By Nandini Sukumar and Edgar Ortega,
London: Deutsche Boerse AG, operator of the Frankfurt stock exchange, agreed to buy International Securities Exchange Holdings Inc. for about $2.8 billion in cash to create the largest trans-Atlantic derivatives market.
The price amounts to $67.50 per ISE share, Deutsche Boerse said today, or 48 % more than ISE’s closing price of $45.72 on 27 April. The purchase will be carried out by Deutsche Boerse’s Eurex AG unit, Europe’s largest derivatives exchange.
Buying New York-based ISE will give Deutsche Boerse access to the US options market, which in 2006 grew at its fastest pace in six years as hedge funds and investors turned to derivatives to bolster returns. Deutsche Boerse CEO Reto Francioni has been seeking partners since losing out to NYSE Group Inc. in a battle to buy Euronext NV last year.
“This move will offer Deutsche Boerse an excellent foothold into the very rapidly expanding US options market,” said Brad Bailey, a former options and stock trader who’s now an analyst at Boston-based consulting firm Aite Group LLC.
Shares of ISE, the second-largest US options market, surged $20.97, or 46 %, to $66.69 in composite trading on the New York Stock Exchange. Deutsche Boerse rose 2.35 euros, or 1.4 %, to 172.55 euros in Frankfurt. Together the two exchanges would have a combined market value of $20 billion, just shy of the $22 billion market capitalization of NYSE Euronext.
The deal marks a new strategy in the US for Eurex, which is owned by Deutsche Boerse and SWX Swiss exchange. After unsuccessfully taking on the Chicago Board of Trade in the Treasury futures market in 2004 and 2005, Eurex agreed to sell 70% of the US unit to London-based Man Group Plc.
ISE started trading in May 2000 and grew to match the Chicago Board Options Exchange as the largest US options market by offering investors an all-electronic way to match orders.
After the transaction is completed, the ISE will operate as a separate exchange overseen by the US Securities and Exchange Commission, Deutsche Boerse said in a statement. The ISE also will retain its “full management,” current governance structure and brand, Deutsche Boerse said.
“By completing this transaction, we will be positioned to build upon ISE’s successful business model and to solidify our future,” ISE Chief Executive Officer and founder David Krell said in a statement.
Taking on Debt
The purchase will close in the fourth quarter, Deutsche Boerse said, adding that it will fund its 85% share of the purchase price with a bridge loan of about 1.5 billion euros and cash. Deutsche Boerse will change its legal structure to free up cash and will have net debt on its balance sheet after the transaction, the exchange said.
Deutsche Boerse expects savings before taxes of about $50 million per year with 50 % of the reduction achievable in 2010.
The German exchange’s offer for the ISE represents “a staggering premium,” said Michael Long, an analyst at Keefe, Bruyette & Woods Ltd. in London. Shares of ISE have almost quadrupled since their debut in March 2005.
“Deutsche Boerse has now opted for an acquisition to drive its US strategy,” said Long, who has a “market perform” rating on Deutsche Boerse shares.
Deutsche Boerse and the ISE are pursuing their plan after NYSE Euronext moved to generate $40 million a year in fees for options and futures trading by linking markets on both sides of the Atlantic. NYSE Euronext owns the Arca options market, which is the fourth largest in the U.S., and the London-based Euronext.Liffe derivatives market, which is Eurex’s closest rival in Europe.
Options trading in the US will grow at an annual rate of more than 28 % this year and next, spurred by a government mandated test to quote some contracts in 1-cent increments instead of nickels and dimes, according to Fox-Pitt, Kelton Inc. About 20 % of the roughly 10 million contracts that change hands daily in the US involve trades completed by European investors, according to a survey by the Options Clearing Corp., which guarantees all US trades.
The Philadelphia Stock Exchange, the third largest US options market, is in talks about a possible deal with rivals including Nasdaq Stock Market Inc. Negotiations earlier this decade between the Philadelphia exchange and Eurex collapsed on concern US regulators would reject the plan for the joint market.
“We are talking and have talked to a whole bunch of folks, and we are seriously looking at all our options,” Sandy Frucher, chairman of the Philadelphia exchange, told reporters on April 27 at the Options Industry Council conference in San Antonio.
CBOE Seat Prices
The ISE deal helped lift prices for memberships, also known as seats, at the CBOE. Three seats sold today for a record price of $2.4 million. Another seat sold for $5,000 less than the record while two more memberships went for $2.3 million, the previous all-time high set last week, the exchange said.
The CBOE is seeking regulatory approval to become a publicly traded company. The exchange, which has 931 memberships, is valued at about $2.23 billion based on the record seat prices. The Deutsche Boerse bid valued the ISE at about $2.62 billion.
“The ISE is on the cutting edge of technology and has a lot less overhead than the Chicago Board Options Exchange,” said Larry Tabb, president of the Westborough, Massachusetts-based consultant Tabb Group. “It’s a pretty valuable franchise.”
Exchanges have announced more than $60 billion of joint ventures and acquisitions since 2005 as they rush to provide investors the ability to trade securities across asset classes and time zones. Intercontinental Exchange Inc. has bid $9.6 billion for the Chicago Board of Trade based on closing share prices on 27 April, compared with an $8.2 billion offer by the Chicago Mercantile Exchange.
Global trading in futures and options contracts on derivatives connected to interest rates, currencies and stock indexes totaled $465 trillion in the third quarter of 2006, up from $288 billion two years earlier, according to the Bank for International Settlements. The data reflects the so-called notional value of the assets on which the contracts are based.
A derivative is a financial contract whose value is derived from changes in an underlying asset, index or the outcome of specific events. Derivatives include futures, which are agreements to buy or sell assets at a set date and price, and options, which are the right but not the obligation to do so.
Deutsche Boerse was advised on the transaction by Deutsche Bank AG and JPMorgan Chase & Co., the exchange said. ISE was advised by Merrill Lynch & Co. and Evercore Partners, according to Molly McGregor a spokeswoman for the US exchange.
Deutsche Boerse and the ISE will hold a press briefing in New York tomorrow at 8:30 a.m. local time, followed by a conference call for investors at 10:30 a.m. in New York.