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CME $17 Billion Decline No Barrier to Deutsche Boerse Bid

While $17 billion of lost market capitalization has cost CME Group Inc. (CME) the title of world’s most valuable exchange owner, its stock commands a valuation that would make buying Germany’s Deutsche Boerse AG (DB1) a bargain.

The Chicago Mercantile Exchange owner approached Deutsche Boerse at the end of last year to consider starting talks on a merger, according to four people familiar with the situation. The Frankfurt-based owner of the Eurex derivatives exchange is hesitant about entering discussions, said the people, who asked not to be identified because the information is private. Deutsche Boerse said in a statement yesterday that it’s not in merger talks.

CME’s overture is the fourth time it has considered an acquisition since Phupinder Gill replaced Craig Donohue as chief executive officer in March 2012 and may be its best chance to expand in Europe. While down 59 percent from its peak in 2007, its shares trade at 19.8 times last year’s earnings, a premium of more than 30 percent over Deutsche Boerse.

“The big difference in the multiple is a function of CME is really a pure play of a derivatives business, it’s best in class, monopolistic and has got good growth,” Alex Kramm, a New York-based exchange analyst at UBS AG, said by phone. “Whereas Deutsche Boerse, there’s a lot of other businesses and cash equities in Germany, clearing. So they probably have a conglomerate discount.”

Takeover Talks

CME and Deutsche Boerse officials met last month to debate whether to begin formal takeover talks and haven’t made a decision, the people said. No offer has been made, nor have terms been discussed, they said. Frank Herkenhoff, a spokesman for Deutsche Boerse, and Allan Schoenberg of Chicago-based CME, declined to comment.

CME shares trade close to the average multiple of 19.9 for American and European derivatives venues in the Bloomberg World Exchange Index. By contrast, markets that focus on stock transactions such as Nasdaq OMX Group Inc. (NDAQ), London Stock Exchange Group Plc (LSE) and NYSE Euronext are priced at an average of 13.2 times annual income, data compiled by Bloomberg show.

Deutsche Boerse, with a market value of $12.4 billion compared with CME’s $19.2 billion, is in the middle at about 14.

Trading futures is more valuable than stocks because exchange operators usually control the clearing of derivatives contracts, limiting the ability of rivals to offer the same products. The ability to clear contracts inhibits competition because member firms trading on different venues would have to post collateral at separate clearinghouses, even for positions that offset one another.

Higher Valuation

The higher valuation is little consolation to CME owners who have held the shares since the credit crisis. While the stock has rallied 9.8 percent since Intercontinental Exchange Inc. agreed to buy NYSE Euronext (NYX) for $8.2 billion on Dec. 20, it remains down 59 percent from its 2007 peak of $142.15. The record was reached after an 848 percent rally over four years that was second only to Apple Inc. in the Russell 1000 Index.

“The markets aren’t robust, the sector is out of favor, and CME is trying to do something about it,” Larry Tabb, chief executive officer of the Tabb Group in New York, said in a phone interview. “When they went public there was some optimism that volumes would go to infinity and these guys were going to mint money. Now investors are trying to figure out reality.”

Hong Kong Exchanges & Clearing Ltd. overtook CME as the world’s largest exchange operator by market value in December as the Chinese company completed its $2.2 billion takeover of the London Metal Exchange. The Hong Kong bourse is the largest in the industry with a capitalization of $20.8 billion, according to data compiled by Bloomberg.

Derivative Contracts

CME’s business spans agricultural, energy, metal and financial futures linked to corn, oil, gold and interest rates. The value of the company’s shares climbed as high as $38 billion in 2007, data compiled by Bloomberg show.

Earnings at CME slumped 13 percent to $989.4 million excluding some items last year, the second decline since the company went public in December 2002. Analysts’ forecasts show profit will climb 6 percent to $1.05 billion this year, according to data compiled by Bloomberg.

Deutsche Boerse’s Eurex division is Europe’s largest derivatives market, hosting benchmark contracts on German and French government bonds. Income tumbled 22 percent to 660.90 million euros ($863.7 million) in 2012 and may rebound 8 percent to 715.6 million euros in 2013, data compiled by Bloomberg show.

Antitrust Review

Any transaction would be subject to antitrust review by regulators in Europe, who blocked a bid last year by NYSE Euronext to merge with Deutsche Boerse. A deal would also face opposition on political grounds, said Peter Kovalski, an analyst and portfolio manager at Alpine Woods Capital Investors LLC in Purchase, New York, which manages about $6 billion. Alpine owns shares of CME.

“Consolidation within the industry makes sense but seeing the past, I’m surprised they would be trying to do something like this,” he said in a telephone interview. “They should probably wait for better economic times when antitrust and political issues are less of concerns. In this environment now with struggling employment, each country’s going to worry about job losses.”

Competition authorities will also examine Intercontinental Exchange’s takeover of NYSE. The companies said in December that the new business will hold on to Liffe and NYSE Euronext’s U.S. securities markets including the New York Stock Exchange and would explore an initial public offering of the company’s European stock venues once the merger is completed.

Attempted Deals

“CME doesn’t have the same obstacle from antitrust regulators because it doesn’t have a material European business today,” Elmer Funke Kupper, chief executive officer of ASX Ltd., Australia’s main exchange operator, said in an interview in Sydney today. “They are not competitors in the way that NYSE and Deutsche Boerse were. The reason that they said no is that you had the German exchange and Liffe, which together would be very, very large.”

Exchange companies have been the subject of $50 billion in attempted deals in the past three years, most of them never consummated, amid shrinking profits for securities trading, according to data compiled by Bloomberg. Regulators scuttled a merger agreement between NYSE Euronext and Deutsche Boerse in February 2012 because it would have created a dominant European exchange operator for derivatives.

Profit for companies in the Bloomberg World Exchanges Index contracted 0.7 percent in 2012 and will increase 7.6 percent in 2013, according to analysts’ estimates.

Rebuffed Overtures

CME shares slipped 0.9 percent to $57.78 yesterday, trimming their 2013 gain to 14 percent. Deutsche Boerse shares jumped as much as 12 percent before ending up 5.6 percent at 49.30 euros, bringing the 2013 advance to 6.7 percent.

As Gill tries to turn around the share price, he has been rebuffed in approaches for the London Metal Exchange and NYSE Euronext. In October, CME said it would buy the Kansas City Board of Trade and in August the company announced plans for a new derivatives exchange in London.

“It would be a good use of CME’s high-multiple stock to go shopping with it and there could be significant cost savings,” Niamh Alexander, an analyst at KBW Inc. in New York, wrote in a report yesterday, referring to a purchase of Deutsche Boerse. “An acquisition could be compelling even with the multiple arbitrage alone, though we would see significant cost savings by combining the operating systems.”

Revenue Slide

CME’s revenue is fading in the face of declining trading following the 2008 financial crisis. Volume of contracts in the fourth quarter fell 13 percent from a year earlier, led by equity index, energy and interest rate contracts, the company said on Feb. 5. Revenue slid 10.3 percent to $661 million last quarter.

Average daily price moves for the S&P 500 have narrowed to 0.43 percent in 2013 from an average 1.08 percent the past five years, the steepest decline for any corresponding period since the 1930s, according to data compiled by Bloomberg.

“CME still has a strong business model,” Rich Repetto, an analyst at Sandler O’Neill & Partners LP in New York, said in a phone interview yesterday. “Investors think CME’s volumes are suppressed by cyclical issues such as low interest rates and low equity volatility, so volumes are seen rebounding over time.”

To contact the reporters on this story: Nandini Sukumar in London at nsukumar@bloomberg.net; Lindsey Rupp in New York at lrupp2@bloomberg.net

To contact the editor responsible for this story: Andrew Rummer at arummer@bloomberg.net

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