Exchange Merger Mania!

aakanksha is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

In October 2012, Jeff Sprecher, chief executive of upstart IntercontinentalExchange (NYSE: ICE), approached NYSE Euronext (NYSE: NYX) CEO Duncan Niederauer with a modest proposal to team up on clearing trades in London.

As the men continued talking, Sprecher grew bolder, instead suggesting that ICE buy NYSE in what became an $8.2 billion (5 billion pounds) deal announced on Dec. 20.

The deal will link up the two most powerful derivatives exchanges and clearing house operators, but threatens to further reduce the clout of the New York Stock Exchange. It has to some extent reflected Niederauer's inability to get his company's share price out of the doldrums. Before the latest ICE offer emerged, NYSE Euronext's shares had fallen by nearly a third since ICE and Nasdaq launched their thwarted joint bid.

While the New York Stock Exchange has stood for 200 years as an iconic symbol of U.S. capitalism, it is almost an afterthought in this deal.

For ICE, the crown jewel of NYSE Euronext is Liffe, Europe's second-largest derivatives market. ICE's current main operations are in energy futures trading, and it has steered clear of stocks and stock-options trading, key businesses for NYSE Euronext. ICE started out as an online marketplace for energy trading before Sprecher initiated a string of acquisitions from the London-based International Petroleum Exchange in 2001, to the New York Board of Trade and, most recently, a handful of smaller deals, including a climate exchange and a stake in a Brazilian clearing house.

Liffe will help ICE compete against U.S.-based CME Group Inc. (NASDAQ: CME), owner of the Chicago Board of Trade. Derivatives trading remains highly profitable for the exchanges, and new rules next year will dramatically expand the demand for clearing over-the-counter contracts.

The Deal

While ICE is a rising star in the exchange world, it said it will operate dual headquarters in Atlanta and New York, and stressed that it has no current plans to shut down the NYSE's famous trading floor, a move cheered by U.S. Sen. Charles Schumer. "They have assured me they will keep the floor open," said Schumer. "I am pleased they will keep the New York Stock Exchange name and protect the brand."

ICE's Sprecher will be the CEO of the combined organization. Niederauer will be the CEO of the NYSE Group.

The deal values each NYSE Euronext share at $33.12. NYSE Euronext stock rose 34 percent to end at $32.25 on Thursday. ICE said it would pay annual dividends of $300 million to the companies' shareholders once the deal closes, about what NYSE pays its shareholders now.

Shareholders will have the option of accepting $33.12 in cash per NYSE Euronext share or 0.2581 ICE share or a mix of $11.27 in cash and 0.1703 ICE share, subject to a maximum cash consideration of $2.7 billion.

Conclusion

Long-time Wall Street traders saw the potential takeover of the venerable stock exchange by a 12-year-old derivatives upstart as fraught with symbolism."It's the end of an era," said a director on the board of a rival exchange who did not have clearance to speak to the press and asked not to be named.

A combined ICE-NYSE Euronext would leap-frog Deutsche Boerse to become the world's third-largest exchange group with a combined market value of $15.2 billion. CME Group has a market value of $17.5 billion. Hong Kong Exchanges and Clearing is the world's largest exchange group with a market cap of $19.5 billion.

However,Standard & Poor's Ratings Services (S&P) has cast a concerned outlook on the merger, which is expected to culminate by the first half of 2013, subject to the fulfillment of regulatory compliances in the U.S. and Europe. The ratings agency is skeptical about the raised debt amid weak fundamentals. Accordingly, S&P has assigned an issuer credit rating of "A+/A-1" on NYSE.

S&P's concern hovers around NYSE's inflated debt position, which the company plans to carry in the merged company as well. Further, with a long-term debt of $2.5 billion at the end of the first nine months of 2012, NYSE bears the brunt of higher borrowing costs, which further constricted the operating margins to about 33% during the same period from 9% in the year-ago period. At present, higher debt and capital expenditure has led NYSE's debt-to-EBITDA ratio to deteriorate to 2.4x at the end of September from 1.6x at 2011-end, which again underscores ample financial and operating risks.

The financial risks from the higher debt obligations do not make this potentially strong merger any less risky. This is due to the fact that IntercontinentalExchange plans to squeeze all of its cash of $1.0 billion and raise another $1.8 billion from its revolving credit facility. This leaves the combined entity with a debt burden of about $4.7 billion and debt-to-EBITDA ratio of 2.2x, according to the S&P, which remains in a perilous state.

Nevertheless, the ratings agency is optimistic about ICE Clear Europe providing clearing services to NYSE Liffe, as part of the merger. This clearing pact allows NYSE to diminish the cost and risk of building its own clearinghouse in London and mutually benefit from the diverse product portfolio. Moreover, S&P believes that NYSE is making efforts to reduce its debt obligations through refinance and other activities. Even post merger, the joint entity has the potential to improve its operating cash flow and produce cost synergies worth about $300 million by 2014.

However, these actions would take quite a long time given the company's capital and other extraordinary cost requirements of about $150 million in 2013. Hence, a risky financial and operating leverage could also shake investor confidence, and it calls for an appropriate check and control system instantaneously.

 


Aakanksha19 has no positions in the stocks mentioned above. The Motley Fool owns shares of CME Group. Motley Fool newsletter services recommend NYSE Euronext. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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