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CME Group Inc. made a smart move by staying out of the merger battle for NYSE Euronext. Instead, the Chicago  exchange operator has focused on its own expansion strategy, and analysts expect the company to outperform the market this year.

CME Group makes wise choice of battles

by Anjelica Tan
May 25, 2011

CME Stock Prices

Anjelica Tan/MEDILL

The stock price of CME Group Inc. is quite high relative to the stock of other exchanges in the industry. It hovers around $300, about double the price of its rival, IntercontinentalExchange Inc.

Choosing not to fight in the highly publicized merger battle for NYSE Euronext was a smart move by CME Group Inc. Instead, the largest futures exchange in the world has focused on growing its already well-established worldwide business, and analysts agree the company is primed to continue its success in the coming year.

“CME’s done well, and volumes have increased in 2011,” said Richard Repetto, a principal analyst at Sandler O’Neill + Partners LP in New York. “The company’s stayed true to its disciplined strategy and continues to invest in global expansion.”

In 2010, the Chicago-based company posted $3.0 billion in revenue and $951.4 million in net income, both up from the previous two years. The trend continues into 2011 with CME Group reporting record first-quarter revenue of $831.6 million and net income of $456.6 million, or $6.81 per diluted share, a 90 percent increase from the year-earlier period.

CME Group’s stock price rebounded in April from an 8 percent dive in mid-March. It took another dip early this month and has been selling for shy of $300 a share in the first half of May. Compared with the 52-week high of $330.99 in December and $234.50 low in August, the stock is on the upside, closing at $297.24 on May 18. The price-earnings ratio on the same date was 18, compared to the Standard & Poor's 500 Stock Index price-earnings ratio of 16.

Of the 23 analysts surveyed by Bloomberg LP, 14 recommend buying the stock, while nine have a hold on it. None rate it a sell. The analysts expect diluted earnings of $19.12 per share in 2011, sharply higher than the actual diluted earnings of $14.31 per share in 2010.

“There may be some seasonality in the summer, but overall volumes are improving, up approximately 10 percent,” said Repetto.

Contributing to CME Group’s success this year is its strength in food and energy futures. The company, which owns the Chicago Board of Trade and the New York Mercantile Exchange, has benefitted from continued demand for grains and meat in growing Asian economies, as well as U.S. demand for energy commodities. Agricultural products such as wheat and cattle are negotiated at the CBOT, while crude oil is traded on the NYMEX.

CME Group’s interest rate products, such as government bonds and Eurodollars, have suffered a bit from near-zero levels of interest rates in the U.S. Although Federal Reserve Chairman Ben Bernanke announced recently that interest rates would remain low, some observers think they'll increase sometime in the near future.

“Once investors start to worry about interest rates going up, they’ll want to lock in the low rates right now,” said Francisco Palomino, a finance professor at the University of Michigan Ross School of Business who specializes in monetary policy. “There is demand pressure in this market and that demand is good for CME.”

On May 9, CME Group announced a $750 million share buyback program of common stock. Analyst Patrick O’Shaughnessy of Raymond James & Associates Inc. believes investors, who have been waiting for a concrete plan from the firm to return capital to shareholders for quite some time, will welcome authorization of the buyback program.

“The announcement also upstages IntercontinentalExchange a bit, as that firm reported its own smaller repurchase plans [on May 6],” O’Shaughnessy said in a research note.

This isn’t surprising since CME Group, which has strategic partnerships with exchanges across the globe, has the upper hand when it comes to competition from Atlanta-based IntercontinentalExchange Inc. and others in the industry. While ICE, a much newer player in the game of futures, has established itself as an innovator with its clearing services for over-the-counter derivatives, the array of its products is not as wide as that of CME Group.

According to Christopher Culp, a senior advisor at consulting firm Compass Lexecon, a finance professor at the University of Chicago Booth School of Business and an expert on derivatives, “ClearPort [CME Group’s clearinghouse] has experienced explosive growth over time.”

In a 2010 research paper published in the Journal of Applied Finance, Culp compared the types of product clearing offered by a number of exchanges around the world. Both CME Group and ICE clear credit default swap and energy derivatives, but only CME Group has plans for interest rate swaps and foreign exchange clearing. Furthermore, according to CME Group, the company will soon offer clearing for its equities and weather products.

Staying on top of these plans, CME Group will launch clearing services for its OTC foreign exchange products this year, starting with U.S. dollar versus Chilean peso futures. In a press release, Craig LeVeille, the group’s director of FX products, said Chilean institutions hedging currency risks can mitigate credit constraints and should see a boost in liquidity by using the firm’s ClearPort service.

In the third quarter of 2011, CME Group will launch phase two of its partnership with the Mexican Derivatives Exchange, the second largest exchange in Latin America. The first phase provided a south-to-north connection that gives Mexican investors access to CME Group’s benchmark derivatives contracts, and the second phase will run a north-to-south connection that will give CME Group clients access to MexDer’s interest rate and equity index derivatives.

In 2012, CME Group will launch co-location services, which comprise hosting, connectivity and support to Globex, its electronic trading platform. The heart of co-location services is a data center that will provide paying customers the fastest connection to trade on the system.

In a letter to the Securities and Exchange Commission regarding co-location, CME Group CEO Craig Donohue said the company has “a model that is fair and equitable and can be used as a blueprint for other exchanges.” Analysts say CME Group’s edge in co-location will bring in another revenue stream as electronic trading and demand for speed continue to grow in the market.

The adept ability of CME Group to operate and expand in a rapidly changing environment has proven to be one of its most valuable assets. The decision to leave the Big Board merger battle to a competitor, which lost in the end, allowed CME Group to focus on its already successful global strategy. With a bottom line that continues to grow year over year and an unrelenting effort to expand, CME Group is expected to remain a dominant force among worldwide exchanges well into the future.