THE HEDGEYE EDGE
BATS Global Markets (BATS) stock was up over +20% recently on rumors of a pending merger with the Chicago Board Options Exchange (CBOE). While corporate takeout rumors are sometimes farfetched which provide opportunity for investors to sell into unwarranted strength, in this case there is a lot of industrial logic for the deal to move forward.
Firstly, we have outlined that BATS' best idiosyncratic opportunity is within the equity options marketplace which is bedrock for CBOE and thus the incremental functionality that BATS brings can easily be bolted onto the existing platform in Chicago.
Secondly, CBOE has struggled to develop a cash equity marketplace which has been the biggest growth area for BATS both in the U.S. and Europe. Thus with over 25% share in stock trading both domestically and in Europe, spread trading between cash equities and options can be facilitated. This includes the nascent ETF business that BATS is developing which sits at just 1% share on a listings basis but a segment which has won over 30% share of new listings year-to-date.
Lastly, CBOE still has a big real estate footprint in expensive locations with high tax rates in Illinois including leased square footage. Thus the more economically viable BATS headquarters in Kansas City may provide some simple cost synergies in a basic corporate re-org.
While investors may be tempted to take some profits in the recent BATS melt up, we outline that the sector has sported some of the healthiest merger takeout premiums in the S&P 500. Median exchange sector takeout multiples have been ~49x free cash flow; 21x forward earnings; 9.8x EBITDA, and 2.5x revenue. Furthermore it has not been uncommon once an exchange is in play for multiple bidders to come into the fold to express interest or simply to try and force competitors to pay higher premiums.
In 2007, CME Group's $8 billion bid for the Chicago Board of Trade, ended at over $10 billion with ICE launching several rounds of competing bids forcing CME's initial valuation up over $2 billion or +25%. There was a similar outcome recently in Deutsche Borse's takeout of the London Stock Exchange with ICE again conducting due diligence on the deal for a competing offer. While ICE eventually dropped a follow-on tender, LSE stock drifted higher in anticipation.
We estimate that our 2018 estimate of $1.99 for BATS is an earnings target that accounts for the company's full opportunity in options and a substantial leap in market share in ETFs. Thus this opportunity may be used as "terminal value" for BATS' earnings power in a takeout offer. Thus fair value on EPS in this scenario sits at $35-$42 per share.
Median takeout multiples across metrics are some of the healthiest in the S&P 500. This screen outlines the 9 most recent deals in the exchange sector (Source: Bloomberg):
As outlined in our Black Book recent deal tickets have sported astronomical values on the scarcity value of exchange properties (Source: Bloomberg):
We think the earnings opportunity becomes more cyclical at ~$2.00 per share in 2018 which incorporates near 20% share for BATS options marketplace and a move from 1% to 5% of listings in the ETF business. Thus this level could be used as "fair value" for BATS stock in a take out:
ONE-YEAR TRAILING CHART
