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CBOT Has a Tough Foe in Battle of Chicago

Both get rich valuations, but CME's a tough one to outshine.

For the

Chicago Board of Trade


, the comparisons are getting tiresome.

Shares of the midwestern derivatives exchange are up 86% since pricing at $54 each in October, a triumphant gain by most measures. Still, with shares of its neighbor the

Chicago Mercantile Exchange

(CME) - Get Free Report

up by a factor of nearly 12 since coming public three years ago, the runup loses some luster.

Ditto the company's growth prospects, which currently call for a doubling of annual income by 2007, using the Thomson First Call consensus estimate. At the CME, earnings rose by 141% over its first three years as a public company, and are expected to climb from $8.81 a share in 2005 to $13.43 a share in 2007.

Momentum-hungry investors are rewarding both companies with rich valuations, with the CME sporting a price-to-earnings multiple of 37 times next year's estimate. At the CBOT, the multiple is 39 times the 2006 consensus.

Analysts are less generous. The CBOT has two underperform ratings and three sell ratings out of the seven Wall Street firms that cover it. Not even the 22% rise in January volume that the company reported on Monday could elicit much excitement. J.P. Morgan lowered its first-quarter estimates on CBOT and said that the exchange needed to take in record average daily volume through March to reach its first-quarter volume estimates.

"We believe the current valuation levels incorporate most of the positive fundamentals for the firm," Dan Harris, a J.P. Morgan analyst, recently said in a report.

The CME, while no unanimous pick of analysts, is viewed more favorably. It has only one underperform among the eight analysts who cover it, though it's been downgraded by three analysts since September.


It has never paid to short or recommend against buying shares of CME, and both it and the CBOT have relatively low short interest compared with their public floats (6% for the CME and 1% for the CBOT). Although the amount of short contracts for both has grown in the past month, neither level suggests the market is getting skeptical.

Still, Wall Street is aware that any significant stumbles would be bad news for stocks priced like these. Among other things, competition from European exchange competitors could heat up, squeezing margins, analysts say.

One opportunity for the CBOT to rally the faithful will be Thursday, when it reports fourth-quarter earnings. Analysts are currently calling for a profit of 35 cents a share on sales of $115.7 million. Again, however, the performance of its rival hangs heavy in the air: The CME posted a 37% rise in its fourth-quarter profit, reported last week, and beat analyst estimates handily.

The similarities of the CME and CBOT can be likened to that of their New York stock trading counterparts. Both companies have similar fundamentals -- they make money by charging a fee to buy and sell contracts on the market and make additional revenue from market data. Neither really competes with the other in terms of the types of futures contracts they trade. The CME focuses on four different types of derivatives -- interest rates, equities, commodities and currencies -- and it is fairly well diversified among the groups. The CBOT, conversely, is mainly concentrated in interest rate futures and sells some agricultural contracts.

Beyond diversification, the CME has access to the more attractive interest rate contract: the short-term interest rate. Because the volatility in the short term interest rate market is far greater than the long-term one, volume in that area is also higher. To add additional volume, the CME offers short-term interest contracts for many countries. Only U.S. Treasury futures are traded on the CBOT.

But what the two exchanges do compete for are investor dollars, and of the two neighbors, CME could still be better situated at the start of 2006. It has $1 billion cash on the balance sheet and looks ripe to make an acquisition. Its strategy to attract overseas participants to trade on the exchange is laid out better than the CBOT's, analysts say, and it has the added advantage of having been publicly traded longer, which means it doesn't have many of the distractions that CBOT may have during its first year of public ownership.

Meanwhile, analysts see CBOT's main growth potential in its agricultural trading business.

"We believe there is tremendous potential for outsized volume growth and operating margin explosion if and when agricultural trading more fully migrates to an electronic platform," Credit Suisse analyst Howard Chen said in a report.

Whether that market will be enough to level the playing field is an open question.