Bloomberg News

NYSE at 42% Size of CME Is Niederauer Dilemma as Deal Fails

February 03, 2012

(Updates second paragraph with NYSE Euronext and Deutsche Boerse terminating their deal.)

Feb. 2 (Bloomberg) -- Duncan Niederauer, poised for the past year to become chief executive officer of the world’s biggest exchange company, is back in charge of No. 6.

European regulators yesterday blocked NYSE Euronext’s merger with Deutsche Boerse AG, a deal that at its peak would have created a company worth more than $26 billion. The companies terminated the transaction today. Alone, NYSE Euronext’s value of $6.9 billion leaves it 42 percent as big as CME Group Inc. in Chicago and 53 percent the size of BM&FBovespa SA in Sao Paulo. The New York Stock Exchange owner is the sixth- largest operator of equity and derivatives venues.

Losing the Deutsche Boerse deal leaves Niederauer, a former executive at Goldman Sachs Group Inc., with one fewer option for closing the gap with CME and BM&FBovespa, companies with stock valuations as much as 86 percent higher because of the profitability of trading and clearing derivatives.

“I’m sure the investment bankers and his old friends at Goldman are going to be egging him on to get more deals,” James Angel, a professor of finance at Georgetown University’s McDonough School of Business in Washington, said in a phone interview. “This is a mature business, most product lines are fairly mature business lines, and that’s the challenge they face. How are they going to grow?”

Diverging Margins

Richard Adamonis, a spokesman for NYSE Euronext in New York, declined to comment. NYSE’s shares rose 0.9 percent to $26.67 at 11:20 a.m. New York time. Before today the shares had risen 1.7 percent since Dec. 20, the day before two people familiar with the matter said European Union regulators told NYSE Euronext and Deutsche Boerse that new concessions they offered to allay antitrust concerns didn’t go far enough.

The advantage of derivatives trading can be seen in NYSE and CME’s financial statements. In the nine months ended Sept. 30, 2011, NYSE had net revenue of $2.04 billion and earnings of $506 million, for a profit margin of 25 percent, according to a company statement. CME had $2.54 billion in sales and $1.07 billion in profit, a 42 percent margin, the company said.

NYSE Euronext’s captures 68 cents per contract in its London-based NYSE Liffe derivatives business, compared with 4 cents for 100 shares in U.S. equity trading, according to a third-quarter presentation from the company. The operating margin for futures and options is 57 percent, about 13 percentage points higher than it is for equities, the data show.

CME, BM&FBovespa

That helps explain the relative values for the world’s biggest markets. Hong Kong Exchanges & Clearing Ltd. is the largest at about $19 billion, followed by CME Group at $16.4 billion and BM&FBovespa at $13.2 billion, data compiled by Bloomberg show. Deutsche Boerse is fourth at $11.9 billion. Merging with the Frankfurt-based company would have given Niederauer more than 90 percent of exchange-traded derivatives in Europe.

Unions among the biggest companies are unlikely after yesterday’s rejection by antitrust regulators “set back large global exchange consolidation for two to three years,” wrote Richard Repetto, an analyst at Sandler O’Neill & Partners LP in New York. A combination between NYSE and ICE, which teamed with Nasdaq OMX Group Inc. on a hostile bid for the New York Stock Exchange last year, is a “possibility,” he wrote.

Frank De Maria, a spokesman for New York-based Nasdaq OMX Group Inc., Lee Underwood of IntercontinentalExchange Inc. and Michael Shore of CME declined to comment. Naomi Kim of Deutsche Boerse didn’t reply to a request.

Sevenfold Surge

Higher margins have translated into gains for CME shareholders, who have seen the stock appreciate more than sevenfold since its 2002 initial public offering, 13 times the gain in the Standard & Poor’s 500 Index. NYSE has fallen 67 percent since March 8, 2006, its first trading session as a public company, compared with an 3.6 percent gain in the S&P 500 over the period.

“NYSE is extremely competitive in its core businesses, but does now need to make some acquisitions to become more vertically integrated,” Tim Hoyle, director of research at Radnor, Pennsylvania-based Haverford Trust Co., which manages $6 billion and owns NYSE Euronext shares, wrote in an e-mail.

Rejection of the Deutsche Boerse deal by the European Union may leave Niederauer focused on cost cuts for now, after $37 billion in proposed industry takeovers failed in the last 15 months. NYSE Euronext will resume a buyback and present “pretty detailed 2012 plans” when it reports quarterly results next week, he said in a phone interview yesterday.

LSE, LME

Given the regulatory environment, NYSE Euronext may consider a strategic alliance with London Stock Exchange Group Plc or a deal with an exchange in Asia, Larry Tabb, chief executive of financial services research firm Tabb Group LLC in New York, said in a phone interview. Buying a smaller venue that has drawn takeover interest, London Metal Exchange, wouldn’t be a “game changer,” he said.

There are “lots of assets that are available right now,” Niederauer said in an interview with Bloomberg Television in Davos, Switzerland, on Jan. 27. “Everyone will take a look at LME,” he said, declining to comment on whether NYSE would bid.

Deutsche Boerse will develop products and expand, CEO Reto Francioni told reporters in Frankfurt yesterday, calling regulators’ decision “a black day for Europe.” Directors of NYSE Euronext are “fully supportive” of Niederauer, Jan- Michiel Hessels, the chairman, said in an e-mail. There are “no grounds for any fundamental shift” at Deutsche Boerse, wrote Manfred Gentz, chairman of the supervisory board.

Cross-Border Mergers

Exchanges will have a hard time pursuing cross-border mergers, said Brian Barish, president of Cambiar Investors LLC in Denver, which manages about $7 billion including about 4.2 million shares of NYSE Euronext. Instead, NYSE should capitalize on a push by regulators to move over-the-counter derivatives onto exchanges, he said.

“There are growth opportunities, not through M&A, I don’t think,” Barish said yesterday. “There’s still room to consolidate derivatives and futures markets.”

Derivatives venues derive their advantage from clearing trades, the process where transactions are guaranteed by an entity that becomes the buyer to every seller and the seller to every buyer. Most futures exchange operators including Deutsche Boerse, CME and ICE own their own clearinghouses and don’t permit similar contracts traded on other venues to be processed with their own. That creates a barrier to competition that allows the exchanges to charge more.

Writing Rules

Regulators around the world are writing rules to drive most bilaterally negotiated transactions among market participants into clearinghouses to reduce the fallout of a default. NYSE Euronext may now pay closer attention to over-the-counter derivatives as off-exchange trading is pushed toward electronic platforms called swaps execution facilities, Tabb said.

Exchange-traded derivatives globally were worth about 12 percent of the $708 trillion over-the-counter market at the end of June, according to data from the Bank for International Settlements. CME accounted for 44 percent of volume traded in the 10 most active exchange-listed interest rate derivatives contracts globally in the first half of last year, compared with 39 percent for Eurex and Liffe together, data from the Washington-based Futures Industry Association show.

CME, ICE, London-based LCH.Clearnet Group Ltd. and New York-based Depository Trust & Clearing Corp. already have businesses and offerings focused on over-the-counter derivatives. ICE, based in Atlanta, clears most credit-default swaps globally, while LCH.Clearnet dominates the interest rate swaps market.

OTC Derivatives

NYSE could gain a presence in over-the-counter derivatives by acquiring an interdealer-broker as ICE did in 2008 when it bought Creditex Group Inc. The deal gave ICE a platform that processed credit derivatives swaps completed privately among securities firms.

“Why aren’t these guys building out CDS trading platforms?” Michael Vogelzang, who oversees $2.1 billion including NYSE Euronext shares as chief investment officer at Boston Advisors LLC, said in a phone interview. “This is what they should be doing as opposed to trying to figure out whether they should take over Germany.”

--With assistance from Inyoung Hwang and Joanna Ossinger in New York and Nandini Sukumar in London. Editors: Chris Nagi, Nick Baker

To contact the reporters on this story: Nina Mehta in New York at nmehta24@bloomberg.net; Whitney Kisling in New York at wkisling@bloomberg.net

To contact the editor responsible for this story: Nick Baker at nbaker7@bloomberg.net


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