Chicago Board of Trade's parent, CBOT Holdings (BOT), went public on October 9th, 2005 at a price of $54 per share. Yesterday it traded at $118.88 per share, which is above the highest price target at $118, issued by Wall Street´s analysts. The lowest price target is currently at $100 and the median price target is at $105 (Source: Thomson/First Call).
On August the 15th, analyst Jason Willey of Standard & Poor's Equity Research lowered his investment recommendation (sub. req.) on shares of CBOT to "strong sell" from "sell" and put a price target on the stock of $105. Currently 8 analysts have a "Hold", 2 a "Sell" and 1 analyst has a "Strong Sell" recommendation on the stock (Source: Thomson/First Call). However, despite the analysts´ reservation about the growth prospects of CBOT in comparison to it´s biggest rival the Chicago Mercantile Exchange (NASDAQ:CME), the stock has outperformed CME with an year-to-date return of 26.8 percent.
On a trailing earnings basis BOT trades currently at an PE of 52 where CME trades at a PE of 45. Regarding this year´s earnings both trade at a PE of 39. On a forward looking basis, BOT trades at a slightly higher PE of 32 in comparison to CME which trades at a forward PE of 31 for 2007 earnings. To justify these high PE ratios, well above the price-earnings ratio of less than 20 on the average S&P 500 stock, both companies should exhibit the same growth prespectives.
Both companies derive their biggest part of revenues from clearing and transaction fees (see figure below). However, it should be noted that the CME provides clearing services for the BOT and the NYMEX. An increase in the clearing revenues of the BOT or the NYMEX should therefore also boost clearing revenues of the CME.
As the figure below shows, trading volume on both exchanges has increased over the last 3 years by 26 percent on the CBOT and by 31 percent on the CME. A lot of the trading volume on these two exchanges has moved from the open outcry market to the electronical trading platforms, as the growth rates for electronic trading volume have outpaced the growth rates of the total trading volume. CBOT currently processes 67 percent of it´s trading volume electronical, whereas CME processes 70 percent of it´s trading volume over it´s GLOBEX trading platform.
This trend seems to be the key-factor which drives the profitability of these two exchanges. However, the figure below clearly shows that the CME with a operating margin of 61 percent is by far more profitable than the CBOT, which has a operating margin of less than 46 percent. The CME had a much higher revenue growth compared to the CBOT while it maintained to grow expenses at a lower rate than the CBOT did.
The figure below shows the product mixes of the two exchanges. It can be clearly seen that the CBOT earns most of its money from its interest rates products and agriculture products, whereas CME has a host of products that cover trading in interest rates, stock indexes, currencies, and commodities.
The most important point regarding the valuation of the two exchanges are their growth prospects. The figure below compares the year over year (YoY) growth rates of the total trading volume on both exchanges to their 3 1/2-year compounded annual growth rates [CAGR].
It can be clearly seen that the YoY-growth rates of the CBOT have already decreased in the recent quarters whereas the YoY-growth rates of the CME are still at their historical CAGR-levels and show no sign of a sharp decrease. A more detailed look into the different product categories (see figure below) reveals, that the YoY-growth rates of interest rates products of the CBOT have dramatically cooled down to single digit growth rates at 9% in the latest two quarters, which is well below its 3 1/2-year CAGR at 24 percent. Growth rates for equity index products, which contribute only 4 percent to the total trading volume of the CBOT, have also sharply decreased in the recent quarters.
The main contributors to the recent upswing in the YoY-growth rates in the total trading volume were the agricultural products and the metal products, which are not displayed as they contribute only 2 percent to the total trading volume on the CBOT. However, the trading volume in agricultural products is highly cyclical and will not deliver steady growth rates in the quarters ahead. And the strong growth rates for metal products were due to an increase of market share against it´s rival Comex, which is part of the New York Mercantile Exchange. However, this trend should be short lived, as the Comex plans to introduce electronic trading for gold futures in the near future. So with decreasing growth rates in it´s flagship product "Interest Rates" and a recent up-swing in its cyclical agricultural business, the CBOT should exhibit lower growth rates in total trading volume in the coming quarters.
Unfortunately, growth rates of interest products at the CME have also declined in the recent quarters. However, they are still well above the growth rates of the CBOT. Growth rates of the equity E-mini products, which contribute 28 percent to the total trading volume of the CME, are on the rise and growth rates of foreign exchange products exhibit strong growth rates with a 3 1/2-year CAGR of 50 percent. The CME is going to expand it´s foreign exchange products in the coming months with the launch of Chinese Renminbi futures and options contracts against the U.S. dollar, euro and Japanese yen on August 28th and the launch of Korean Won futures and options on September 18th. Additionally, CME has created FXMarketSpace, the world’s first centrally-cleared global FX marketplace, in cooperation with Reuters. This joint venture should boost revenues from the FX market. Given the mentioned facts, the current growth outlook for CME is clearly much better than for the CBOT.
The figure below shows the rates per contract [RPC] of the open outcry and the electronic trading markets of both exchanges.
It can be clearly seen that the CME currently earns 30 percent more than the CBOT for one contract traded on its electronic trading platform GLOBEX.
To summarize, the CME clearly has a much better growth outlook compared to the CBOT and has more pricing power. Both facts should translate into higher trading volume growth rates and higher earnings growth rates. However, higher growth prospects should be priced in by a premium in the forward PE ratio of the CME compared to the CBOT. As currently the forward PE ratios of both exchanges are nearly the same, the shares of the CBOT should underperform relativ to the CME in the coming weeks. Possibly, if the earnings estimates for the CBOT are to high, the fall could be even much bigger.
Given the recent outperformance of the CBOT against the CME (see chart above), a relative value trade (long CME and short BOT) seems to be a good low-risk profit-opportunity. If an investor decides to set up the trade, he should be careful and watch the merger discussion of New York´s Board of Trade (NYBOT). A merger between the NYBOT and the CBOT could change the whole picture, as the NYBOT would bring a clearing business into the partnership.
BOT-CME 1-yr comparison chart:
Disclosure: The author has a long position in CME and a short position in BOT.