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CME Group earnings down, analysts say improve volume

by Hollis Templeton
Oct 30, 2008

CME Group Inc. reported a 16 percent drop in third-quarter earnings, missing analysts’ estimates and attributing the decline to investment write-downs, a large tax adjustment and mid-quarter acquisition of rival exchange NYMEX Holdings Inc. But the stock popped 4 percent in the broad market advance.

The derivatives exchange operator’s GAAP net income for the three months ended Sept. 30 fell to $168.7 million, or $2.81 per diluted share, from $201.6 million, or $3.97 per diluted share, in the same quarter a year ago. Analysts surveyed by Bloomberg LP estimated GAAP net income of $238.8 million, or $4.00 per diluted share.

Revenues climbed 20 percent to $681 million from $565.2 million in the third quarter of 2007.

Lower earnings reflect one-time expenses, including a $48 million tax liability, $28 million in write-downs of FXMarketSpace and Swapstream ventures, a $16 million revaluation of the company’s securities lending portfolio and a $7 million termination of the company’s foreign exchange hedge associated with its investment in Brazilian exchange BM&F BOVESPA SA.

“During September and October our markets remained deeply liquid, daily pay and collects took place on schedule and without incident, and has always been true over our 110 year history, no customers lost any money due to counter-party failure,” said CME Group Chief Executive Officer Craig Donohue during a Wednesday conference call.

“What we are most proud of is that this is business as usual for us," Donohue stated.  "Our markets, our clearing methodology, and our technology are designed for robust, seamless functionality during the most chaotic conditions imaginable.”

Third-quarter GAAP earnings reflect the operations of the Chicago Mercantile Exchange and the Chicago Board of Trade, as well as the results of New York Mercantile Exchange parent NYMEX Holdings Inc., which CME Group acquired in August.

Since last year’s results did not include NYMEX, a direct comparison with third quarter 2007 results is difficult.

On a pro-forma basis, which reflects CME Group and NYMEX results as if the two were combined for both periods, third quarter revenues increased 6 percent to $786.7 million from $743.7 million a year ago. Pro-forma net income rose 3 percent to $277.8 million, or $4.13 per diluted share, from $269.2 million, or $4.00 per diluted share.

Average daily volume on a pro-forma basis totaled 13.2 million contracts and drove $665 million in clearing and transaction fee revenues, an increase of 4 percent from $641 million during the same quarter a year ago.

Overall volume was down 7 percent year-over-year, mainly due to reduced activity in CME Group’s interest rate products stemming from the credit crisis. Interest rate products were down 25 percent year-over-year.

“We believe the key investment debate centers on the sustainability of volume growth in core products and structural growth opportunities in new markets,” stated Morgan Stanley Research analysts in a note. “We expect the credit crisis to pressure ‘same-store’ growth through at least 2009… This will overshadow expectations for attractive post-credit crisis opportunities.”

However, as Donohue explained during Wednesday’s call, “There are many factors affecting interest rate volumes, including the de-coupling of LIBOR from fed funds, a trend to the shorter end of the yield curve in Treasury products, a slowdown in corporate debt origination, difficulties in the agency market, and a decrease in mortgage-related transactions... We continue to see these factors as essentially cyclical in nature.”

Offsetting declines in interest rate products were record volumes for E-mini equity indexes and foreign exchange products, which increased 19 percent and 12 percent respectively year-over-year.

For the nine months ended Sept. 30, GAAP net income rose 43 percent to $653.4 million, or $11.61 per diluted share, from $457.5 million, or $11.18, for the same period in 2007. Sales increased 56 percent to $1.5 billion from $988.8 million. On a non-GAAP pro-forma basis, net income rose 21 percent to $844.1 million, or $12.59 per diluted share, from $699.1 million, or $10.36 per diluted share. Revenues rose 15 percent to $2 billion from $1.7 billion.

CME Group is promoting its ability to trade and clear credit default swaps on its electronic trading platform. As Washington considers whether and how to regulate the swaps, CME and its competitors are working with the government to provide opportunities for both the buy and sell sides of the CDS market.

According to Donohue, CME Group is operationally ready to implement a CDS market, as indicated by the company’s teaming up with hedge fund Citadel Investment Group LLC earlier this month.

However, analysts still suggest that CME Group should focus its efforts on higher volume. “While the company has formulated a new CDS clearing initiative and also is involved in a new order routing initiative with the Brazilian Mercantile Exchange, these initiatives are likely less impactful than a return of higher volume to the exchange’s interest rate franchise,” wrote Jonathan Castelyn, an analyst at Wachovia Capital Markets LLC in New York, which still rates CME Group as “outperform.”

CME Group Inc. stock closed at $275.67 Thursday, up $10.67.