We raise our fair value estimate for wide-moat ASX (ASX: ASX) by 3% to $75 per share following its first-half results. Management commentary increased our confidence that ASX can return to historic operating margins, although exact timelines are still unclear.

We expect operating margins to start recovering in fiscal 2026. ASX shares continue to trade materially below our fair value estimate as the market focuses on near-term expense and capital expenditure growth. Shares are currently trading at a 13% discount to our fair value.

Management increasingly wants to balance the interests of market participants and regulators, with shareholder interests. Thereto, management emphasized its business rationalization efforts. These included a targeted restructuring, which is expected to result in an $11 million reduction in annual operating expenses, as well as a strategic review of ASX’s equity portfolio, which included the sale of its stake in Yieldbroker.

Notably, the ASX rationalization efforts do not touch the core of the business, thus protecting the interests of market participants and regulators. Instead, the restructure will reduce the use of external consultants and noncore businesses. In this vein, ASX also wants to sell its stake in Digital Asset Holding. Although we haven’t been expecting current expense levels to represent a new normal, we liked hearing management emphasize its focus on expense discipline.

In the near term, however, we expect ASX to remain focused on investing in replacing its aging Clearing House Electronic Subregister System, or CHESS, and on other technology modernization. We view these investments as supportive of its social license, and, indirectly, its regulatory licenses, which we consider part of its economic moat. CEO Helen Lofthouse again described ASX's licenses as some of their “most important assets” and we agree.

Business strategy and outlook

We expect 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 licences 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. However, after several years of delays and cost overruns, this project has been shelved, which has renewed discussion on opening up the clearing and settlement market to more competition.

ASX, we believe, will 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 would be opened up to competition that ASX’s business would remain well protected due to network effects inherent in ASX’s 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.

Economic moat

Read more about how identifying a company with a moat impacts investment results.

We award ASX a wide economic moat rating based on network effects and intangibles in its listing, trading, clearing, and technology and data businesses. We expect ASX’s competitive advantages to be durable for at least the next two decades.

We consider ASX’s clearing business to have a wide economic moat based on network effects and intangibles. When market participants trade securities, they need to insure themselves against counterparty risk, especially with leveraged securities such as futures.

Clearing houses fulfil this need by acting as the middleman on every transaction and collecting collateral from market participants in accordance with the level of risk involved. Economic moats naturally arise from this in multiple ways. Most importantly, clearing houses can net out offsetting collateral, such as long and short positions. This offsetting decreases collateral requirements for market participants, which thereby lowers their indirect operating costs.

As the number of trades, participants and products that go through a clearing house increases, collateral requirements decrease correspondingly due to more collateral being netted out across the house. This creates strong network effects as lower trading costs attracts additional participants and products, thereby lowering these costs further, in a positive feedback loop.

Most exchanges are also vertically integrated, meaning trades on an exchange need to be cleared through its own clearing house, which creates a product suite-based network effect between trading and clearing, and provides a base level of collateral to the clearing house that it can use to offset against. Additionally, contrary to trade execution, orders for clearing are inherently less conducive to transferability between exchanges due to the complexity that is involved with monitoring collateral and risk of market participants across multiple clearing houses. Collateral is therefore captive to the clearing house where it is posted. This

inherently disincentivizes market participants from participating in multiple clearing houses due to capital requirements needing to be duplicated, thereby supporting market consolidation around a single clearing house.

Given the market dynamic toward consolidation and the importance of avoiding financial instability caused by potentially defaulting market participants, or worse, a defaulting clearing house, clearing houses are strictly regulated, making licenses to operate them valuable intangibles.

ASX holds licenses for clearing nearly all trading in Australia, which we consider an intangible asset. ASX does face some competition from U.K.-based LCH, and U.S.-based CME Group, who hold licenses for clearing certain derivatives products, but these licenses are of a limited nature. Both the federal government and regulators have sought to reduce ASX’s exclusivity over some of these licenses and to increase competition.

ASX had long been able to hold on to its exclusivity by promising to deliver a world-leading new clearing system, based on blockchain. After several years of delays and cost overruns however, this project has now, for most intents and purposes, been shelved, which has renewed discussion on opening up the market to competition.

Although the regulatory outcome of this process is still unclear, we believe the network effect in ASX’s clearing house should enable ASX to defend most of its market share in clearing, even if clearing is opened up. ASX’s clearing houses clear equities, debt and derivatives, both exchange-traded and over-the-counter, which allows for strong offsetting of collateral.

We believe these network effects lower indirect operating costs for market participants and create the gravity for the market to remain consolidated around ASX.

We believe ASX’s trading business has a wide economic moat based on network effects and intangibles. The strongest moats we see in exchange trading businesses come from the creation of markets for unique and globally relevant derivatives products, which are based on underlying assets which previously had prohibitively low market liquidity. Exchanges solve this liquidity issue by first creating standardized contracts for the quantity, quality, and settlement of the underlying asset. Through this process of standardization, market participants achieve the certainty required to be able to trade the underlying asset. Subsequently, exchanges need to attract trading volumes for the product.

This will initially often require various incentives to market participants, but once sufficient volumes have been attracted to the market, liquidity tightens, and indirect trading costs based on bid-ask spreads decrease. When this is achieved a tipping point can be reached whereby additional market participants and volumes are attracted to the market, which further tightens liquidity and further decreases indirect trading costs, creating a positive feedback loop and strong network effects.

Given that these derivatives are based on contracts which are the proprietary intellectual property of the exchange that created them, they are nonfungible, meaning the liquidity pool is captive to the exchange. Although competing exchanges can develop similar products based on comparable contracts, they will often struggle to attract significant volumes, even when incentives are offered, because the indirect trading costs from larger bid-ask spreads will far outweigh the benefits derived from reduced trading fees, resulting in significant first-mover advantages for innovative exchanges.

We believe the economic moat in ASX’s trading business is widest in its various exclusive derivatives products, such as equity indexes, interest rates, and Australian energy. Although ASX is not the main trading venue for any derivative products that are relevant on the global stage, there is sufficient demand for its products from Australia’s outsize local financial services sector. As a result, we expect ASX to continue earning attractive returns on these products. ASX’s cash equity trading business has faced competition from Chi-X for over a decade, but Chi-X has been unable to increase its market share over 10%, leading us to believe Chi-X will not be able to generate meaningful profits or market share.

We believe ASX’s technology and data business has a wide economic moat based on product network effects and intangibles from its vertical integration with its trading business. Market participants, especially quantitative high frequency traders, require data on historical trading volumes and current order book volumes to make informed trading decisions. Given that most trading takes place on exchanges rather than over the counter, exchanges have proprietary data on the pricing of securities. By selling access to this data to market participants and offering co-location hosting services near the exchange itself, exchanges have additional avenues of monetizing trading activity that competitors don’t have.

We see this most frequently leading to high margin data businesses. However, some exchanges use these additional revenue streams to cross-subsidize trading activity. In this setup, the exchange charges lower trading fees (sometimes at or below cost) which increases its market share of total trading activity, which subsequently increases the value of the data and connectivity services, in a positive feedback loop of data network effects.

ASX’s data and technology business equates to around a third of ASX’s trading and clearing revenue, which is above peer exchanges. Given the limited competition in Australia’s trading and clearing markets, we believe ASX possesses unique data assets and also don’t believe ASX has a need to use its data and connectivity business to cross-subsidize its trading and clearing businesses. We therefore believe ASX uses its proprietary data assets to run a highly mature and profitable data and technology business generating high returns on capital, given its capital-light nature.

We believe ASX’s listing businesses has a wide economic moat based on ecosystem network effects and intangibles. Prospective listers of securities primarily look for a marketplace that can connect them to an investor base that can provide them with capital. As such, exchanges need to provide them with access to an ecosystem of professionals that can price a certain security and have capital to deploy. We view this as largely an undifferentiated endeavor.

Financial hubs throughout the world have the human and financial capital to meet these requirements. Potential moats do exist, however. Some exchanges benefit from operating in a strong legal system and stable regulatory environment that puts them at an advantage over exchanges operating in weaker legal systems and with less stable regulatory environments. Additionally, regulators may grant some exchanges, such as their national exchange, a monopoly for certain types of listings, such as primary equity listings, debt listings for sovereign debt, or derivatives for local electricity prices. Some exchanges have also managed to differentiate themselves globally by developing a niche or brand for trading certain types of securities.

ASX has an effective monopoly on equity listings in Australia with over 95% market share. Given this level of market share, we expect the financial ecosystem in Australia to continue consolidating around ASX. Additionally, ASX’s catchment zone also extends to New Zealand, with New Zealand based companies listed on the ASX equating to around a third of total companies listed on the New Zealand Stock Exchange itself. Moreover, even though ASX’s catchment zone for listings is still relatively small in terms of population size and size of the economy, ASX benefits from Australia’s outsize natural resources sector, which has delivered a constant flow of new listings.

Companies in the materials and energy sectors make up around half of all listings, and, given their below-average life span, an even higher share of new listings and secondary capital raisings. We believe this process will continue and even accelerate as the energy transition sparks demand for resources in which Australia holds world-leading positions, such as lithium, copper, rare-earth minerals, iron ore, metallurgic coal, uranium, and natural gas. We expect this will provide ASX with a constant stream of new listings and a long tail of recurring revenue from ongoing listing fees, secondary capital raisings, as well as trading, clearing, and settlement fees from these highly volatile materials and energy companies.