CBOE: A Blue Chip IPO Without a Doubt

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Bill Simpson

Bill Simpson CBOE TradingIPOs subscribers

The text of Mr. Simpson's original writeup follows:

• • •

CBOE Holdings plans on offering 13.5 million shares (assuming over-allotments are exercised) at a range of $27 - $29. Insiders will be selling 2.1 million shares in the deal. Post-ipo CBOE will have 104.3 million shares outstanding for a market cap of $2.92 billion on a pricing of $28. Ipo proceeds will be utilized to purchase insider shares in a tender offer to come in two stages, 60 and 120 days post-ipo. Assuming tender offers are fully subscribed, CBOE will have 93.6 million shares outstanding for a market cap of $2.62 billion.

From the prospectus :

'Founded in 1973, the CBOE was the first organized marketplace for the trading of standardized, listed options on equity securities.'

World's first and largest options exchange in the US, based on both contract volume and value of contracts traded.

Hybrid model of open outcry and electronic trading in a single market. Contracts include options on individual equities, market indexes and exchange-traded funds. Not all of CBOE's products currently trade on their electronic platform, notably S&P 500 options. Note that CBOE is planning on launching a second e-platform later in 2010 which will be capable of trading all of CBOE's products. It appears that slowly CBOE is phasing out open outcry.

In 2009 volume of options contracts traded at CBOE was 1.13 billion, or 4.4 million contracts per day. US market share in US listed options was a leading 31.4%. 4.5 million contracts in the 3/10 quarter for a 30% market share. ***Note that as market volatility increased in early May, so did CBOE's volumes. April/May volume averaged 6.08 million contracts per day, well above first quarter 2010 volume of 4.5 million per day. Listed US options volume actually hit an all-time record in May, 2010, so pretty good timing here for the CBOE ipo.


Equity Options - Put/Call options with terms of up to nine months on 2400 NYSE/Nasdaq/Amex stocks. In addition, CBOE offers LEAP options on 800 equities. Of note, CBOE invented LEAP options. Average transaction fee per contract is 18 cents.

Index Options - Option on 10 different market indexes, including the CBOE developed VIX index. Others include the usual S&P 500, Nasdaq, Russell and Dow Jones Industrials.

**CBOE has exclusive rights to list options on the S&P 500, S&P 100 and DJIA indexes. With exclusive rights to the VIX and S&P/DJIA products, average transaction fee for Index options is much higher at 60 cents per contract.

ETF Options - Options on 250 ETFs and LEAPS on 66 ETFs. The ETF options have been a large growth area showing 38% annual growth rate the past 4 years. Average transaction fee is 24 cents.

In the most recent quarter (3/10), equity options accounted for 56% of CBOE volume, ETF options 23% and indice options 24%.

Bulk of revenues (74%) are derived from transaction fees, 11% for access fees and 5% for data fees.

Sector - Over the past decade, use of financial derivatives has expanded dramatically, as we are all aware. Exchange traded options are utilized for hedging, speculation and income generation while also providing leverage. 8.8 billion listed options were traded globally, with 3.6 billion traded in the US. 25% annual growth rate in listed options over the past five years. Should be noted the financial havoc in late 2008 resulted in only a 1% growth in US listed options volume in 2009.

Future growth - A potential driver is the transition of over the counter derivatives to an exchange traded model. This is an expected result of the 2008/2009 financial crisis fueled in part by unregulated over the counter derivative products.

**The International Securities Exchange (( ISE )) has legally challenged CBOE's exclusive license on DJIA/S&P index option products. Actually ISE has challenged the use of exclusive licenses for options in general. Cases are currently pending. A determination in favor of ISE would most likely dent CBOE's market share position in specific index options.

Another risk is a recent SEC proposal to limit transaction fees to 30 cents per contract. CBOE estimates if this proposal is enacted it would have meant a 4.4% revenue hit in 2009.

Post-ipo, CBOE will issue monthly access permits for firms to trade. This will replace the old member or seat status of access to the CBOE. CBOE expects 1,025 permits with fees ranging from $2,500-$7,500 excluding discounts. This should result in approximately $35 million in annual access fee revenues.

Closest competitor is ISE, with 21.5% of listed US options volume. ISE was bought out in 2007. The Philadelphia stock exchange (owned by Nasdaq) has a 20% market share.


$2 3/4 per share in cash. Note that this assumes 104.3 million sharecount with no shares tendered in CBOE's offer to buy out current shareholders. If tender offer is fully subscribed, cash on hand will be $0.25 per share, but sharecount will be 93.6 million shares.

Dividends - CBOE plans on paying regular quarterly dividends that annually equal to 20%-30% of prior year's net income. In 2009 this would have equaled approximately $0.25 per share. On a pricing of $28, CBOE would yield nearly 1% based on 2009 net income.

2010 - Due to market volatility, the 2nd quarter looks to be the best one for CBOE in at least the past six quarters. When factoring in increased access fees the second half of 2010, total revenues should be $475 million, a 5% increase over 2009. Operating margins of 40%, very strong. Net margins of 23%. Earnings per share of $1.05. **Assuming stock tender offer is fully subscribed, earnings per share would be $1.14. Let's cut the difference and make it $1.10. On a pricing of $28, CBOE would trade 25 X's 2010 earnings.

As CBOE's primary competitor, ISE was bought out a few years ago; we do not have a pure comparable. We do have two exchanges that ipo'd this decade - [[CME]] and [[ICE]]. Each is trading 18-22 X's 2010 earnings estimates.

CBOE is a blue chip ipo without a doubt. The issue here is the aggressive valuation considering the lack of growth in 2009 and 2010. CBOE's transaction volume grew just 1% in 2009 and, until a very volatile May 2010, looked to be rather flat again in 2010. With SEC mulling limits on transaction fees and ISE legally questioning CBOE's exclusive index options, CBOE's profit driver is in question. That profit driver is their exclusive index option products, which derives up to twice the transaction fees per contract compared to the rest of their products. Future EPS growth will be difficult if those index transaction fees are reined in, which it appears only to be a matter of time.

Something to consider - Nymex Holdings, CBOT Holdings and International Securities Exchange were all bought within three years of their IPOs. In doing research for this piece, there seems to be a thought that the initial ipo range here consists of a bit of a 'buyout premium' here as a base. I tend to agree and think the initial range here reflects the chance that a buyer will step up over the next few years to purchase CBOE.

Conclusion - A must own in range due to blue chip name and leading position in the US listed options exchange market. There does appear to be a premium here in comparison to other options exchanges and definitely in comparison with stock exchanges traded publicly. Some of that premium may be warranted, but be wary of buying this in the aftermarket up too much from range. If buying this in aftermarket $30+, realize that you are paying a premium here in the sector, and definitely a premium for current market conditions.

Should absolutely work in range short, mid and longer term, this is a very good looking ipo.

Note that until we see the actual access fee revenues post-ipo, they are quite difficult to estimate. I plugged in an annualized $40 million, as CBOE will be discounting these pretty heavily for 2010 (and possibly beyond). As usual this is probably slightly conservative.

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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 Nasdaq, Inc.

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

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