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.
