Giełda Papierów Wartościowych w Warszawie Spółka Akcyjna (I think we all agree that going forward it’s better to call it GPW) is the primary financial exchange for everything that goes on in Poland, from equities to fixed income to derivatives to a large business in electricity and gas trading.
Traded under the ticker GPW.WA and with a market cap of around $400 million, the group includes the Warsaw Stock Exchange, the biggest in Central & Eastern Europe (55%-60% of group revenues); the TGE Group, the only licensed commodity exchange in Poland (35%-40% of group revenues); and a 33% stake in KDPW, the central infrastructure for the depository, clearing and settlement system in Poland. [Note: the company trades in PLN and reports its numbers in PLN: to allow for easier comparisons, I have converted some metrics to USD.]
Some economic background
A full history of the evolution of the Polish financial markets is beyond the scope of this write-up: Undervalued Shares has several excellent articles on what it means to invest in Poland, including some specific stock ideas: you can find them here, here and here. Some of the following considerations are indeed taken from these posts.
Poland is one of Europe’s most consistently growing economies: it was the first Eastern European country to achieve "
high-income" status and today ranks alongside its Western counterparts. Macroeconomic conditions have hugely improved since the late 1980s, when it was one of the poorest countries in Europe with salaries just one tenth of neighbouring Germany and outdated and inefficient infrastructures and industries.
Here is the more recent history: 27 consecutive years of economic growth, averaging 4.2% p.a. from 1992 to 2019 (+5.1% expected in 2021 after the -2.7% Covid drop), a period during which it grew faster than Singapore, Taiwan and South Korea.
Poland is now the seventh largest economy in Europe, ahead of Sweden, and to fund its growth it didn’t even have to rack up an outrageous amount of debt: it’s latest debt/GDP ratio is still only 57%, compared to 70% for Germany, 115% for France or 155% for Italy. This is reflected in very solid credit ratings: A2 (stable) from Moody’s, A- (stable) from S&P and A- (stable) from Fitch.
The Warsaw Stock Exchange held its first trading session on April 16, 1991 with five listed companies, all of which were formerly state-owned enterprises that had been privatised. In 1999, Poland reformed its pension system, which contributed to an increase in domestic institutional investment, and in 2004 it joined the EU. In 2010 GPW listed on its own exchange.
GPW offers the full suite of products and services of a modern exchange (but no crypto for the moment).
It has the biggest capitalisation of all exchanges in Central and Eastern Europe: it currently lists 429 companies on the Main Market (47 non-Polish) for a total ~$315 billion in market cap and an additional ~300 companies in the junior New Connect Market. In terms of numbers of listed companies, this is in line with Germany and more than France. Using the “Buffett indicator”, market cap to GDP in Poland is around 55%, not that dissimilar to Germany (62%) but ahead of Italy (44%). With the same amount you can buy SAP and Linde (#1 and #2 in the DAX index), or the entire main market in Warsaw. Given the growth of the Polish economy, it is not an unlikely scenario that GPW’s market cap closes its gap toward more developed markets.
The economic success of the country did not however translate into a decent performance for Polish blue-chip stocks: the WIG20 Index is currently trading at the same level as early 2000 and more than -40% off the peak reached in 2007.
Problem #1: “it’s just old economy, often state-controlled”
Most of the blue-chip companies that make up the WIG20 index are old economy, and in many cases the government is a significant (or even dominant) shareholder: such companies tend to trade at a discounted valuation, whether in Poland or elsewhere.
But if you dig a bit deeper, you actually discover a high-tech hub for IT, biotech, healthcare and media/gaming companies. Thanks to a mix of culture and affordable living costs, many European companies have outsourced their programming to Poland, where there is indeed a thriving start-up scene. The country's large, highly educated population puts it at an advantage: it has one of the better university systems in the world, ranked among the top 10 globally by some surveys, and a talented pool of developers. The most well-known companies are CD Projekt and Allegro, but also Amazon has 15.000 employees in its Development Center in Gdansk, including a variety of teams that deliver innovative solutions to power Amazon products and services around the world such as the cloud-based voice-recognising virtual assistant Alexa.
Venture capital investments have also exploded over the last two years, including a significant increase in foreign interest: some of those start-ups will inevitably list on the Warsaw Stock Exchange in the future.
Problem #2: “there is little domestic demand for equities”
It is true that the overall interest in equities in Poland is well behind other countries in Western Europe, let alone the US or Asia. Poland has also been lacking a sophisticated sector for pension monies going towards purchasing domestic equities. These are some of the long-standing, widely accepted narratives why the Polish stock market has not been able to pick up pace.
However, things are changing (albeit slowly). Following year-long debates and extensive public consultations, Poland has revamped its pension system, a move that could provide a tailwind for the stock market. Introduced in 2019, the new regulation is coming into force in tranches: contributions to the system will be financed by employers, employees and the state budget and will consist of a mandatory stake of at least 3.5% of employee’s gross salary with an optional additional contribution of up to 4.5% of salary.
From the stock market perspective, the reform means substantial annual capital inflows as the institutions entitled to run these Employee Capital Plans (ECPs) will be obliged to invest a significant portion in the Polish capital markets: the ECPs investment policy assumes allocating at least 40% of the equity portfolio in shares (and share-based instruments like futures and options) included in the WIG20 index, and no more than 30% in other GPW-listed companies.
In addition, there is potential for the growth of retail investments (but forget anything WSB-style!): while household assets have tripled since 2006, only 5% are in equities, with most of the money still in bank deposits.
Some other future developments the company expects to bear fruits in the next years include:
Frontier markets: GPW has the clear ambition to be the leading exchange for the East European bloc. Companies in countries like Ukraine, Georgia, Czech Republic and Armenia do not think it very attractive to list on their local exchanges, which are too small. At the same time, these companies might not be big enough to list in London, Amsterdam or Paris. GPW would then be a kind of middle ground and ideal destination.
Listing business: venture capital did not exist 15 years ago in Poland and small companies used the New Connect exchange to raise money. This is the main reason GPW has so many tiny listed companies. With VCs funds now active for some years, this resulted in a decline of small companies coming to the market, which is a clear negative for an exchange. But the VC funds that snapped up these small companies over the past 5 years will want to make an exit at some point. So GPW management expects a pipeline of new medium companies to come to the market in the near future.
Blockchain/tokens: as many other financial firms, GPW is looking into blockchain technology and plans to launch a token platform, in part driven by the large number of gaming companies in Poland that want to finance projects through crowdfunding which could be enabled through this type of platform.
Selling trading systems: the small frontier markets mentioned above might be the first customers for modular, turnkey solutions that they don’t have the capabilities to build themselves.
Some financial numbers and valuation
Since going public in 2010, and while there have been ups and downs, the stock has been basically flat; actually, the current price is even below the IPO price.
In contrast, the company does show a solid performance: revenue growth of 5.5% since the IPO is nothing spectacular (core net income CAGR has been slightly lower at 4.9%), but it has a diversified revenue structure (over time it added different markets such as commodities) and has always been profitable, with a ~17% average ROE and ~48% EBIT margin.
EBIT and core income have failed to follow revenues for a couple of reasons. The first is the increase in FTEs over the last couple of years, necessary to handle the expansion plans currently in development (these costs are sticky but should yield a return – with a lag – as projects are finalised). The second reason cited by management are supervisory fees and charges which the company claims are hard to predict or control. All in all, GPW seems to have been taking costs for the future, combined with some unfortunate headwinds that would not necessarily repeat. Even if equity markets would be softer in the near term, GPW can likely remain quite profitable.
The company is also more diverse than one might think in terms of revenue and earning streams: it is not just stock listings and/or trading.
For the ownership structure, the State Treasury of Poland has the largest stake (35%) but it is also the majority voteholder (52%).
With all the limitations of standard metrics like P/E and EV/EBITDA, GPW appears to be the cheapest exchange in the world, even cheaper than Mexico, Russia and other emerging countries that do not offer the political stability and growth that Poland has shown over the last two decades.
Source: Koyfin. All metrics are “NTM (next twelve months)”.
GPW is a highly cash generative company with a net cash position: it does not require much in terms of capex (mostly technology-related intangibles) and is able to fund development projects in-house while still maintaining a strong profitability. Free cash flows are mostly used to pay large dividends: the current policy is to pay out at least 60% of consolidated net profits, probably due to the government owning a 35% stake and enjoying a reliable paycheck.
With a market cap of $400 million, GPW (a business with a ~17% ROE, a $80 million net cash position, a dividend yield of ~8% and a P/E of 10x) is simply overlooked, forgotten and undervalued.
Should it become the target of an acquisition (see below), it could easily demand a much higher price than the current PLN 40: when Euronext acquired Borsa Italiana from LSE Group last year (admittedly, a more mature business), it paid €4.4 billion, equivalent to 9x sales and 16x EBITDA. On those multiples, GPW could be worth between PLN 90 and PLN 100. Even assuming a discount for all the considerations above, it is clear that GPW is currently undervalued, at least from what it is potentially worth to an acquirer.
Potential catalysts
Improved perception of emerging markets
GPW largest source of revenues is a toll on trading activity (volume x price), which has been depressed by investor neglect of emerging markets, and even more so by the decline in the Polish stock market index. If the price part recovers, revenues get a boost.
MSCI upgrade
Directly linked to the point above, many institutional investors follow investment policies which directly or indirectly refer to indices. FTSE Russell and Stoxx already promoted Poland in 2018 from emerging to developed markets; however, a majority of equity funds (measured by assets under management) rely on MSCI indices, where Poland is still considered an emerging country with a <1% weight in the MSCI EM Index. Should MSCI also decide for an upgrade, any rebalancing of global index portfolios will directly boost trading in GPW-listed stocks.
Takeover target
There are not that many exchanges around the world which are still independent, and very few in Europe: the global exchange industry has consolidated into four/five mega-players, each of which has scooped up smaller players over the years.
Given its still small size in a consolidating industry and representing the #1 market in Eastern Europe, GPW could be of interest to both Euronext (which today owns the exchanges in Paris, Milan, Amsterdam, Lisbon, Dublin, Brussels and Oslo) and Deutsche Boerse. This is just one of the recent articles where the CEO of Euronext said he is “eyeing a large number of targets”. GPW also use Euronext’s Universal Trading Platform (UTP) trading system – originally developed by NYSE – which could further facilitate an acquisition.
While still controlled by the state (a negative for many investors), Poland does have a history of its small(ish) companies being acquired by bigger European rivals (mainly German): the government shouldn’t be a roadblock if a deal partner emerges.
Risks
The biggest risk to a long thesis is not economic but rather political: we all know Poland’s recent controversial positions on several topics and its on-going confrontation with the EU (it is currently being fined €1m per day for ignoring an EU ruling that called for the country's Supreme Court disciplinary chamber to be suspended). Everyone has likely an opinion on how things will evolve: I’ll just point out that nearly all Polish exports end up in a European country and there is low probability of a “Polexit” (Poles might share their government’s positions - they voted for it -, but unlike the UK the vast majority is absolutely in favour of the EU membership).
There is also competition from Multilateral Trading Facilities (MTF): trading in Polish equities has been offered by the London-based venue Turquoise since 2015 and by CBOE Europe Equities since 2018. However,
the volume of trades on both platforms has so far been negligible.
Another problem is that the rising living costs in Poland (government wants to double minimum wages by 2023) might reduce the country’s competitiveness and deter European companies from continually outsourcing their development projects. Outsourcing is a two-edged sword: on the one hand, it can quickly boost rising economies; on the other, it can move as quickly as it came.
Finally, the biggest weakness in a long thesis is probably GPW itself. While developments in the company and the behaviour of investors are positive, there is no clear catalyst for valuations to expand: improving results will likely raise the stock price, but it doesn't mean that valuations will re-rate to a higher level. I don't believe it will be stagnant for another decade, but the opportunity cost might not be worth it.
Conclusions
Exchanges are some of the best businesses in the world due to their (quasi)monopolistic positioning: it’s inefficient to transact across multiple venues and investors want to be where the liquidity and best prices are. Electronic execution has changed this, as prices can be advertised across multiple venues, but it still isn’t quite that simple: there are still regulatory/settlement barriers that make switching exchanges difficult. It is no coincidence that these businesses earn high margins and high return on capital year after year.
That said, it is easy to extrapolate the performance of US exchanges and conclude that results will come. But history, culture and politics matter much more in other countries, especially in EM: some companies (and exchanges) are cheap for a reason.
GPW is however a very profitable organisation with a strong balance sheet that is somewhat overlooked:
while growth has not been spectacular, this is a wide moat company that is growing its trading volumes and information services. It is also selling at a highly attractive valuation (~20% of the market cap is covered by net cash and another ~14% by equity investments), where the bear case gives some downside protection.
It is also not valued on some sort of bull cycle/high level of volumes, revenues or earnings, as since 2010 the Polish market has been trading sideways (similar to many other emerging markets, whose exchanges nevertheless are accorded higher valuations).
It seems reasonable that someday Poland will experience a resurging market. Whether that happens tomorrow or in 10 years, who knows. But the optionality is on the upside: it’s like a cheap call option that if Poland has a (relatively stronger) equity market, GPW will do very well.