CBOE IPO seen a step to being acquired

by Phil Wahbam, Fri Aug 22, 2008 7:27am EDT

NEW YORK (Reuters) - Since its long-standing dispute with CME Group Inc's (CME.O: Quote, Profile, Research, Stock Buzz) Chicago Board of Trade over trading rights is just about settled, the Chicago Board Options Exchange may soon become a takeover target.While the CBOE is expected to pursue an initial public offering, with a filing possible as soon as next month, many exchange industry experts see that as only an interim step. It will be like sticking a "for sale" sign up, they argue.

Despite being the top U.S. equities options market, with a stranglehold on index options, the CBOE may have to consider a bigger partner.

It is one of the few remaining stand-alone exchanges, which leaves it vulnerable to a squeezing of its margins by growing competition, particularly exchanges that can offer investors stocks and options under the same roof.

"I think talks between various global players and the CBOE will begin within days, not weeks," said Jon Najarian, founder of optionmonster.com and a CBOE seatholder.

Analysts expect the exchange will first launch an IPO to give potential suitors a sense of the exchange's value, and then begin to negotiate with prospective buyers, much as NYMEX Holdings Inc (NMX.N: Quote, Profile, Research, Stock Buzz) did in 2006 on the way to being acquired by CME. That deal is expected to close on Friday.

"They are not in immediate danger," said Diego Perfumo, an analyst with Equity Research Desk, who expects the CBOE to float its shares within six months in a $650 million IPO. "But they are not in the driver's seat because competition for options will intensify and the exchanges are consolidating."

Given the battering exchange stocks have taken this year -- CME and NYSE Euronext (NYX.N: Quote, Profile, Research, Stock Buzz) have each fallen by at least 50 percent -- and a moribund IPO market, a CBOE IPO runs the risk of falling flat. Complicating matters, a wave of consolidation among exchanges has left fewer potential suitors for CBOE.

"Yes they are dominant, but they are an exchange," David Menlow, president of IPOfinancial.com, said of the CBOE. "They will be lumped into the sector and there may not be enough investors who think they're different enough."

The CBOE is the largest U.S. options market, with a market share of 32 percent, according to the Options Clearing Corporation, with 86 percent of index options through its exclusive rights to trade Standard & Poor's contracts.

"It's not the best time to come to market," said Patrick O'Shaughnessy, an exchanges analyst with Raymond James and Associates, of an IPO market suffering its worst slowdown in five years.

It will all depend on how the markets perform. "Exchanges will go up when there is a bull market," said Perfumo, who expects the IPO market to open up by the end of the year.

WHO MIGHT WANT THE CBOE

Analysts wonder whether exchanges already digesting purchases they have made in recent years will show much interest in the CBOE.

Both NYSE Euronext and Nasdaq OMX (NDAQ.O: Quote, Profile, Research, Stock Buzz) already operate their own options markets, and Deutsche Boerse (DB1Gn.DE: Quote, Profile, Research, Stock Buzz) last year bought International Securities Exchange, the CBOE's closest rival with 29 percent of the options market.

Some analysts suspect CME may have its eye on the CBOE, but Perfumo argues that CME would pass on it to avoid coming under U.S. Securities and Exchange Commission oversight, leaving NYSE Euronext the most logical candidate.

But with its shares off 56 percent in 2008, Perfumo said it won't be in a position to make an acquisition until it finishes integrating Euronext and solves the riddle of its dwindling share of NYSE-listed stock trading, which it is losing to Nasdaq, BATS Trading and Direct Edge in a liberalized market.

The small number of likely suitors makes a CBOE bidding war unlikely, O'Shaughnessy said, weighing on its potential buyout price. That is one reason many members would prefer an IPO.

IPO AS FIRST STEP

"Their assets through shares offered in an initial public offering would command a greater multiple than a straight buyout by the CME Group or other interested parties," Najarian said.

The major exchanges have been trading at multiples ranging from 10.4 times estimated 2009 earnings for NYSE Euronext to 16 times for CME, according to Thomson Reuters data, and analysts estimate the CBOE could be worth a multiple in the high teens or low 20s.

But analysts put the CBOE's value at about $2.5 billion, much less than it would have commanded a year ago.

Still, the company has attributes that make it attractive even in a jittery market.

"It has the hallmarks of what institutional investors are looking for -- it's a clearly branded leader in a defined, growing niche, and they're cash flow positive," said Francis Gaskins, president of IPO Desktop.