It was a surprise to hear about ICE's offer for the Chicago Board of Trade this morning, but after thinking about it for a bit, I wondered if the CME wins either way, given they control the clearing for the Chicago Board of Trade.
Rick Santelli, one of the best financial reporters on television, and certainly the best at CNBC and conveniently located in the Treasury pits at the BOT, commented earlier this morning that BOT traders still think the best deal is with the CME, (which is understandable given the product breadth between the two exchanges) and the BOT traders likely know best. However the one aspect of the CME - BOT merger that hasn't been discussed publicly and may be the reason Justice asked for the 2nd review of the proposed merger, is the clearing corp. advantage that CME holds.
Long before the BOT went public, the CME took over the clearing operations for the BOT, given that the CME was the low-cost clearing operator and thus benefits from the volume at both exchanges, but the CME also got a look at BOT's operations at an intimate level.
If ICE wins in a hostile acquisition, as they have intimated they will fight if BOT turns them down, it isn't clear what will happen with the clearing, but if it stays with the CME, they still benefit (i.e. without the fees) from the volume between the merged entity in addition to what ICE might bring to the table.
It is difficult to really vet the clearing issue since the disclosure on these operations is minimal (although CME got into it a little bit in their '06 10-K) but you still have to think the advantage resides with the CME in any battle with ICE over the BOT both from the product breadth and the low-cost clearing operation standpoints.
In terms of whether CME might have to up their offer for the BOT, they certainly have the cash to do so, since for every dollar of cash generated from operations, about $0.50 falls to the free-cash-flow line for the CME. As of q4 '06, 4q trailing cash from operations for the CME was $472 ml, while free-cash-flow (after dividends) was almost $300 ml. The only other exchange we've modeled - the Nasdaq (ticker NDAQ) looks even better: $200 ml in cash from ops in '06 generated almost $180 ml in free-cash, so as you can see with the business models of these exchanges whereby higher trading volumes are being driven over a fixed-cost base, the free-cash-flow leverage is formidable.
Trading action and volume in the CME has been positive since the stock neared its 200-dma and filled the gap at $513 in February. CME's weakness here could present opportunity for the informed buyer, although headline risk and arbitrade activity may drive near-term trading action.
Long CME
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