Why the ICE Takeover of NYSE Euronext Makes Sense
The ICE -- aka the 12-year-old IntercontinentalExchange (ICE), has just swallowed whole the 220-year old New York Stock Exchange as well as financial markets with even longer pedigrees by its agreement to acquire NYSE Euronext (NYX). It's a transaction that it would have been hard for the latter to turn down -- not only does it give the bigger exchange's shareholders a hefty premium, but ICE is growing at a more rapid clip than are the global markets that collectively make up NYSE Euronext. Indeed, ICE, as a newer player in the high-growth derivatives arena, is also seeing its revenues grow at a faster clip than those of CME Group (CME) , which operates Chicago's established futures and options markets.
Moreover, although NYSE Euronext's revenues are nearly double those of the ICE, the latter's profits have more than doubled over the last five years even as those at NYSE Euronext, after a big dip in late 2008 and early 2009, are little changed over that period. ICE's focus on listed derivatives rather than stock listings and trading has helped it keep its profit margins at a higher level.
There is strategic logic to the deal. ICE, which made itself known by trading commodities but has branched out into financial derivatives (including a clearing house for the infamous credit derivatives) has long coveted the business of NYSE Euronext's London-based derivatives exchange, the LIFFE, one of the two biggest European players in this arena. The $8.2 billion acquisition of NYSE Euronext will make ICE the biggest owner of financial markets in the world, and creates the opportunity for lower costs and greater synergies in everything from trading in listed derivatives to clearing.
Analysts had been trimming their forecasts for ICE's earnings before the announcement of the new transaction, but those bearish forecasts might not reflect the potential of the newly merged entity. True, there's a degree of risk associated with the integration -- the combination of the NYSE with the Euronext exchanges (which include markets in Paris and Amsterdam) wasn't a smooth and seamless process and there's no reason to suppose this will be any different. But if any exchange is to undertake this kind of acquisition, ICE is the one that will be most able to navigate the regulatory hurdles (there is little overlap between the two exchanges' businesses) as well as manage the financial challenges of financing the transaction and waiting for those synergies to show up on its new bottom line.
Clearly, ICE has been able to deliver a much higher return on equity to its investors than any other of the major U.S. exchange groups, and while its debt/equity ratio isn't the lowest among them, it is low enough that financing the deal (especially at today's rock bottom interest rates) likely won't impose too much of a strain. ICE clearly is betting that an increase in volatility and higher interest rates will boost investors' interest in hedging via the financial futures markets in which it now will be one of the dominant players. Stock trading will never again be as profitable as it once was, and trading in financial futures, options and other derivative products as well as offering clearing for over-the-counter securities, will be what drives profits for ICE. And for those to grow, investors need to feel the need to hedge.
If trading volumes move upward, there could be significant upside ahead for ICE. The longer the newly merged company has to wait for that to happen, the more uncertainty will cloud its outlook and the less appealing it will be as an investment.
Suzanne McGee, a contributing editor at YCharts, spent nearly 14 years as a reporter at the Wall Street Journal, in Toronto, New York and London. She is also a columnist for The Fiscal Times, and author of "Chasing Goldman Sachs", named one of the best non-fiction books of 2010 by the Washington Post. She can be reached at email@example.com.