8,589 8,589 Tax - - - - Investments revaluation reserves 965 965 965 965 Adjusted Net Profit 63 110 99 126 Retained Earnings 695 805 904 713 IPO and other income 6 - - - Total Equity & Liabilities 8,707 8,784 8,883 8,692 Exceptional Items (non tax adj) - - - - Reported Net Profit 68 110 99 126 Balance Sheet Income Statement (AED mn, year ending Dec. 31) 2007 2008 2009E 2010E 2007 2008 2009E 2010E Cash and cash equivalents 1,313 1,106 1,517 1,587 Revenue 827 689 447 631 Investment deposits 1,000 562 303 444 Operating Cost 165 158 151 161 Receivables and other current assets 548 38 7 8 EBIT 662 531 296 470 Property, plant and equipment - net 313 308 309 315 EBITDA 748 619 385 560 Other financial assets - non current 1,296 944 954 954 Depreciation & Amortization 86 89 89 90 Goodwill & other intangible assets-net 5,754 5,678 5,602 5,526 Non-operating income (expense) 310 74 102 65 Total Assets 10,223 8,636 8,692 8,834 Interest expense 0 0 0 0 Investment Revenue 119 263 92 115 Payables and other current liabilities 337 103 73 76 Gain from revaluation of HFT securities 190 61 10 0 Bank Loan 0 0 0 0 Impairment Loss on AFS Investments 0 (250) 0 (50) Other long term liabilities 282 283 283 283 Profit Before Tax 972 605 398 536 Share capital and reserves & surplus 8,408 8,589 8,589 8,589 Tax 0 0 0 0 Investments revaluation reserves 189 (975) (965) (965) Adjusted Net Profit 972 605 398 536 Retained Earnings 1,008 637 713 851 IPO and other income 468 0 6 0 Total Equity & Liabilities 10,223 8,636 8,692 8,834 Exceptional Items (non tax adj) 0 0 0 0 Reported Net Profit 1,440 605 404 536 Cash Flow Statement 2007 2008 2009E 2010E Key Ratios 2007 2008 2009E 2010E Net Profit - Reported 1,440 605 404 536 Per share data (AED) Depreciation 10 13 13 14 Shares outstanding (mn) 7,944 7,944 7,944 7,944 Other non-cash and non-operating items (700) 2 (13) (40) Adj. Basic EPS 0.12 0.08 0.05 0.07 Changes in Working Capital 89 (241) 1 2 Adj. Diluted EPS 0.12 0.08 0.05 0.07 Cash from operating activities 839 379 405 512 Book Value per share 1.21 1.04 1.05 1.07 Employees' end of service indemnity 0 0 - - Interest paid - - - - Valuation ratios (x) Net cash from operating activities 838 379 405 512 P/E 10.2x 16.4x 35.6x 26.8x EV/EBITDA 11.5x 14.2x 33.4x 22.8x Net Capex (14) (10) (14) (20) P/BV 5.1x 1.2x 1.7x 1.7x Other Adjustments (1,150) 198 348 (25) Net cash from investing activities (1,164) 188 334 (45) Other Ratios (%) Adj. ROAA 15.5% 6.4% 4.7% 6.1% Proceeds from long term loans 558 - - - Adj. ROAE 16.5% 6.8% 4.9% 6.4% Dividend - (774) (318) (397) Adj. ROACE 16.5% 6.8% 4.8% 6.4% Other Adjustments 500-10 - Net cash from financing activities 1,058 (774) (308) (397) EBIT Margin 80.0% 77.0% 66.2% 74.5% EBITDA margin 90.4% 89.9% 86.0% 88.8% Net (Dec.) / Inc. in cash 732 (208) 431 70 Net Profit Margin 117.4% 87.8% 90.3% 84.9% Cash at the beginning of period 582 1,313 1,106 1,517 Debt/Equity 0.0% 0.0% 0.0% 0.0% Cash at the end of period 1,313 1,106 1,517 1,587 Interest coverage ratio NA NA NA NA Source: Company Data, ADCB Research ADCB Wealth Management Group I Research I +97126973525 ADCBresearch@adcb.com 6
Investment Ratings: Buy: More than 15% potential return. We recommend that investors buy the stock based on the annualised return to the shareholders over 6-24 months time horizon (percentage change from current price to the projected target price). Sell: Negative potential return. We recommend that investors sell the stock based on the annualised return to the shareholders over the 6-24 months time horizon. Hold: Between 0 and 15% potential return. We take a neutral view on the stock over the 6-24 months period. Other Disclosures: Abu Dhabi Commercial Entity (ADCB) publishes independent research based on its own opinions and does not have investment banking relationships with any firm whose security is mentioned in this report. ADCB does, however, hold securities of the firm mentioned in this report through its fund management activities. If you choose to use the information in this report, you do so on your own initiative, and you are responsible for compliance with any applicable local laws. ADCB certifies that no part of the research analyst s compensation was, is, or will be, directly or indirectly, related to the specific recommendations or view expressed in this research report. The information and opinions in this report were prepared by employees of ADCB and are current as of the date of the report. The information contained herein has been obtained from sources that they believe to be reliable, but ADCB does not guarantee its accuracy, adequacy, completeness, reliability, or timeliness. Moreover, it is not responsible for any errors or omissions or for the results obtained from the use of such information. All opinions and estimates included in this report are subject to change without notice. ADCB will furnish, upon request, available investment information supporting this recommendation. This report is intended for qualified customers of ADCB. This research report provides general information only. Neither the information nor any opinion expressed constitutes an offer or an invitation to make an offer, to buy or sell any securities or other investment or any options, futures or derivatives related to such securities or investments. It is not intended to provide personal investment advice and it does not take into account the specific investment objectives, financial situation and the particular needs of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities, other investment or investment strategies discussed or recommended in this report and should understand that statements regarding future prospects may not be realised. Investors should note that income from such securities or other investments, if any, may fluctuate and that price or value of such securities and investments may rise or fall. Accordingly, investors may receive back less than originally invested. Past performance is not necessarily a guide to future performance. Any information relating to the tax status of financial instruments discussed herein is not intended to provide tax advice or to be used by anyone to provide tax advice. Investors are urged to seek tax advice based on their particular circumstances from an independent tax professional. Foreign currency rates of ADCB Wealth Management Group I Research I +97126973525 ADCBresearch@adcb.com 7
exchange may adversely affect the value, price or income of any security or related investment mentioned in this report. In addition, investors in securities such as ADRs, whose values are influenced by the currency of the underlying security, effectively assume currency risk. To the fullest extent permitted by law, neither ADCB nor any of its employees will be liable to you or anyone else under any tort, contract, negligence, strict liability, products liability, or other theory with respect to this presentation of information. You may not redistribute this report without explicit permission from ADCB. Note: is an Islamic financial institution that does not deal with interest and follows Islamic law (Sharia) in all its practices. We have used the terms interests & loans solely for the sake of comparing s financial performance against other commercial entities in the market. ADCB Wealth Management Group I Research I +97126973525 ADCBresearch@adcb.com 8
ADCB Research Team: Khaled Akl, MBA, CFA Head of Research Khaled.A2@adcb.com +971 2 696 2843 Sami Benghezal, M.Sc, FRM, CFA Research Manager sami.b2@adcb.com +9712 697 3525 Jehad Saeed Al Mazrooei Research Analyst Jehad.s@adcb.com +9712 697 3522 Rakesh Kumar Agrawal, MBA Research Analyst Rakesh.k@adcb.com +9712 697 3685 ADCB Wealth Management Group I Research I +97126973525 ADCBresearch@adcb.com 9