The ASX result was out on Friday, quite a miss compared to consensus (e.g. actual EPS 1.19 vs street at 1.257).

ASX has more than a few segmentals, and as such it’s a touch more diversified than you might think, at first, for an exchange operator.

Market-related activity such as new listings and cash equities trading was weak to flat, futures and options were (in parts) better and technology-related items (connectivity, market data, technical services) were all better. None of that really mattered, it was all about cost, but we’ll come to that in a moment.

Some of those revenue lines are quite cyclical, and at some point they’ll be back. You can see how capital market activity for the ASX fell off a cliff, relative to the prior few years.

Net interest income was a positive, higher rates means more generated on collateral balances (even as those collateral balances were down, lower vol means less margin posted which reduces the overall balance on which higher rates can accrue).

That’s all good to look at it, but what drove the result was the the cost line. The ASX has had several high-profile issues, ranging from market outages (despite being infrequent, these are huge credibility hits to the ASX’s license to operate) and the CHESS replacement debacle (mgmt, a few years ago, decided to use unproven/untested blockchain tech to replace CHESS, and it failed spectacularly).

To fix these operational and regulatory pressures, ASX has had to hire staff, hire contractors, spend money on more projects than one would like, and all of that was very visible in the step up in operating expenses.

Most of the damage was done in the prior half, but there was still cost pressures in this half. That ate into EBIT.

The good news, perhaps, is that the rate of cost growth is set to come down in the second half. Some of the cost pressures were one-off in nature (related to engagements with ASIC) that won’t keep recurring, and the ASX has now (after being full of staff) set upon a cost-out exercise, and will let 3% of the staff base go, amongst other things.

Part of our investment thesis was that ASX completely messed up, had material regulatory and operational costs imposed upon it, and with the share price having corrected from ~$90 to low $60’s, would embark on a transformation program (succeed in replacing CHESS, succeed in repairing relationships with industry stakeholders (everyone from APRA to the RBA to to ASIC to other financials) and would get the cost base right.

I continue to think that at some point the ASX will announce a much more ambitious cost out program, but they probably need to finish doing the above before they have the licence to go much harder on the restructuring plans.

To round out this conversations on cost, I found this exchange from the Q&A call quite illustrative. Specifically, the maths of the second half, in order to have cost growth over the year of ~15%, suggests a fall in costs in the second half, which would mean, all else equal, EBIT growth.

The analyst community is highly skeptical, and so that is a key area of difference, a variance to market. New management are highly incentivised, expectations are low, there seems to be plausible reasons about why growth should moderate, and, looking further out, with over a 1000 employees working at the ASX, there is considerable scope for efficiencies to be found over time, that could plausibly surprise the market to the upside.

Margins are now middle-ish of the pack, and should all of the above play out as expected, would return the ASX towards the upper end of the table.

Perhaps one last Q&A exchange. Sidd below references perhaps the metric that in the end really matters. ROE is currently south of the target. How, and how quickly can they get back.

And hence the reminder that it’s all about cost out. If they succeed there, the path to return is set, and that it’s not too far away. Thus, I think, it wouldn’t take too much to go right, to surprise to the upside. Also, perhaps not touched on too much in our note here, but the ASX have pricing levers, that Siddharth refers to, and a mix of prices up and cost out would work.

The ASX is ungeared, and typically quite cash generative. At 25x forward, we are comfortable with the balance of risks. It generates a modest yield, and is quite defensive, ordinarily, which we think is attractive in the current environment.

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