By Joseph Weber Judging by the sell-off slamming the stocks of the already public exchanges, investors might want to tread carefully as the New York Stock Exchange's owners prepare for their biggest step in going public -- the Dec. 6 vote on merging with publicly held Archipelago Holdings (AX). The balloting, expected to lead to a publicly traded NYSE as early as January, has speculators salivating.
Memberships -- or seats -- on the still-private NYSE have climbed from $975,000 in January to $3.5 million in late November. But the optimism at the NYSE may be a bit overdone. Triggered by a couple adverse analyst reports, the slide in the already publicly traded exchange stocks shows how inflated the sector has become.
The Chicago Mercantile Exchange (CME), which went public at just $35 a share in December, 2002, and soared to nearly $397 by Nov. 25, has fallen nearly 7%, closing at $370 on Nov. 29. The Chicago Board of Trade, which leapt from a $54 offering price on Oct. 18 to $134.50 by Oct. 24, has skidded even more sharply, to $93. After offering its shares for $26 each on Nov. 16 and shooting above $44 the same day, Atlanta's fast-growing energy futures bourse, the IntercontinentalExchange (ICE), has dipped below $32. Archipelago itself, which went public at $11.50 a share in August, 2004, jumped to $62 by Nov. 22, but has now slipped under $55.
STARK DIFFERENCES. The reality is that not all exchanges are created equal. Unlike the NYSE, for instance, the Chicago futures markets have virtual monopolies on the products they trade. They have proved this by rebuffing challengers such as Eurex, the European giant that so far has failed to horn in on the Board of Trade's Treasury bond trading or, more recently, the Merc's foreign-currency markets. In spite of such assaults, volumes on both Chicago markets have climbed relentlessly -- even while the Chicagoans have raised prices for traders.
With such edges, they're better bets than the equities markets, says analyst Richard Herr of Keefe, Bruyette & Woods. He adds, "It's important to make distinctions."
Even between the Chicagoans, there are stark differences. The Mercantile Exchange, for example, owns its own clearinghouse and provides clearing services for the Chicago Board of Trade under contract. The clearing of trades -- guaranteeing that buyers and sellers of futures contracts will have their orders met -- is a lucrative and central function that gives the Merc a choke hold on the CBOT.
What's more, the Merc lately has been far more innovative than the CBOT, constantly churning out new products for investors to trade. With such advantages, it's not surprising that the Merc sell-off has been small compared to the slide afflicting its crosstown rival.
LOTS OF UNCERTAINTIES. The differences between the futures markets and such equities exchanges as the NYSE and Archipelago are even more important. Forget the idea of a monopoly with the equities exchanges: Investors can buy a stock on the NYSE and then sell it on Nasdaq, Arca, or any of several local stock exchanges (such as the Chicago Stock Exchange).
This means that, despite its world-class brand name, the NYSE's market power is feeble next to the futures bourses. Indeed, the NYSE lately has been losing market share to its many rivals and has now slipped below 74% in its own listed stocks -- maybe its worst performance ever.
The deal with Archipelago will bring back some of that market power -- particularly as the all-electronic Arca Exchange brings the NYSE the ability to handle electronic trading that will match or exceed the power of rival Nasdaq. As the NYSE and Arca blend their operations in the coming year, investors increasingly will be able to bypass the specialists who now slow down trading on the NYSE floor.
But even if Arca boosts the NYSE's share of stock trading, price cuts or other consumer-friendly moves by Nasdaq and other rivals could pare the NYSE's market share still more, warns analyst Richard Repetto of Sandler O'Neill & Partners. "They won't be able to maintain," he argues, predicting that the NYSE and Arca combined could slip, maybe to 60% or so of the trading in NYSE-listed shares in the coming year.
For all of the exchanges, though, lots of uncertainties are further clouding matters. Equities have largely moved sideways in the last year, and no one knows whether the lackluster volumes will continue. While the growth in futures and options trading has been stunning -- driving the Merc stock particularly -- it's not clear whether the breakneck pace of gains will slow now that electronic trading has settled in as the norm at the Chicago Mercantile Exchange.
SHIFTING TIDES. Finally, it's not clear whether such foreign players as Euronext and Eurex could make inroads into the U.S. -- or whether the U.S. markets themselves will grow as they reach overseas. "Things are pretty opaque," warns analyst Herr.
For investors, far too many questions remain. Will the New York and Arca exchanges merge seamlessly? Will they and others look abroad for growth? Will the equities markets move into futures and vice versa? "You're going to see a coming together," former NYSE chairman John S. Reed said on Nov. 29, after appearing with Merc CEO Craig S. Donohue at a panel discussion on the exchanges at the University of Chicago's Graduate School of Business. But how quickly will that happen and what form will it take? No one knows.
As the answers to such questions unfold, investors certainly can't bet -- as some have so far -- that the rising tides will lift all the exchanges equally. If the most recent downturn in the exchange stocks shows nothing else, it makes clear that the shifting tides will take some of the outfits down a lot more sharply than others. And, over time, the differences among the exchanges will likely loom larger, making the battle far more intriguing but perhaps even tougher to call. For those hoping to profit handsomely from a public NYSE, the risks are daunting.
Weber is BusinessWeek's Chicago bureau chief