Intercontinental Exchange: Worth Owning As A Core Holding

Intercontinental Exchange (NYSE:ICE) reported earnings Thursday morning before the market had its second worst day this year. With just over 300 stocks on the NYSE advancing versus over 3,000 declining, the stock had its work cut out for it, but ended the day positive - bucking the overall market trend.

The last time I wrote about ICE, the company was in the middle of an attempt to acquire the Chicago Board of Trade. The end result was the BOT was acquired by the Chicago Mercantile Exchange (NASDAQ:CME) but for a much higher price than originally expected.

ICE spent $10.9 million in this failed attempt but it did not discourage the company from pursuing other deals. The company is working through the process of integrating NYBOT, and had added other small companies such as a natural gas liquids platform that will operate under its OTC segment.

Earnings were positive as increased volatility in the markets made for strong transaction revenues. All four transactions segments came in with strong growth including

1) ICE Futures - revenues of $43m,
2) Global Crude - 50% global market share,
3) NYBOT - pricing power allows it to increase rates,
4) OTC - contract volume grew 31%.

It is hard to find too many weak spots with statistics confirming strength in most all of the areas ICE covers.

One of the most remarkable points of the earnings release was the increase in rates for NYBOT contracts. The Rate Per Contract [RPC] came in at $1.85 versus $1.59 last quarter. The company instituted a 50 cent increase in prices across the board during the last month of the quarter. It stands to reason that if 2/3 of the quarter were under the original price schedule, Q3 should show additional robust increases in RPC for NYBOT products. Wachovia noted that for every 5 cent increase in RPC, the company should earn an additional 4 cents per share in 2008.

The expense items look high at first glance. The company reported operating expenses of $60 million which is up 130% from last year. However, $10.9m of that was from the BOT attempt which is a non-recurring item.

Another big expense for the company is the build of ICE’s clearing platform for futures business. Up to this point, ICE has outsourced much of this function to a LCH Clearnet. It has been known for some time that ICE is building its own back office to be able to handle this function, but Thursday the company announced it has given LCH notice that it will terminate services as of July 2008. Assuming the transition is relatively smooth, this will significantly increase revenues as the company gets to keep payment for this process of each trade. While guidance is conservative, this could add a material amount to EPS in 2008 and following.

The stock finished the week out strong with Friday’s action bringing it back to the 50 day average. With a current PE of 50, the stock looks fairly expensive, but if one expects the company to earn $5.00 for 2008, ICE is only trading at a 30 multiple to forward earnings with a growth trajectory that is both rapid and stable. Management is developing a great track record with this company and continually creating value for their investors. I believe this is a name worth keeping as a core holding.

ICE 1-year chart


Full Disclosure: Author has a long position in ICE.