Buyback Seals CBOT Deal

A big buyback plan appears to have put Chicago Mercantile Exchange (CME) over the top in its effort to buy the Chicago Board of Trade (CBOT).

The CME sweetened its offer for the CBOT Friday, increasing the amount of stock it will issue to CBOT holders. But what may have won the day for the exchange was a plan to return cash to shareholders by buying back a big hunk of its stock after the merger closes.

The CME move was embraced by the CBOT board, which after two months of fence-sitting finally shunted aside an unsolicited bid from the InterContinental Exchange(ICE). ICE said it is evaluating its options.

Shares in all three companies rose sharply, as CME and CBOT holders celebrated what is expected to be a smart merger and ICE fans breathed a sigh of relief that their company may be able to avoid a costly bidding war.

CME said CBOT shareholders will get 0.35 CME shares for each CBOT share. That values the stock portion of the deal at $9.25 billion. CME said it will also buy back $3.5 billion worth of its own stock after the merger closes, at $560 a share -- a 12% premium to recent trading prices.

CME's buyback plan echoes a strategy embraced earlier this year to great effect by CVS (CVS) in its bidding war with Express Scripts (ESRX) for Caremark. CVS, which had agreed to buy Caremark back in late 2006, used two postmerger dividends totaling $6 a share to bring its otherwise less lucrative proposal in line with the unsolicited Express Scripts bid.

By returning cash to shareholders after the close of a merger, an acquirer can woo shareholders of the target company while simultaneously rewarding its own investors. Doing so also allows an acquiring company to increase the value of its bid without risking criticism that it's overpaying.

Back in October, when the companies announced plans to merge, CME was planning to issue 0.3006 CME shares for each CBOT share in a deal that was worth just over $8 billion. CME said at the time that it would pay as much as $3 billion of the merger consideration in cash, if CBOT holders so chose.

The ICE surprised its Chicagoland rivals two months ago with an all-stock bid valued at $10.1 billion. The ICE's offer of 1.42 shares for each CBOT shares is worth $199 a share at Friday's prices, which is well above the $175 a share for the CME deal.

But the promise of the big CME buyback appears to have settled the matter.

The CBOT said Friday that it considered a number of factors in its decision, including integration risk, strategic fit, potential synergy value and potential operating efficiencies.

"We led an extensive diligence of the ICE proposal and worked diligently with ICE management on that proposal," said Bernard Dan, the CBOT's CEO, during a conference call.

Charles Carey, the CBOT chairman said a CME-CBOT combination "presents significantly less integration risk than a combination with ICE."

An ICE spokeswoman was not available for comment. CBOT's management declined to discuss how it would respond if the ICE raised its offer. ICE shares rose 4% Friday as investors appeared to breathe a sigh of relief that the exchange wouldn't be drawn into a costly bidding war.

"The CME knows they're the preferred merger partner," says Edward Ditmire, an analyst at Fox-Pitt Kelton. "Most people will weigh the various prices in conjunction with how comfortable they feel about the integration process. In general they will take some discount price as long as ICE doesn't increase its bid again."

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