Intercontinental Exchange: Long Term Prospects Look Good

[Author's Note: I have become aware of some discrepencies in this post. Please see my post on CBOT Holdings (BOT) for a better understanding of the ICE / CBOE agreement.] Intercontinental Exchange (NYSE:ICE) is an exchange specializing in the trading of derivative contracts and Over the Counter [OTC] contracts relating to energy products. Historically OTC contracts were particularly risky for traders because each party had to trust that the counter party (the one taking the opposite side of the trade) was able to deliver on the agreement. ICE has created a new proprietary system in which they are able to clear these contracts or essentially vouch for the credit-worthiness of each party. This clearing function has served to increase traders' confidence and has therefore increased the volume in such transactions, resulting in more revenue for ICE.

The technology and platform that ICE uses is extremely sophisticated and scalable. As the company adds volume, both on the clearing side as well as the execution (transaction) side, their ability to handle the trades has not been impeded. The company expects to be able to continue to ramp volume for the foreseeable future without having to make substantial improvements in their technology. Currently the platform appears to be faster and more robust than the platform used by the NASDAQ.

Consolidation is rampant in this industry. The ICE has recently purchased the New York Board of Trade [NYBOT], which trades futures and options on the US Dollar index [USDX], as well as contracts on the Russell 2,000 and 1,000 indices. The NASDAQ is currently recovering from a failed bid to buy the London Stock Exchange, and just last week announced they will be buying the OMX, which is the Nordic exchange operating in Northern Europe. NYSE (NYSE:NYX) has mostly completed its purchase of Arca, allowing it a foothold in the electronic trading of equities.

The most important deal for ICE right now revolves around the Chicago Board of Trade (BOT). BOT has agreed to be acquired by the Chicago Mercantile Exchange (NASDAQ:CME), but ICE has thrown its hat in the ring as a potential competing buyer of BOT. Most analysts agree that CME will likely win the battle to acquire BOT, but ICE has been busy working out ways to make its proposal more attractive. Most recently, last week ICE inked an agreement with the CBOE (former subsidiary of BOT) to acquire all of CBOE pending its ability to close the deal with BOT. This would be beneficial to BOT because there has been a long-standing argument with the CBOE as to certain ownership rights that the BOT still feels it is entitled to after it spun off the CBOE. This matter is still pending in court and could be a costly battle long-term.

All of this consolidation has an effect on the way these companies' stocks trade. At this time, it seems that ICE's shares are under pressure, as investors fear the company will pay too much for BOT. At the same time, ICE stock has performed very well due to the company's growth and innovation and I assume that once this uncertainty surrounding the BOT is settled the stock will continue its run as the underlying business has wonderful prospects both as a stand-alone business or in conjunction with the BOT. One final wild card is that another player (some speculate the NYSE or a European exchange) may step in and make a bid for ICE, which would have a profoundly positive effect on ICE's stock. At any rate, I believe the prospects for ICE are very good and I am maintaining a significant investment in the firm.

ICE 1-yr chart