Merrill Lynch -

Reinstate coverage with a Sell; Fair value S$12/sh Singapore exchange-operator, SGX, has cleverly positioned itself at one of the cross-roads for Asian stock listings, paid out its excess capital and benefited from surging turnover. The stock, in turn, has reacted jubilantly, up 13-fold since its IPO in 2000. However, with the stock trading at a PER of 37x in 2008E and 31x in 2009E, we believe that valuations now fully reflect SGX?s rosy growth outlook. We reinstate coverage with a Sell and advise investors to wait for better entry levels. Our DDM-based fair-value is S$12/share, which assumes a 5-year EPS CAGR of 22%, a 90% payout ratio and terminal growth rate of 4%.

Stretch-assumptions still finds stock expensive
We recognize that having a negative call on a stock with such strong momentum (+160% YTD) is risky, especially with market turnover showing few signs of meanreverting. But, after stretching our earnings estimates, for example assuming stock-market turnover velocity rises to 80% by 2010 from 60% in 2006, we still find the stock expensive. Our numbers assume from now until 2010 that average turnover doubles to S$3.2bn per day, derivatives revenue rises at an average 16% pa and that SGX?s cost-income ratio falls to 30% (from 37% last year). Yet, despite this, our profit estimates are 19% below consensus for 2008 and 2009.

Corporate action could be wildcard
One common rationalization for SGX?s high valuation is that it warrants a takeover premium. Feverish M&A activity in global exchanges, as well as the Tokyo Stock Exchange taking a 4.99% stake in SGX in June this year, certainly adds fuel to the fire. But, we think it equally likely that exchanges in Asia that are granted effective monopoly status by their regulators may resist being controlled by a rival country?s exchange.How much is too much for an Asian exchange gateway?