The News Issue Week Day

RICH AMERICA, POOR AMERICA The split nature of today's economy has been great for stock like Coach, tough for ones like Wal-Mart. Why that won't change much, even as the Democrats gain clout in Washington. he New IBM

Big Blue's shareholders have been blue for the past few years. But the tech giant has a new strategy, focused on software. Best of all, it's working.

Randall Forsyth The buck may be real loser in Iraq ...

Review&Preview A vote keeps ASMI intact. Going more nuclear ...

Storming Ahead, After run-up, a few insurers look good ...and Direct TV

Smooth Style Polo stock will stay in fashion ...

Follow the Leaders Copying smart stockpickers is one way to build a best-ideas portfolio, and it saves on management fees. A look at Oracle, Sears, AutoZone,Wendy's and other top holding of five closely watched hedge funds ...

Coming Spinoff Duke Energy's powerful idea ...

The New Big Blue Cover Story: IBM investors may soon be smiling like CEO Palmisano, as Wall Street comes to realize that Big Blue's reinvention as a software giant gives it a steadier, more profitable business with plenty of potential for further improvement ...

Spreading Joy The four rules of good giving ...

Technology Trader Microsoft stock could be ready for takeoff, now that new version of Vista and office have launched ...

13 Great Gadgets Our pick for sleek and sophisticated gadget gifts include Sony TAV-L1 all-in-one home theater, a digital SLR camera, Logitech's Harmony 1000 universal remote ...

Friday

Windfall in the Windy City


FOR 157 YEARS, THE CHICAGO BOARD OF TRADE existed as a member-owned market for trad­ ing agricultural and financial fu­ tures. Last week, just in time to celebrate its first anniversary as a publicly traded company, it agreed to be sold to the Chi­ cago Mercantile Exchange for a price three times tha;t at which it made its de­ but. You can say it was a very good year.



The year ahead doesn't look half-bad ei­ ther. The $8 billion deal unites the two big­ gest U.S. futm'es markets, spawning a $26 billion colossus that lists durivatives on for­ eign exchange, interest rates, stocks and commodities. The underlying value of the contracts traded each day is a staggering $4.2 trillion,

Because the two markets tra
So are the potential savings from com­ bining two trading floors and operations situated just an easy stroll from one an­ other. And because the CME already clears and guarantees contracts traded at the CBOT, and the two know each other as intimately as only arch rivals can, the usual integration hazards are minimized.

A CME-CBOT deal has long been the subject of happy-hour jabber in the Windy City, and its logic was flagged here when the two talked just before the CBOT went public ("Harvesting Value," July 4, 2005).

Given the public market's rabid appetite for exchange stocks, CBOT members were right to hold out. The stock came public last October at 54-near the CME's then-offer of about 60- but quickly climbed above 120. Last Wednesday, after the sale was an­ nounced, it rose 13%, to about 152.

CBOT stockholders will swap each of their shares for 0.3006 of a CME share, although they can elect to receive a pro­ rated amount of cash (up to $3 billion to­ tal). The CME will control the combined company. While the concentration of so much pricing power in one hand will worry customers-both exchanges have raised fees in recent years-industry ex­ perts don't foresee major regulatory hur­ dles, given the lack of overlapping prod­ ucts, and competition from overseas and over-the-counter markets.

Until the merger's expected mid-2007 close, CBOT shares will trade in tandem with their acquirer's. At 501, CME stock has soared more than 1,330% since the ex­ change went public at 35 nearly four years ago.

The shares are by no means cheap at 39 times future earnings. While the entire sec­ tor has rallied -the Dow Jones Global Ex­ changes index last week hit a record high and was up 54% this year-the CME com­ mands a premium even within this exalted group, partly because trading volume in U.S. futures and options is growing at more than 25% a year. The CME and CBOT also enjoy virtual monopolies in theU.S., with exclusive rights to trade many key products. The stock could fall hard if growth slows or the favorable regulatory climate cools, but neither is likely to happen soon.

On the other hand, CME profits can climb further. The exchange earned $8.81 a share in 2005 on a pre-tax margin of 52%, and analysts expect $11.44 this year.

Management's forecast of post-merger savings seems modest. Keefe Bruyette & Woods analyst Richard Herr expects the CME to save 20% of the projected com­ bined costs, or $175 million, versus the 14%, or $125 million that the CME an­ nounced. He says his estimate "may still be too conservative."

Less tangible is the advantage of having one concentrated li­ quidity pool to which risk managers will flock. Herr raised his earnings per-share forecast for the CME to $15.50 from $14.50 for 2007, and to $20.50 from $17.50 fOr 2008. He also bumped up his price target for CME shares to 600 from 500.

The deal spurred yet another wave of speculation. The New York Mercantile Ex­ change saw increased interest in its pend­ ing IPO, as chatter grew about a potential takeover once it is listed. And at the Chi­ cago Board Options Exchange, seven seats were sold at record prices near $1.5 million the very day the CME deal was announced-compared with 104 seats for all of last year at prices no higher than $S75,000.

Complete Archive Desember 2006

The New Cisco As technologies like Internet video take off, Cisco Systems, the king of computer networking, will be among the biggest winners. Why its shares could rally another 15%.

Survivor! GOP Will Hang On Despite a profusion of predictions to the contrary, the Republicans will keep control of Congress through just barely. So says our highly reliable seat by seat analysis of local political funding.

The New IBM Big Blue's shareholders have been blue for the past few years. But the tech giant has a new strategy, focused on software. Best of all, it's working.