The CME Group should buy the CBOE soon. I can’t believe I am writing this, but that is the conclusion I have come to. The reason why is that if they don’t act soon, the CBOE may become too expensive to justify buying.
The CBOE stock price was up 76 percent last year and its market cap is $4.3 billion. The CME’s stock was up 55 percent, still outperforming the market, but not the CBOE. CME’s market cap stands at $25 billion, just a shade above InterContinentalExchange’s (ICE) $23.7 billion.
The other reason is that the CME is the natural buyer for the CBOE and the market knows it. In fact, I think some of that 76 percent gain last year is just pure takeover speculation premium after ICE closed the deal for NYSE Euronext.
With the CME’s US rival ICE now in control of NYSE Euronext and their two equity option exchanges, ARCA and AMEX, the CME has to consider its own foray into equity options. With ICE Group’s two equity options exchanges and Nasdaq OMX with three exchanges, and Eurex too with ISE and Gemini, the competition has revenue opportunity in a key sector the CME does not have.
One important aspect of this is the growth of commodity price exposure now available to securities account customers. You don’t have to open a futures account anymore to have exposure to important commodity markets like gold, oil or commodity indices. CME needs exposure to this important pool of customers.
Sure, the CME has lots of equity derivatives with their futures, and options on futures, but equity options markets have not endured the depression that futures markets have after the MF Global and PFG Best implosions. Besides, the CBOE has a competitive position in the equity options business that the CME can truly appreciate. CBOE also appears to have finally put its legal challenge from ISE over the S&P and Dow licenses behind it, with ISE deciding not to appeal its 7-year case against CBOE.
CBOE’s rivals complain that the CBOE subsidizes its single-name equity options business with the profits from its monopoly position in SPX and other indices for which the CBOE has exclusive contracts. True or not, CBOE holds a unique position among options exchanges with its equity index group that dovetails nicely with the CME’s index suite, which includes futures and options on the S&P 500. CME also has a 24 percent ownership stake in S&P Dow Jones Indices. (In March 2013, CBOE and S&P Dow Jones Indices extended their exclusive licensing agreement to list S&P-based index products until 2032.)
The CME has traditionally been very cautious about getting involved in anything where the SEC is involved. However, with more than 10 years of SEC oversight as a public company, the CME should be able to handle it.
Phupinder Gill has yet to make a major acquisition since assuming the CME CEO role from Craig Donohue, who interestingly is now the executive chairman of the Options Clearing Corp. Gill has focused on organic growth, strategic investments and relationships and not on the big deal. Well, the big deal is right there.
The CME should be well-finished digesting the CBOT or the NYMEX deals, despite the sour stomach some former members, now B Shareholders, may bring from time to time. They are ready for another acquisition and the CBOE is a great fit.
Both organizations are industry innovators, with a history of designing new successful contracts.
The trick to a potential tie-up is that the CBOE has a fierce independent streak and tremendous loyalty to its staff. And new CBOE CEO Ed Tilly is just getting his feet under him. He needs to show he is capable of being a player in the global exchange consolidation trend. Either CBOE becomes a shark, or it is going to be bait.
The CBOE has the currency with their stock to go make a deal. The problem is that one of the last times the exchange bought something, NYSE’s options business, it created more competition for itself when Gary Katz and David Krell subsequently founded ISE.
And the options world is kind of like that today, every time you play whack a mole, another new exchange pops up.
There are other potential suitors for CBOE, but CME makes the most sense strategically at this point. CME better get its game together soon, or the CBOE is going to grow up and become a shark.