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Bats IPO Makes Exchange Built by Wall Street Public

Bats Global Markets Inc., founded by a high-frequency trader and nurtured by the world’s top securities firms into the third-largest U.S. stock exchange operator, will seek more than $100 million for its owners today.

Bats plans to sell 6.3 million shares between $16 and $18 apiece after the close of trading, according to a filing yesterday with the Securities and Exchange Commission. Underwriters led by Morgan Stanley, Credit Suisse Group AG and Citigroup Inc. are pricing the shares at about 16.9 times estimated 2013 earnings, according to Diego Perfumo, an analyst at hedge fund adviser Equity Research Desk.

Started in 2005 with 13 employees, Bats was steered to prominence by brokers and traders trying to hold down fees as the New York Stock Exchange and Nasdaq Stock Market bought their biggest electronic rivals. Now, with its venues accounting for 11 percent of U.S. share volume, the Lenexa, Kansas-based company is seeking a valuation that is higher than its biggest competitors, data compiled by Bloomberg show.

“Naysayers would have said these guys were just a disruptive influence and Bats was created to beat up on the traditional exchanges,” Larry Tabb, chief executive officer of research firm Tabb Group LLC in New York, said in a phone interview yesterday. “The IPO makes the case that Bats is a legitimate exchange just like NYSE and Nasdaq.”

Early Investors

Tradebot Systems Inc. and early investors Getco LLC and Wedbush Inc., firms whose profits are tied to high-frequency trading and market-making strategies that use the Bats platform, will see proceeds via a dividend tied to the sale, scheduled for today after the close of trading. Citigroup, Lehman Brothers Holdings Inc. and Credit Suisse are among its largest owners.

Net income at Bats totaled $23.5 million last year while net revenue was $128 million after deducting fees such as payments to traders and routing costs, giving the company a net margin of 18.4 percent. On the same basis, NYSE Euronext and Nasdaq OMX Group Inc. each had 2011 net margins of 23 percent on net revenue of $2.67 billion and $1.69 billion, respectively.

Perfumo, based in Greenwich, Connecticut, estimates Bats will trade for 16.9 times his forecast of 2013 earnings, assuming the company sells stock today at the midpoint of its targeted range. That compares with price-earnings ratios of 9.8 for NYSE Euronext, 8.7 for Nasdaq OMX and 11.3 for London Stock Exchange Group Plc, according to average analyst estimates for 2013 profit in a Bloomberg survey. CBOE Holdings Inc. trades at a multiple of 15.2, the data show.

Lehman, Morgan Stanley

Almost half of the 6.3 million Class A shares being offered will come from the estate of Lehman Brothers Holdings Inc., with another 1.1 million from Getco, according to the Bats filing with the SEC. Lehman is selling 3.03 million of its 3.98 million Class A shares.

Getco’s Class A and Class B shares give it a 13.9 percent voting interest in the company, more than any other owner. Bats is paying a $100 million dividend to shareholders including its 10 main financial company investors, prior to the IPO’s closing.

The exchange operator is seeking to raise money less than two years after a crash erased $862 billion in less than 20 minutes from U.S. share values, a plunge that some critics linked to the fragmented electronic market structure that helped Bats thrive. While federal regulators imposed brakes to prevent a recurrence of the so-called flash crash on May 6, 2010, future regulation is hard to predict, said Kevin Shacknofsky, a money manager at Alpine Mutual Funds.

‘Big Overhang’

“The combination of weak volumes, more competition and increased regulation is a big overhang for exchanges,” Shacknofsky, who helps oversee about $5 billion, said in a telephone interview. “Bats is a classic example of the increased competition. They’re pressuring the other markets because they’re offering an alternative.”

The IPO comes after the biggest wave of global takeover offers ever foundered on antitrust concern and populist outcry. Regulators blocked Deutsche Boerse AG’s acquisition of NYSE Euronext, Singapore Exchange Ltd.’s attempt to buy Australia’s ASX Ltd. failed, and London Stock Exchange was thwarted in its bid for Toronto Exchange operator TMX Group Inc.

Executives embraced consolidation after the number of U.S. and European trading venues increased by about 50 in the past decade, driving down profitability. NYSE Euronext revenue per European equity trade has dropped 61 percent since 2007 to 64 cents, and in the U.S., the amount per 100 shares is projected to fall 9.8 percent in 2012, according to Macquarie Group Ltd. At the same time, volume on American equity exchanges reached the lowest point since at least 2008 this month.

SEC Request

Bats said Feb. 23 that the SEC enforcement division asked for information on the types of orders customers use on its venues. The request sought information about how order types have evolved at the exchange.

The company said regulators asked for documents “related to the development, modification and use of order types, and our communications with certain market participants,” including some of Bats’ owners. The regulator also asked for information about technology systems and trading strategies, Bats said.

Randy Williams, a spokesman for Bats, declined to comment on the SEC query.

Bats executed 10.9 percent of U.S. equities volume last month, compared with 10.7 a year earlier, the company said. Its U.S. options market share was less than 3 percent and its two European platforms had a combined share of 25.3 percent of value traded, Bats said.

Fully Electronic

Bats was initially built to service high-frequency firms like Tradebot and brokers. Automated trading company Getco in Chicago and Wedbush, owner of a Los Angeles-based investment bank whose clients include high-frequency firms, bought equity stakes in 2005.

Bats was formed in June 2005, two months after the NYSE said it would go public by combining with rival Archipelago Holdings Inc. and Nasdaq Stock Market announced its purchase of Inet ECN. Archipelago and Inet were then the largest electronic communication networks, or ECNs, which match buy and sell orders and compete with exchanges.

The company is the first fully electronic U.S. market operator to go public since the International Securities Exchange in March 2005. Eurex, partly owned by Deutsche Boerse AG, bought ISE for $2.8 billion in December 2007.

Cummings, Ratterman

Dave Cummings, founder of Tradebot, said in 2005 he created Bats with 12 employees to counter the emerging NYSE and Nasdaq duopoly. Executives at Goldman Sachs Group Inc., Citigroup, Merrill Lynch & Co. and other banks said at the time that the lack of competition after the purchases would hurt users by limiting their choice about how and where to execute orders and enabling exchanges to raise transaction fees.

“We were concerned with NYSE and Nasdaq having their hands on those properties and weren’t sure whether they’d continue to push the positive market-structure evolution we saw from 2000 to 2005,” Stephen Schuler, co-founder of Getco, said in a phone interview. Investing in Bats was a “great opportunity” to back a company that could boost “efficiency in markets from both a cost perspective and technology and speed perspective,” he said.

CEO and President Joe Ratterman was one of the employees Cummings hired at Tradebot. He took over Bats in July 2007 when Cummings returned to their old employer in Kansas City, Missouri. Before joining Tradebot in 2004 to focus on business development, Ratterman oversaw 650 people as chief technology officer at Bridge Information Systems Inc.

Unmet Need

“Cummings saw a need that was unmet in the industry, created that and got it on its way,” Tabb said. “Ratterman is a tremendous executive. He’s kept the vision, built out the technology infrastructure and done an excellent job implementing those early plans.”

Bats got SEC approval to operate as an exchange in 2008 and introduced a second trading platform in 2010. New York-based NYSE Euronext and Nasdaq OMX each own three stock exchanges, while Jersey City, New Jersey-based Direct Edge Holdings LLC has two. Exchanges employ different rules and trading fees to cater to different users.

Bats plans to enter at least two new markets by the end of 2014, according to an SEC filing. Bats is considering an expansion into Treasuries, foreign exchange and U.S. futures, and may enter Canada and Brazil. The company previously said it’s exploring the possibility of creating a Brazilian exchange with a Sao Paulo-based asset manager.

Keith Ross, chief executive officer of PDQ Enterprises LLC, a Glenview, Illinois-based firm that operates a private network to match stock orders without publishing quotes, said in a phone interview that Bats’ success hinges on giving users what they want. Ross, a former CEO of Getco who left the company in early 2005, said the exchange has attracted volume through its technology, speed and ability to cater to the needs of clients.

“Brokers’ execution business will go to the market where they think they’re getting the best execution and lowest cost for their customers,” Ross said. “If they’re not getting the fills they need, they’ll migrate to another exchange.”

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