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Elevator Pitch

Intercontinental Exchange (NYSE:ICE) has announced a deal to pay a 38% premium or $33.12 per share for NYSE Euronext, on December 20 2012. The deal should cost ICE about $8.2 billion. This acquisition should help Intercontinental Exchange create one of the biggest global financial exchange groups, covering a diverse set of markets on a worldwide stage.

Company Description

Intercontinental Exchange operates global futures exchanges, over-the-counter (OTC), markets, derivatives clearing houses and post-trade services. ICE operates and manages its business on the basis of three segments: futures segment, global OTC segment and market data segment.

ICE's Role In Consolidation

The financial exchange companies have seen increased consolidation in the recent years, particularly with Intercontinental Exchange involved. The company has been involved in several acquisitions including that of The Clearing Corp in 2009, Climate Exchange PLC in 2010, and a failed joined bid with the NASDAQ Group (NASDAQ:NDAQ) for NYSE Euronext in April 2011.

Thesis & Catalyst For IntercontinentalExchange, Inc.

  • This acquisition should help the company in competing with the CME Group.
  • With this deal, Intercontinental Exchange is grabbing a huge opportunity through NYSE's London based LIFFE business of trading interest rate futures.
  • This combined company will help both NYSE's and Intercontinental Exchange's dreams of being the biggest entity involved in European trading of energy, commodities and fixed income as well as the clearing business.
  • The deal is of course subject to regulatory approval, but the Department of Justice should not really mind the deal considering that this deal is really focused on synergies in Europe rather than a substantial market gain or direct overlap in the U.S.
  • According to the CEO Jeffrey Sprecher of Intercontinental Exchange, the NYSE's U.S. based business may already be accretive to ICE's earnings and cash flows, and both companies will be able to derive massive synergies within the next two years itself.

Valuation and Fundamentals

  • ICE has PEG of 0.9353 which happens to be the lowest in the investment services industry.
  • Its Return On Equity is impressive at around 16%.
  • Given the interest coverage ratio of about 21, the company should easily manage to fulfill its debt regulations.
  • Sans this deal, ICE has seen huge revenue gains from 2006 to 2011.

    Take a look at the company's growing revenues, operating income, cash and cash flows since 2006. (see chart). (click to enlarge)

Revenue, EPS Outlook and Target Price

The average of 22 analysts' EPS estimates for year 2013 comes to be $8.51, the low being $7.85 and high $8.88.

Considering the company's expansion and growth in most fundamental metrics, including the expected EPS growth from $8.50 in 2013 to $8.90 in 2014 and $10.00 in 2015, the company should trade at a higher multiple in the next two years. Applying a multiple of 18x to the 2013 EPS estimates, ICE should trade in the $153 in 2013, north of $161 in 2014 and around $180 in 2015.

Variant View

The company faces integration risk with this deal. Also, irrespective of this deal, financial exchanges usually face a risk related to lower trading volumes, increased regulations and increased competition due to consolidation among competitors.

Conclusion

If the NYSE-ICE deal goes through, the EPS numbers and target price could be higher due to accretive earnings and synergies. At the current stock price of $125.10, ICE happens to be a tremendous long term investment with more than 40% upside in the next two to three years.

Happy Investing, folks!

Source: The Long Case For Intercontinental Exchange

Additional disclosure: ICE has moved down more than 3% as I write this piece, which makes it an enticing buy. I plan to keep my finger on the trigger to enter a new position, as more news and clarifications about the deal come out.