The Deal: BATS, Direct Edge Take Swing at Incumbents

NEW YORK ( The Deal) -- BATS Global Markets Inc. and Direct Edge Holdings have agreed to merge in a deal that will leapfrog the exchange operators ahead of Nasdaq OMX Group ( NDAQ) as the second-largest U.S. equity trading venue.

The new company will have its headquarters in Kansas City, where BATS is currently located, and sit just behind NYSE Euronext ( NYX), which has the largest market share of U.S. equity trading at close to 30%.

Nasdaq has a 16% share, while BATS and Direct Edge will have a combined share of around 21%.

BATS chief executive Joe Ratterman will remain in his role with Direct Edge chief executive William O'Brien to act as president.

Financial terms for the all-stock deal were not disclosed. The merger is subject to regulatory approval and set to close in the first half of 2014.

"This agreement is an important milestone for the US equities market and other markets around the globe as it will combine two organizations that have been innovative in creating a more competitive marketplace to benefit all investors," said Mr Ratterman.

Sanford C. Bernstein & Co. equity research analyst Brad Hintz said the deal would pressure the market shares of the NYSE and Nasdaq "because clearing of equity trades is a utility, the equity exchange business model has become a very competitive, scale business with no barriers to entry," he said.

Combining the exchanges would enable more volume to be sent across a single technology platform and reduce the cost per trade, Hintz noted. This would allow the BATS/Direct Edge venue to pass through savings and ultimately capture more volume, he said.

Much global exchange consolidation is being driven by a desire to combine flagging cash-equity trading revenues with increasingly popular derivative products. Last week's trading glitch and resulting shutdown in trading for all Nasdaq securities for three hours prompted questions over market integrity.

IntercontinentalExchange Inc. is working to complete its agreed $10.2 billion acquisition of NYSE Euronext, announced in December. Last year, Hong Kong Exchanges & Clearing Ltd. bought the London Metal Exchange Ltd. for $2.2 billion. Tokyo Stock Exchange Group Inc. --once a key venue for foreign company listings--combined its cash equities business with the growing derivatives platform of the Osaka Securities Exchange Co. Ltd. through a merger in January.

BATS attempted a float last year of 6.29 million of its shares, anticipating an offer price of $16 to $18. However, it scrapped the IPO due to problems in its trading system. Ratterman was stripped of his dual role as BATS chairman and chief executive around the same time--though the board supported his ongoing service as CEO.

BATS posted EBITDA of $101 million in 2012 and an EBITDA margin of 65%, according to a company spokesman. Its owners include Credit Suisse ( CS), Citigroup ( C), JPMorgan Chase ( JPM), Deutsche Bank ( DB), Morgan Stanley ( MS), Nomura and KCG Holdings.

Citadel LLC and International Securities Exchange LLC hold stakes in Direct Edge.

BATS and Direct Edge were established by trading firms and banks to run platforms with cheaper fees and what they claim is newer technology and better customer service compared to incumbents such as NYSE.

Last week private equity players Spectrum Equity Investors and TA Associates Management bought a combined 12% stake in BATS. Direct Edge was last year reported to be in talks to be acquired by Canadian exchange operator TMX Group Inc. before a group of Canadian banks bought TMX last September.

BATS also operates a U.S. equity options market and the largest stock exchange in Europe, BATS Chi-X Europe. Direct Edge is aiming to expand internationally by opening an equity market in Brazil. BATS was advised by Broadhaven Capital Partners while Direct Edge was advised by Bank of America Merrill Lynch and an Evercore Partners ( EVR) team comprised of Jane Gladstone, Scott Patrick, Jin Lee, Andrew Steinberg, Shawn Ng and Meghan Mirchich.

Written by Jane Searle