(Refiles to fix typo in headline)
* Q3 EPS C$0.56 vs analysts' EPS view C$0.61
* Revenue falls 6 percent to C$130.2 million
* Market share in September down 15 points year over year
* TMX shares drop 8 percent to C$31.05 (Adds CEO quote, updates share price)
By Jennifer Kwan
TORONTO, Oct 28 (Reuters) - Exchange operator TMX Group Inc (X.TO), which is aggressively diversifying as smaller rivals erode its market share, reported a lower quarterly profit on Wednesday as revenue fell and expenses rose.
TMX, whose share price closed down 8 percent at C$31.05, said net income fell 18 percent to C$41.7 million ($38.6 million), or 56 Canadian cents a share, in the third quarter.
That compares with a profit of C$50.9 million, or 66 Canadian cents a share, in the year-before period.
Analysts, on average, had expected TMX, which operates the Toronto Stock Exchange, the small cap TSX Venture Exchange and Montreal derivatives market, to earn 61 Canadian cents per share, according to Thomson Reuters I/B/E/S.
A key element driving profit lower was weak cash equity trading revenue on the senior Toronto exchange, which fell because of a new pricing program that came into effect at the beginning of the year.
One aspect of the program targeted high frequency traders, referred to as electronic liquidity providers (ELPs), and it successfully boosted volumes, but also eroded average revenue per trade.
"(It) missed estimates as the exchange offered higher rebates to protect market share," said Diego Perfumo, an analyst at Equity Research Desk in Greenwich, Connecticut.
Recognizing the problem, TMX announced changes to its pricing model in August, including a fee reduction on some orders for stocks trading at less than C$1, and lowering rebates for ELPs trades. Those changes took effect Oct. 1.
TMX executives said on a conference call the pricing change is expected to have a neutral impact if the mix of trading remains the same. However, if the mix changes, average revenue per trade could erode further, or could rise.
Other sources of revenues weakness included market data and issuer services.
Perfumo said higher technology costs also hurt TMX's profit as the company invested in co-location and data centers. Co-location essentially allows clients to place their computer services next to TMX's trading engines to cut response times.
"We are operating in a hyper-competitive market, one that requires strategic investments in key parts of the business, particularly with regard to technology," TMX Chief Executive Thomas Kloet said in a conference call.
Kloet said there were reductions in revenues in certain areas of the business, but he was encouraged by the improving market conditions pointing to increases in the value of initial public offering and secondary financing activities.
Total revenue fell 6 percent to C$130.2 million, missing analysts' average forecast of C$134.7 million. Operating expenses in the quarter rose 10 percent to C$68.4 million, boosted by expenses related to the company's May 2008 acquisition of the Montreal Exchange, as well as technology investments.
The drop in profit was partly offset by higher revenue from energy trading, cash markets equity trading revenue on the TSX Venture Exchange and fixed income trading, TMX said.
Increased competition has cut TMX's market share by 15 percentage points to 83 percent in September, down from 98 percent for the same period in 2008.
"There's been this shift to equity trading becoming a commodity and that's really hurting a lot of the businesses," said Jennifer Radman, vice-president at Caldwell Investment Management, which has holdings in exchanges including TMX.
She said, however, that TMX has done a good job in trying to recapture lost revenue.
"The big advantage they have is that they do still have control of the derivatives market," she said. "That's a pretty big asset."
There are currently seven alternative trading venues in Canada but TMX's main competitor is Alpha Group, which is backed by the dealer arms of the country's biggest banks.
It has made several moves recently to encroach on TMX's turf, including the announcement of a new pricing program to boost volumes, as well as teaming up with Thomson Reuters Corp (TRI.TO) to offer consolidated market data.
On Wednesday, Alpha announced it will offer co-location services.
$1=$1.08 Canadian Reporting by Jennifer Kwan; editing by Rob Wilson