Deals

Tara Lachapelle is a Bloomberg Gadfly columnist covering deals. She previously wrote an M&A column for Bloomberg News.

Gillian Tan is a Bloomberg Gadfly columnist covering deals and private equity. She previously was a reporter for the Wall Street Journal. She is a qualified chartered accountant.

Bats Global Markets, the Cinderella story of Wall Street exchange operators, may be about to get its fairy-tale ending.

Once upon a time, the Lenexa, Kansas-based company was the butt of jokes, having botched its own initial public offering in 2012. Bats retreated from the public eye and spent the last few years morphing its image from one of a scrappy newbie into a formidable rival in equities, options and currencies trading. This past April, Bats took itself public -- successfully this time. Its shares gained 40 percent since the debut through Sept. 22, outpacing its U.S. peers and the Bloomberg IPO Index, which tracks stocks during their first publicly traded year.

Like a Bat Out of...
Shares of Bats have taken off since the company debuted on its own exchange earlier this year -- a retort to critics of its embarrassing IPO fail in 2012.
Source: Bloomberg

Now, the company is in talks to sell itself to Chicago-based competitor CBOE Holdings and a deal is potentially weeks away from announcement, Bloomberg News reported Thursday. 

Some are disputing the logic of such a transaction because it would vault CBOE -- a company focused on options and futures contracts -- into the lesser attractive world of cash equities, which is in decline. But who says CBOE has to keep that business? It's entirely possible that CBOE could break up Bats and that there would be buyers interested in the U.S. and European equities businesses -- Nasdaq, Intercontinental Exchange (the owner of the New York Stock Exchange) and Euronext come to mind. Nasdaq and ICE could also step up as suitors for the entire company, but CBOE's clean balance sheet -- with zero debt -- makes it a likelier buyer.

Bats is known to be a lean operation, which may mean it provides CBOE little in the way of cost synergies -- Evercore ISI pegs this figure at $145 million, to be realized during the first two years. But the goal of this merger would be scale more than savings. Bats and CBOE each operate two of the 14 options exchanges in the U.S. and together would have a nearly 40 percent share of that market. Combining with Bats would put CBOE back in the lead over Nasdaq, which has beefed up in options after purchasing three electronic exchanges from Germany's Deutsche Boerse this year for $1.1 billion. 

Scaling Up
With an acquisition of Bats, CBOE would reclaim its lead over Nasdaq in the U.S. options market. CBOE also has exclusive rights to S&P 500 and VIX index contracts.
Source: Company filings

Interestingly, Nasdaq inked that deal in March, before Bats became publicly traded and would have been a cheaper target for CBOE (assuming it was interested).  Now, CBOE will have to pay a much higher price for the company. Bats priced its IPO at the top end of its marketed range, at a valuation of $1.8 billion. Including Friday's gains, it's now worth $3 billion -- and any acquisition would likely come at a slim premium to that.

It's also possible that CBOE made overtures before Bats's IPO, only to be rebuffed. After all, Bats surely wanted to redeem itself from its 2012 snafu and probably preferred to allow public markets to determine its valuation. 

But even after the stock's rally, Bats is among the world's cheapest exchange companies relative to its earnings per share and Ebitda -- it's cheaper than CBOE by those measures. But considering analysts have been fairly neutral on Bats's stock and forecast no upside for the stand-alone company, its shareholders should welcome the chance for a takeover premium now. 

Pricing in a Deal
Bats surged as much as 24% Friday on news that CBOE may acquire it. The stock is now trading well above what analysts consider to be Bats's fair value as a stand-alone company.
Source: Bloomberg

Its pre-IPO investors -- the biggest being Deutsche Boerse and KCG Holdings, with stakes of 9.7 percent and 14.3 percent, respectively -- especially stand to gain. First, a sale would provide a hastier exit than adhering to a lock-up period that spans through October 2017. But also, Bats's surge Friday on the merger speculation to as much as $33 apiece adds as much as $2 per share to KCG’s pro-forma book value, according to Wells Fargo analysts. (Notably, KCG's stock gained just 7.1 percent or $1.04 on Friday -- shareholders should realize there are further returns to be made, including if proceeds from any cash component of the offer is spent on share buybacks.)

Details regarding price and deal structure have yet to emerge, but at first pass, the two could live happily ever after. That's as long as other suitors don't look to break up the deal -- CBOE itself has been a speculated target, so both companies may be in play now.   

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the authors of this story:
Tara Lachapelle in New York at tlachapelle@bloomberg.net
Gillian Tan in New York at gtan129@bloomberg.net

To contact the editor responsible for this story:
Beth Williams at bewilliams@bloomberg.net