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CME Seen Needing CBOE as Profit Woes Spur Speculation

July 18, 2012

CME Seen Needing CBOE as Profit Woes Spur Speculation

Traders work in the S&P 500 pit of the CME Group's Chicago Board of Trade in Chicago, Illinois. Photographer: Tim Boyle/Bloomberg

For CME (CME:US) Group Inc. to improve the exchange industry’s worst profit outlook, the owner of the Chicago Mercantile Exchange needs only to look across the street to CBOE Holdings Inc. (CBOE:US), home of the biggest U.S. options market.

CME’s net income will decline 19 percent in the next three years, according to analysts’ estimates (CME:US) compiled by Bloomberg. CBOE, a $2.47 billion company forecast to boost profit 26 percent in the same period, has rallied (CBOE:US) more than every developed-market peer of similar size during the past two months and reached the richest (CBOE:US) price-earnings ratio versus the industry since September, the data show. That may be a sign of takeover speculation, according to Caldwell Securities Ltd.

Macquarie Group Ltd. and Sandler O’Neill & Partners LP say CME would be the most logical suitor because it owns a quarter of S&P Dow Jones Indices, which has given CBOE exclusive rights to one of its biggest moneymakers: trading Standard & Poor’s 500 Index options. Expanding into equity options would provide new revenue for the largest U.S. derivatives exchange owner in a market that set a ninth straight annual volume record in 2011.

CBOE’s “stock is telling you something is happening,” Thomas Caldwell, who oversees about $1 billion as chairman and chief executive officer of Toronto-based Caldwell Securities and owns CBOE shares, said in a phone interview. “It’s one of the few bright spots in the exchange space worldwide, so that in itself should command a premium,” Caldwell said. “CME’s position would be unassailable” with a purchase of CBOE.

Corn, Crude

Carol Kennedy, a spokeswoman for Chicago-based CBOE, declined to comment on the company’s prospects for being bought. Michael Shore of CME also declined to comment.

Founded in the 19th century, CME’s business spans agricultural, energy, metal and financial futures tracking products such as corn, crude oil, gold and interest rates. The Chicago-based company that’s valued at $17.5 billion has expanded in the past decade with deals, buying the Chicago Board of Trade and New York Mercantile Exchange owner Nymex Holdings Inc. The purchases cemented CME’s dominance in futures, giving it a U.S. market share of about 98 percent.

The Chicago Board Options Exchange, started in 1973 as the first U.S. equity derivatives market, became the last major American bourse to convert to shareholder ownership with its 2010 initial public offering. Former members of the Chicago Board of Trade, now owned by CME, helped found the options market. Their fight over ownership rights delayed CBOE’s IPO.

Fed’s Decision

Net income at CME will fall to $1.46 billion in 2014 from $1.81 billion last year, according to analysts’ estimates (CME:US) compiled by Bloomberg. The Federal Reserve’s decision to hold borrowing costs near record lows since December 2008 has helped slow CME’s volume for interest-rate futures, its most-traded product. In January, the central bank said it plans to keep holding down rates through at least late 2014, meaning investors have less need to hedge the risk that rates will rise.

At the same time, more than 4.6 billion contracts changed hands last year, continuing a streak of annual records that began in 2003, data compiled by OCC show. Transactions are now spread out across 10 venues, including those run by NYSE Euronext (NYX:US), Nasdaq OMX Group Inc. (NDAQ:US) and Deutsche Boerse AG. (DB1) CBOE captured the most total market share in June with 30 percent of U.S. trading on its two bourses.

S&P Dow Jones Indices, owned 24.4 percent by CME, 73 percent by McGraw-Hill Cos. and the rest by News Corp., has granted exclusive licenses to CME for futures based on the S&P 500 and to CBOE for options on the benchmark measure of U.S. stocks. That shared connection would probably make it easier for CME to buy CBOE, said Richard Repetto, an analyst at Sandler O’Neill in New York. CBOE’s license expires in 2018.

Valuation Premium

Repetto estimates CBOE gets at least 30 percent of net income from S&P 500 options. Shares of the exchange have rallied 15 percent since their 2012 low on May 17, beating every developed-market peer valued at $2 billion or more, data compiled by Bloomberg show. The gain drove its price-earnings ratio to 17.4, 19 percent more than the valuation for the Bloomberg World Exchanges Index of companies with an average market capitalization of about $4.2 billion. The ratio was 20 percent higher on June 18, the most since September.

“CBOE is attractive as an acquisition to large exchanges,” said Ed Ditmire, a New York-based analyst at Macquarie. “After all, it’s somewhat bite-sized relative to other public exchanges,” he said. With S&P Dow Jones Indices, “CME would have the best chance of finding comfort with the continuation of that contract, in addition to the obvious Chicago advantage that they’d have,” Ditmire added.

Today, CBOE shares added 0.7 percent to $28.40, the highest level since March 30.

Electronic Trading

CBOE’s profit increased 40 percent to $139.4 million last year. Analysts project (CBOE:US) net income will rise to $176 million in 2014, according to the average estimate.

The company has introduced new products as a way to diversify revenue before the exclusive license with S&P Dow Jones Indices expires. It started electronic trading of options on the S&P 500, known as SPXpm, last year. In 2012, the company began a new pricing structure, called the volume incentive program, which aims to increase business by giving discounts to bigger trades.

While Repetto and Ditmire say a deal is possible, neither see one as imminent.

During a June presentation in New York, Phupinder Gill, who became CME’s CEO this year when Craig Donohue retired, didn’t mention acquisitions as a driver of future growth. Instead, he focused on the partnerships and regulatory changes requiring most over-the-counter swaps to be guaranteed with clearinghouses such as the one owned by CME.

More Innovation

“Our focus will continue, over the next five to 10 years, being on internationalization and globalizing the client base that we have now,” Gill told the prospective investors in the audience. “OTC trades are now going to be deemed mandatory to be cleared. That’s going to lead to innovation, the next set of innovation, which up to this point in time has been difficult for the exchanges to actually crack.”

More than $32 billion in global exchange takeover attempts announced since October 2010 have failed to close, according to data compiled by Bloomberg. Regulators blocked Singapore Exchange Ltd. (SGX)’s offer for Sydney-based ASX Ltd. and two bids for New York-based NYSE Euronext -- one from Deutsche Boerse of Frankfurt and a combined attempt from New York-based Nasdaq OMX and IntercontinentalExchange Inc. of Atlanta.

Competition Risk

The Nasdaq-ICE hostile merger offer proposed breaking up NYSE Euronext, with Nasdaq OMX combining the firm’s stock- trading operations with its own. That would have given Nasdaq OMX about half of total U.S. equities volume. The U.S. Department of Justice said the union would have curbed competition. European officials blocked Deutsche Boerse’s deal for NYSE Euronext because it would have given the combined entity more than 90 percent of the region’s exchange-traded derivatives market.

CBOE’s 30 percent market share in options last month compared with NYSE Euronext’s 23 percent, Nasdaq OMX’s 23 percent and Deutsche Boerse’s 16 percent through its stake in the International Securities Exchange, according to data compiled by Chicago-based OCC, which clears all exchange-traded contracts in the U.S.

The odds that regulators would block CME from buying CBOE are lower because the company doesn’t already offer equity options, said Jeffrey Spigel, head of the antitrust practice at King & Spalding in Washington.

“Certainly it removes an issue the others have had in the past,” he said. A bid by the other companies “would be a lot more difficult,” he said.

$3 Billion

Rich Adamonis, a spokesman for NYSE Euronext, Nasdaq OMX’s Robert Madden and Deutsche Boerse’s Frank Herkenhoff declined to comment on whether their companies are interested in CBOE.

A takeover of CBOE would probably cost $3 billion, or 22 percent more than yesterday’s market value, and CME is the most likely acquirer, according to Keith Wirtz, who oversees $15 billion as chief investment officer at Fifth Third Asset Management in Cincinnati.

“The idea of the globalization of these exchanges is the business concept that’s been attempted, but it’s hard to do these cross-border mergers with the exchanges,” he said in a phone interview. With CBOE and CME, both are “headquartered in Chicago. There are some obvious consolidations that could benefit the income statement.”

To contact the reporters on this story: Matthew Leising in New York at; Whitney Kisling in New York at; Will Robinson in New York at

To contact the editors responsible for this story: Sarah Rabil at; Alan Goldstein at; Lynn Thomasson at

The Aging of Abercrombie & Fitch

Companies Mentioned

  • CME
    (CME Group Inc/IL)
    • $88.52 USD
    • -0.06
    • -0.06%
  • CBOE
    (CBOE Holdings Inc)
    • $65.87 USD
    • -0.01
    • -0.02%
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