Bloomberg News

Bats Agrees to Merge With Direct Edge as Volume Shrinks

August 26, 2013

Bats Global Markets Inc. and Direct Edge Holdings LLC agreed to merge, uniting two of the biggest American exchange operators amid a four-year decline in volume.

The third- and fourth-largest equity market owners said the transaction will close in the first half of 2014. Joe Ratterman, the chief executive officer of Bats, will keep that role at the combined firm, while Direct Edge CEO William O’Brien will be president. Financial details weren’t disclosed.

Formed by some of the fastest traders on Wall Street, the closely held companies have watched volume dry up in the U.S., cutting profits at the proprietary trading firms they count among their biggest customers. Shares changing hands on all U.S. exchanges have fallen 36 percent since 2009 to 6.3 billion shares a day in 2013 and profits for high-frequency traders slipped 80 percent, according to data compiled by Bloomberg and Rosenblatt Securities Inc.

“Volume is weak,” Dan Veru, the chief investment officer who helps oversee $4.5 billion at Palisade Capital Management LLC, said by phone from Fort Lee, New Jersey. “That’s been the trend going on for quite some time. So unless you have real scale, it’s difficult to compete. Mergers like this probably create some scale.”

The companies’ four exchanges will keep operating, using Bats’s technology, according to a statement. The combination will be headquartered near Kansas City, Missouri. Bats is based in Lenexa, Kansas.

Trading Systems

Bats, an acronym for Better Alternative Trading System, started trading in 2006, aiming to match the incumbent exchanges on speed and beat them on prices. Seven years later, the firm’s daily average U.S. equity market share is about 10 percent, according to data from Tabb Group LLC. That compares to averages of 23 percent at NYSE Euronext and 18 percent at Nasdaq OMX Group Inc. Direct Edge has about 11 percent, Tabb said.

The deal comes as IntercontinentalExchange Inc. (ICE:US) prepares to complete the acquisition of NYSE Euronext, which owns the New York Stock Exchange, the oldest U.S. bourse. Combining Bats, and Jersey City, New Jersey-based Direct Edge would make them the second-biggest market by volume.

Bats, which tried and failed to go public last year, was founded in 2005 by high-frequency trader Dave Cummings of Tradebot Systems Inc. and, along with Direct Edge, helped dismantle the duopoly on American stocks that was enjoyed by the New York Stock Exchange and the Nasdaq Stock Market.

‘Dominant Stranglehold’

“When Cummings set up Bats, it was really in response to the New York and Nasdaq having a dominant stranglehold on the equity trading market,” Larry Tabb, chief executive officer of the Tabb Group in New York, said in a phone interview on Aug. 23 after Bloomberg News reported the two companies were in discussions. “But time moves on, order flows declined, it’s gotten much more competitive.”

This year’s acquisition of market-making firm Knight Capital Group Inc. by Getco LLC, the Chicago-based high-frequency trader, may have made today’s merger more likely, Tabb said. Both are shareholders in Bats. Knight, now KCG Holdings Inc., also owns a stake in Direct Edge.

Electronic platforms have seen their reputations dim over the last week after a connectivity issue caused Nasdaq to halt trading in all its listed shares for three hours yesterday and Goldman Sachs Group Inc. bombarded markets with mistaken options orders. Bats shut its main market for almost an hour on Aug. 6 when a computer system malfunctioned.

Multiple Platforms

Bats, run with about 160 employees from a two-story office complex, operates two stock exchanges and an options market in the U.S. as well as Bats Chi-X Europe, the largest pan-European stock exchange.

O’Brien said in September 2012 that he was focused on expanding as an independent company following a report in the Wall Street Journal his firm was in merger discussions with the owner of the Toronto exchange.

Speculation over a Direct Edge sale dates to December 2011, when the U.S. Justice Department made the divestiture of Deutsche Boerse AG’s 31.5 percent stake in the company, held through its International Securities Exchange unit, a condition of its proposed merger with NYSE Euronext. European regulators blocked the trans-Atlantic union two months later and the Frankfurt-based exchange never made a deal.

Both companies count trading firms and banks among their owners, and Bats gained two new shareholders this month. Private-equity firms Spectrum Equity Investors LP and TA Associates Management LP bought all of Lehman Brothers Holdings Inc.’s estate when it exited its investment, according to a statement from Bats and the investors.

Largest Owners

Bats lists Getco as its largest owner with a 15.4 percent voting interest. Other owners include Morgan Stanley, Credit Suisse Group AG, Nomura Holdings Inc. and Citigroup Inc. KCG, Goldman Sachs Group Inc. and Citadel all have a 19.9 percent stake in Direct Edge. An additional 8.8 percent belongs to a group of five brokers, including New York-based JPMorgan Chase & Co.

“It makes sense,” Paul Gulberg, an analyst at Portales Partners LLC, said in a phone interview Aug. 23. “A combined company is probably more efficient to run.”

To contact the reporters on this story: Nandini Sukumar in London at nsukumar@bloomberg.net; Nikolaj Gammeltoft in New York at ngammeltoft@bloomberg.net; Nick Taborek in New York at ntaborek@bloomberg.net

To contact the editor responsible for this story: Lynn Thomasson at lthomasson@bloomberg.net


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