Exchange Mergers Hit Roadblocks
Trading volumes for NYSE Euronext and the CME Group have spiked during the market turmoil. But their aggressive expansion plans face resistance
by Ben Steverman
As the rare players who benefit from wild and crazy financial markets, the two biggest U.S. financial exchanges — the CME Group (CME) and NYSE Euronext (NYX) — reported strong earning on Feb. 5. But record trading volume and profits arrive amid signs that the exchanges' aggressive expansion plans may be running into trouble.
Market turmoil might put a strain on the economy and take big bites out of investors' portfolios, but the companies that run those markets benefit. "Whether people are selling or buying, there is activity on these exchanges," says Sang Lee, managing partner of the Aite Group, a consulting firm.
The worry, however, is that exchanges' attempts to expand rapidly — across the world and to include the trading of all sorts of assets, from equities to exchange-traded funds and derivatives — is meeting resistance.
On Feb. 5, the CME Group, the giant formed by the mergers of the Chicago Mercantile Exchange and the Chicago Board of Trade, reported earnings of $3.75 per share in the fourth quarter, up 96% from a year ago. Revenue of $529.5 million fell slightly short of analysts' estimates.
Most impressive, CME's exchange handled an average of 10.6 million contracts a day, up 23% from a year ago. January's average of 14.3 million was 65% higher than a year ago.
The CME is already contemplating growing again, by buying NYMEX Holdings (NMX) for $11.3 billion. The New York Mercantile Exchange is a popular market for the trading of energy futures.
But on Feb. 5, the federal government seemed to throw a roadblock to that purchase. The U.S. Dept. of Justice says it is worried about an inhibition of competition in the financial exchange industry, particularly the control future exchanges have over the clearing of transactions.
The government ruling puts in doubt the large profits CME Group is expecting from its lucrative clearing operation. Some market participants, worried about CME's growing concentration of power, would cheer if CME were forced to spin off its clearing operation.
CME shares slid lower as news spread of the Justice Dept.'s opinion. Shares ended down 4.88% at 588.60.
The stock fell even as analysts said the recent merger of CME and CBOT seemed to be going well. "It appears further along in its integration with CBOT than we would have expected," wrote Goldman Sachs (GS) analyst Daniel Harris.
Meanwhile, NYSE Euronext isn’t showing as much progress after being formed by the merger of the New York Stock Exchange and the European exchange Euronext. Although NYSE executives have promised huge cost savings and synergies from the cross-Atlantic merger, the company admitted on Feb. 5 that some of the benefits of the combination were taking longer to achieve.
That spooked investors, even as NYSE Euronext reported earnings of 59 cents per share, up from 29 cents a year ago, and revenue jumped 79%. Trading volume was strong, up 50% in January from the year before. Its stock fell 14.14% to 71.03 on Feb. 5.
NYSE Euronext CEO Duncan Niederauer said "culturally, we're making great progress in acting like one company and one firm." But investors are "still not seeing the expense synergies we had expected," wrote Niamh Alexander, an analyst at Keefe, Bruyette & Woods (KBW).
Integrating the platforms of merged exchanges is a large and expensive technological undertaking, Aite Group’s Lee notes. "They face a huge challenge," he says.
NYSE Euronext recently announced yet another deal: the $260 million purchase of the American Stock Exchange.
The exchange industry has been transformed in recent years. It's not just the market turmoil that’s driving extra trading volume. Rapid electronic trading is also making the exchanges busier places, as hedge funds and other investors employ sophisticated trading strategies.
New regulations in Europe and the U.S. encourage even more electronic trading, particularly in equities, but they also have increased competition and lower profits on each trade. Even as it has seen volume spike, NYSE Euronext's trading market share has fallen, hurt by fast, low-cost competition. That's prompted the company to try to expand into other countries and into other products, like options, that offer higher-profit margins than equities.
Analysts expect the consolidation in the industry to continue in 2008, as exchanges snap up rivals in order to compete, expand and find cost savings. Thus, the news from both NYSE Euronext and CME Group on Feb. 5 may be crucial: It demonstrates that the exchange industry's merger mania might not be as easy to accomplish as many thought. |
