Exchanges, NASDAQ and ICE bid to scuttle Deutsche Borse

This morning, the anti-climactic bid from NASDAQ($NDAQ)+ICE ($ICE) hit the street. Virtually everyone knew they were going to make a bid, the question was how much. This is a very different situation than Sprecher’s surprise attack on the CME-CBOT($CME) tie up years ago.

You have to think the DeutscheBorse and NYSE ($NYX) made contingency plans. The competing bid is 19% better. It will be a combination of debt/equity.  The question is can the financial structures of each exchange handle it? ICE has the more robust stock as currency.  The cash flow statement from ICE in the last quarter showed FCF of 82m (Dec 2010).  Nasdaq had negative cash flow.

NASDAQ is interested in the stock/equity options piece, of which only the options piece is really profitable. Stocks are dead for making money.  There are too many other places to trade them; BATS, dark pools, and internalization killed the stock business.  If Regulation NMS were repealed, NASDAQ made a good deal and shares would soar.

ICE of course wants the futures.  That’s the real gem of the whole deal.  To really value the deal, you have to try and separate the LIFFE exchange from NYSE, and see what a standalone futures exchange would be worth.  This is extraordinarily difficult to do because Euronext merged with LIFFE which merged with NYSE, so a lot of operations are consolidated.  But, you can look at average daily volume, project some growth, and then apply the cost structures of ICE or CME to it and try to come up with a number.  It’s guaranteed to be off, but at least it’s a starting point.

I would also assume a lower beta on the cash flows than I have seen in previous deals. There is not as much leverage in the market and the growth is not as fast as it was.  There is a lot of risk assuming a boat load of debt today as well.  I don’t know about you, but I think the Fed is likely to raise rates by the end of the year.  I have not had the time to form a pro forma financial statements this morning, but might undertake that arduous task this week end.

There are really no conflicts at all if the futures were transferred from LIFFE to ICE. Stock listing is not really relevant. Regulated exchanges do less than 30% of total volume, so it doesn’t really matter.

Strategically, what’s the fall out?  If ICE were to get the LIFFE, I think it benefits CME.  ICE+LIFFE is not as tough a competitor as NYX+DB.  The reason for that is that the European yield curve will still be on two platforms.  It continues to set up a battle between the US interest rate complex that has waged the last couple of weeks between NYX and CME, but NYX would have had more leverage with DB.  Cross margining yield curve vs yield curve combined with the cash component is interesting.

Additionally, I don’t think CME has to make a move regardless what happens.  They are a futures exchange.  They need to organically grow their business, pay down debt and look for opportunity.  CME has done a good job with line extensions, akin to a consumer products company filling out shelf space, but they have done a poor job of innovating new profitable products to grow volume.  In their defense, neither has any other exchange.  The slate of contracts that are available to traders is virtually unchanged since I started trading in 1988.   Only the Euribor is a big new liquid contract.  A lot is being made about the CME being aggressive, and that aggressiveness got them in trouble when it came to buying the NYMEX. They can afford to watch and wait.

All this being said, I think the only way the NYX goes to the competing bid is if Federal regulators make it happen.  With as activist as they have become, I wouldn’t be surprised-but I am not sure that’s the best thing for the entire world exchange market going forward.  Ethnocentricity never got us anywhere when it came to markets.

Let the markets decide, let the private leaders of private industry decide.

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