NYSE-Deutsche Boerse Merger Is Free With Derivatives: Real M&A

By Michael Tsang and Whitney Kisling – // Feb 11, 2011 12:42 AM ET

Derivatives are so valuable that Deutsche Boerse AG’s takeover of NYSE Euronext means the combined company may get a stock trading business for free.

Deutsche Boerse, in talks to buy the owner of the New York Stock Exchange, would acquire a company that generates at least half its net income from trading options and futures contracts, according to Macquarie Group Ltd. That portion of earnings will reach $462 million by 2013, based on analyst estimates compiled by Bloomberg. Add Deutsche Boerse’s projected profit from its Eurex unit and the combined entity will earn $1.18 billion from derivatives in the U.S. and Europe within three years.

The derivatives business of NYSE Euronext and Deutsche Boerse alone would then be worth $24.7 billion, based on the average valuation for options and futures exchanges, more than the companies’ combined capitalizations before the talks were announced this week. The deal shows how lucrative derivatives have become for trading venues, producing operating margins as high as 55 percent. By creating the world’s largest futures exchange that also controls 40 percent of U.S. options, the new entity would offset revenue declines in equities trading.

“The main reason that this deal occurred is that the market is moving towards the derivatives,” said Matt McCormick, a money manager at Cincinnati-based Bahl & Gaynor Inc., which oversees about $3.2 billion. “It’s not because they want real estate on Wall Street.”

Medieval Fairs

Ray Pellecchia, a spokesman at NYSE Euronext, and Deutsche Boerse’s Naomi Kim both declined to comment.

Deutsche Boerse of Frankfurt and NYSE Euronext said on Feb. 9 they were in advanced talks, which would create an exchange with about $15 trillion of publicly traded companies. The all- stock transaction would give Deutsche Boerse, which traces its roots back to the Frankfurt Stock Exchange and the medieval fairs of the 11th century, about 60 percent of the new entity.

Prior to the announcement, the companies had a combined market capitalization of $23.4 billion, based on their 20-day trading averages, with NYSE Euronext valued at $8.5 billion.

The New York-based exchange said derivatives revenue climbed 14 percent last year, while cash equities fell 10 percent. By 2013, NYSE Euronext may generate more than 50 percent of its earnings from options and futures, according to Ed Ditmire, an analyst at Macquarie in New York, who has an “outperform” rating on the stock.

A derivative is a contract between two parties linked to the future value or status of the underlying asset to which it refers, including the development of interest rates or prices of commodities such as oil or wheat.

Relative Value

Net income at Eurex, the derivatives unit of Deutsche Bourse, may increase to about $716 million by 2013, based on estimates provided by Credit Suisse Group AG analyst Rupak Ghose in London. Deutsche Boerse’s Xetra cash-market revenue declined about 10 percent last year, according to Ghose.

“Derivatives are faster growing and the more profitable for exchanges,” said Sandler O’Neill & Partners LP’s New York- based Rich Repetto, the top-ranked exchange analyst according to Bloomberg rankings. “It’s one of the most valuable areas no question, and one of the main reasons” for the deal, he said.

With CME Group Inc. and CBOE Holdings Inc. of Chicago and Atlanta-based IntercontinentalExchange Inc. trading at an average of 21 times earnings, the estimated $1.18 billion in net income would give the derivatives business of NYSE Euronext and Deutsche Boerse a value of $24.7 billion, or 5.7 percent more than the standalone companies together prior to the announcement, data compiled by Bloomberg show.

Cost Savings

That doesn’t include the 300 million euros ($410 million) in cost savings the two companies said the takeover will create.

Deutsche Bank AG in Frankfurt and New York-based JPMorgan Chase & Co. are advising Deutsche Boerse, while Perella Weinberg Partners LP of New York is helping NYSE Euronext, said two people familiar with the matter, who declined to be identified because the discussions are private.

The New York Stock Exchange, formed in 1792 under a sycamore tree on Wall Street, became the center of American capitalism through its grip on stock listings and trading.

NYSE Euronext was formed when the operator of the New York Stock Exchange bought Europe’s second-largest exchange in 2007. It now owns exchanges in Amsterdam, Lisbon, Paris and Brussels, as well as London-based Liffe, Europe’s second-largest derivatives market. The company also runs three U.S. stock exchanges: NYSE Arca, NYSE Amex and the New York Stock Exchange, two options platforms and the NYSE Liffe U.S. futures exchange, which will trade contracts linked to interest rates.

‘De Facto Monopoly’

Deutsche Boerse operates the Frankfurt stock exchange and Clearstream, Europe’s second-biggest securities-settlement firm. The company also has Eurex Clearing AG and a holding in Eurex, the region’s largest futures market. Eurex owns International Securities Exchange, an options market that competes with CBOE.

The takeover is subject to review in the U.S. and Europe and may be viewed as creating a “de facto monopoly” in some futures markets, making antitrust concern “the largest outside risk,” according to a report from New York-based Evercore Partners Inc.

“Over a longer period of time, it makes sense, but the devil is going to be in the details,” said Bahl & Gaynor’s McCormick. “There are regulatory issues. This is a trade that does have some risk associated to it.”

Futures exchanges around the world traded 8.2 billion contracts in 2009, almost three times the turnover in 2003, according to data from the Futures Industry Association, a trade group representing Wall Street banks active in derivatives.

Size and Scope

The deal would give the new company about 40 percent of U.S. options volume by adding NYSE Euronext’s two markets with the ISE. CBOE was the biggest options exchange operator last month with 30 percent of contracts handled on its venues.

In all, the merged firm would control 11 derivatives markets that handled a total of 4.8 billion contracts in 2010, according to FIA. That compares to 3.1 billion trades last year at CME, the world’s largest futures exchange.

NYSE Euronext would also handle clearing, the guaranteeing of payments for transactions and delivery of securities, for equities and futures in Europe through businesses run by Deutsche Boerse. Combining products in the same clearinghouse limits the ability of other markets to compete.

‘All About Scale’

“It’s all about scale in this business,” said Kevin Shacknofsky, who helps manage $6 billion in Purchase, New York, for Alpine Mutual Funds, which owns NYSE shares. “One of the main attractions is the derivatives area. At the end of the day, that was a good deal when you look at the synergies.”

Elsewhere in mergers and acquisitions, Amadeus IT Holding SA of Madrid said in a filing to Spanish regulators yesterday that it had agreed to sell its Opodo online travel agency to Axa Private Equity and Permira Advisers LLP for 500 million euros.

American International Group Inc.’s Chartis Inc. unit plans to buy the remaining shares of Oaska-based Fuji Fire & Marine Insurance Co. it does not already own for 46 billion yen ($553 million) to strengthen its business in Japan.

The general insurance unit of New York-based AIG plans to buy all common shares and stock acquisition rights of Fuji Fire through its wholly owned unit Chartis Japan Capital Co. for 146 yen per share, Fuji Fire and Chartis said in statements.

There have been 2,707 deals announced globally this year, totaling $226.2 billion, a 21 percent increase from the $186.9 billion in the same period in 2010, according to data compiled by Bloomberg.

To contact the reporters on this story: Michael Tsang in New York at mtsang1@bloomberg.net; Whitney Kisling in New York at wkisling@bloomberg.net.


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