CME Group Inc. (CME): New Analyst Report from Zacks Equity Research - Zacks Equity Research Report

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Summary:
CME Group's second-quarter lagged the Zacks Consensus Estimate and year-ago figure due to lower trading volumes and weak rate per contract that deteriorated the top line. Alongside, higher expenses marred the margins. A modest capital position and diverse derivative-product line are also adversely affected by intense competition. Moreover, higher infrastructure costs and regulatory compliances, interest rate volatility, pricing pressure and higher tax rate pose operational and financial risks. Although the current scenario appears bleak, CME Group's efforts to promote, expand and cross-sell its core exchange-traded business through strategic alliances, meaningful acquisitions, newer product initiatives and global presence should generate growth in the long run, justifying our Neutral recommendation.

Overview:

Formed in 2007 by the merger of the Chicago Mercantile Exchange (CME) and the Chicago Board of Trade (CBOT), CME Group is the largest futures exchange in the world in terms of trading volume as well as notional value traded. The Chicago Mercantile Exchange was originally formed as a nonprofit organization in 1898, but was converted to a for-profit company in 2000. It became the first publicly traded financial exchange in the U.S. in Dec 2002. CBOT, established in 1848, is a leading futures and options exchange. In Apr 2005, CBOT converted into a for-profit stock-based holding company and for-profit membership exchange subsidiary. As of Dec 31, 2013, CME Group had approximately 2,730 employees.

CME Group offers the widest range of benchmark products covering all major asset classes, specifically futures products and options on futures. The broad product groups are futures and options based on interest rates, equity indexes, foreign exchange, commodities, energy and metals, besides alternative investment products such as weather and real estate.

CME Group's interest-rate trading, which accounted for 47% of the average daily volume in 2013 has benefited from strong demand for Eurodollar futures contracts (per management, CME Eurodollars are the most actively traded futures contracts in the world). Equity trading (21% of average daily volumes in 2013) includes trading of futures products based on indices such as the S&P 500 and NASDAQ 100. Foreign exchange and Agricultural commodities accounted for 16% of the average daily volume in 2013, while energy and metals accounted for 16%. Additionally, the company's clearing house clears, settles and guarantees every futures and options contract traded through the exchange, along with cleared over-the-counter (OTC) products, including credit default swaps (CDS) and interest rate swaps (IRS). Over 80% of CME Group's revenues are derived from the clearing and transaction fees assessed on each contract and executed through the trading venues and cleared through its clearing house.

CME Group has the most diverse product range as a result of continued innovation and evolution and also from mergers and acquisitions. The addition of the CBOT product lines largely contributed to an increase in overall trading volume. The integration was completed in 10 months and the company is on track to realize approximately $150 million a year in cost synergies. The combined entity controls 98% of the U.S. futures market. In Feb 2008, the company completed its transaction with BM&F Bovespa exchange in Brazil and in Feb 2010, CME Group got into a strategic partnership with BM&F Bovespa to develop a new multi-asset class electronic trading platform, thereby enhancing its growth opportunities by offering an integrated technology solution for global derivatives and non-U.S. equities trading. CME Group owns a 5% stake in BM&F Bovespa.

Additionally, in Aug 2008, the company acquired NYMEX and in the first half of 2010, CME added Commodity Exchange Inc. (Comex) metals products to its portfolio. Comex operates as a subsidiary of NYMEX. In 2009, CME acquired a 25% equity stake in Bursa Malaysia Derivatives.

In Mar 2010, CME launched a new joint venture company, CME Group Index Services LLC, where CBOT attained 90% stake while Dow Jones & Company has the remaining 10% interest. This new joint venture will own the Dow Jones Indexes, which includes the Dow Jones Industrial Average (DJI) and approximately 130,000 index properties.

In Oct 2010, CME Group started clearing OTC IRS through CME Clearing, marking it as a multi-year growth initiative, although its contribution to margins is expected to take a longer lead time. On Feb 28, 2011, the company launched a new clearing membership platform, Financial Instruments Clearing Membership (FICM). This new platform would help reduce the trader's cost by nearly 65% enjoying a cross-margin for the company's interest rate futures products and the U.S. Treasury's futures franchise. The FICM was expected to be initiated by the end of Mar 2011 but awaits regulatory approval. Moreover, in Dec 2010, CME Group acquired Elysian Systems Ltd. (Elysian), an independent provider of electronic trading and market technology. The company launched CME Clearing Europe in May 2011 in London.

Further, in Feb 2012, CME Group acquired another 25% stake in the Dubai Mercantile Exchange (DME), thereby owning 50% of this Dubai commodities exchange in total. Moreover, in Apr 2012, the company acquired U.S.-based second-largest carbon exchange GreenX Holdings LLC for an undisclosed price.

In Jul 2012, CME Group, which owns 90% of the CME Group-Dow Jones JV that owns Dow Jones Indexes, along with McGraw-Hill, owner of S&P Indices, announced the launch of S&P-Dow Jones Indices under their joint venture (JV), which was formed in Nov 2011. Accordingly, McGraw-Hill will contribute its S&P Indices business and the CME Group-Dow Jones JV will contribute the Dow Jones Indexes business to create S&P-Dow Jones Indices. According to the terms of the JV, McGraw-Hill will own 73% of S&P-Dow Jones Indices, CME Group will own 24.4% through its affiliates and New Corp.'s Dow Jones will own the remaining 2.6%. Further, according to the deal, McGraw-Hill s S&P Capital IQ acquired the Credit Market Analysis (CMA) business, which was acquired by CME Group in Mar 2008.

In Dec 2012, CME Group acquired the rival exchange Kansas City Board of Trade (KCBT) for a cash payment of $126 million.


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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Stocks

Referenced Stocks: CMA , CME , IRS

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