Shares in stock and commodity exchanges have been crushed in the recent market meltdown. Although the shares have recovered some in the past two days, the CBOE exchange index, which tracks exchanges including the CME, the
Chicago Board of Trade
New York Stock Exchange
, is off 17% in a month. The Nasdaq has dropped 23% and NYSE is down 21%.
But over the same stretch, the CME has held its own, losing only 2% during the last month, in line with the S&P 500. And outperforming its peers is nothing new for the CME, whose shares have jumped nearly tenfold since their December 2002 initial public offering.
The market has rewarded the CME because it sits in a catbird seat among the exchanges and because, unlike the NYSE and Nasdaq, it doesn't appear to be in any danger of making a pricey overseas acquisition.
The company virtually has a monopoly on its Eurodollar futures contract, the financial futures contract that bets on the short-term U.S. interest rate. Because of the complexity of the options, more than 90% of the trades of the contract are on the CME, according to analysis from Lehman Brothers. That contrasts with the equities exchanges, which doggedly compete for market share with huge pricing battles.
Its competitors "have had limited success gaining traction on
the CME's products so far," Lehman Brothers said Wednesday in its first research report on the stock. "We believe this is a testament to the difficulty that futures exchanges have in building liquidity in like products that already have significant liquidity on another exchange."
The CME also is aggressively pursuing initiatives to increase volume in other products. It has a relationship with Nymex to be the electronic trading platform for its energy futures and recently signed an agreement with Reuters to offer the first platform to trade spot currencies. It also trades agricultural futures and equities derivatives, which are all lucrative products.
Meanwhile, the CME's products offer more than exclusivity. Its diversity protects it from sudden market meltdowns, unlike other exchanges that only operate in one side of the business.
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"It's a business that isn't tied to the health of the equity markets," says Phil Guziec, equity analyst at Morningstar.
Analysts expect volumes on the CME to pick up rapidly over the next two years. Lehman Brothers initiated the stock with an overweight rating, saying that the company has the ability to grow volume by 23% in 2006 and by the same amount in 2007.
"We are favorably predisposed to futures-trading exchanges vs. equities exchanges because of the higher barriers to entry that we believe exist, as well as the overall secular growth in futures trading by investors seeking alternative asset classes," the report said. "Continued migration to exchange-based futures trading, as well as increased speculative trading of futures as an asset class, particularly by hedge funds, should drive secular growth of futures-contract volumes relative to other asset classes."
The CME hit a bump, one of the few since it went public in 2002, after its earnings report last quarter. Although the CME reported record volumes for the quarter, the company said that its rate per contract fell. The problem was the mix of trading on the exchange -- the CME's cheaper products were the ones that had the greatest increase in volume.
Some investors saw the rate decline as a weakness and sold the stock after the earnings report. But shares have recovered, and analysts stay positive.
"The CME was selling more of something, just selling more of the less profitable stuff," Guziec says. "It really shouldn't matter for valuation, in my perspective."
Most recently, the CME has something else working in its favor: its ability to stay clear of consolidation.
The CME has, for the most part, avoided rumors about the merger frenzy going on globally in the securities-exchange sector. While its competitors bicker and perhaps overpay for European securities exchanges, the CME has largely stayed on the sidelines. Both the Nasdaq and the NYSE are racing into global consolidation, and both stocks have paid for their ambitions, dropping over 20% in a month. The Nasdaq has launched a raid on the U.K.-based equities exchange the London Stock Exchange, and the NYSE has signed a definitive agreement with the Euronext.
The CME, at one time, was dragged in the fray. The NYSE was said to be interested, but instead it has opted for the Euronext, which lists some of the CME's products on the Euronext.liffe. Some say that the NYSE's desire for the Euronext.liffe is evidence of the attractiveness of the CME's position, but analysts don't see the Liffe as a threat to the CME's business because of the CME's massive market share now.
The CME's lofty multiple is the only bear argument for the stock; its price trades at 32 times its 2007 earnings estimate. That compares to the NYSE that now trades at a 25 multiple and the Nasdaq that trades at 17 times, both of which have fallen significantly in the past month. Morningstar's Guziec does caution that the CME is expensive. But analysts are optimistic about the stock for the long-term, and with its stamina over the past few months, it might be worth a look.