On Wednesday of last week, the Deutsche Boerse announced that it was in
advanced talks with NYSE Euronext (NYX) to combine into the world's
largest exchange. This came just hours after the London Stock Exchange
(LSE) announced its merger with the TMX Group, which runs the Toronto
and Montreal exchanges.
Both of these mergers followed last year's proposed acquisition of the
Australian Stock Exchange (ASX) by the Singapore stock exchange, which
has yet to be approved by the Australian government, but appears to be
Of course, the NYSE/DB tie-up took center stage in the US since it is
the only one easily accessible by US investors, and also because it was
hailed as an assault on an American institution.
Come on people, the nostalgia is nice and all, but this is about dollars
and cents, not baseball and Mom's apple pie. According to the NYSE
February 8 earnings conference call, only 53% of its revenue was dollar
denominated, while 47% was either pound or euro denominated. It
probably would have been closer to 50/50 if they didn't have to account
for $19 million in unfavorable currency translations. Synergies and Survival
Both boards are expected to approve the deal this week; then it will be
in the hands of the regulators. Surprisingly, it might be European
regulators who raise objections, since the combination of Deutsche
Boerse and Euronext operations will effectively control nearly all
European futures trading and may require separating the clearing and
trading portions of the merged company.
Regardless of regulatory outcomes, it's worth taking a look at what is
motivating the potential merger. Exchanges worldwide have experienced
margin pressures in the equities business as the advent of electronic
exchanges has sliced execution costs to the bone. For now, the futures
and options business is where the money is, and the pot is growing.
According to the Options Clearing Corporation, average daily contract
volume in options has grown from 5.9 million contracts per day in 2005
to 15.6 million contracts in 2010, while futures volume has increased
from 22,600 contracts per day in 2005 to 105,600 contracts per day in
2010. And 2011 is off to a rip roaring start at 18.9 million option
contracts per day and 153,800 futures contracts per day.
As exchanges continue to move from floor based operations to electronic
trading, volume is everything. The few extra electrons it takes to send
an additional order to an electronic exchange is minimal from the
exchange's cost perspective, so the bigger the exchange, the greater the
volume and the larger the margins.
Additionally, the combined exchange will offer previously unavailable
ease of access to markets across the pond. It is likely to become much
less complex for the US investor to access European markets, and vice
versa. Again, another avenue for increasing volumes.
The Deutsche Boerse is projecting synergies of $410 million from increased volumes and cost cutting in redundant divisions.Who's Next?
You would think that this would be an easy question, since there are
only four publically traded US exchanges: CBOE Holdings (CBOE), The CME
Group (CME), The Intercontinental Exchange (ICE), and the Nasdaq OMX
Group (NDAQ). However, both Hong Kong and Tokyo have indicated that
they would consider combinations, and the upstart BATS Exchange is not
BATS (Better Alternative Trading Systems), a Kansas based ECN, came into
existence in 2005 and has since jumped to third in equity volume market
share, behind the Nasdaq and NYSE, and its options business is growing
Additionally, on the futures side, ELX Futures has been growing in the
Eurodollar and interest rate space. ELX was created in 2007 by a
consortium including Bank of America, Barclays Capital, Citi, Credit
Suisse, Deutsche Bank, Goldman Sachs, JP Morgan, Goldman Sachs and 5
The table below provides a quick comparison between the publicly listed options and the current value of the NYSE.
What is striking is how far these stocks are from their all-time highs.
Even if the Deutsche/NYSE deal crests $40, it is still a far cry from
its 2006 peak of $112. And the CBOE, which went public in June 2010,
has yet to recover its IPO price of $29. This just goes to show what a
tough business being an exchange is.
Nevertheless, we have to look forward, and NDAQ certainly has the best
earnings outlook and a very digestible market cap. Additionally, the
stock has been strong since the October announcement of the
Singapore/ASX deal. The market seems to have a lot of faith in this
The CBOE has held up rather well since the lock up expired in
mid-December. It is clearly the cheapest on the board, and could bring
$3-$3.5 billion in the best case scenario. Also the CBOE owns the VIX
and other branded products, but mergers of late have been about
synergies, volumes, and cost savings, and it's not clear what they offer
on that front. Notably, volume declined 2% in the most recent quarter
compared to the year ago quarter.
The CME dominates the US futures markets, which makes it attractive, but
its size might make it more of an acquirer rather that an acquiree.
Finally, the ICE is interesting, though not talked about as much. The
company beat estimates in last week's earnings release and is growing
its presence as a credit derivatives clearing house. Price wise it has
held up well and management has a history of executing well.
There is no question that another tie-up or two in the exchange sector
is likely on the horizon, but which players will be at the table is
still up for discussion.I am not recommending any of these stocks, but perhaps you now have a better starting point for your own due diligence.