It's the fashion these days for securities exchanges to go public. With yesterday's IPO of the NYMEX Holdings (NMX), an energy and metals exchange, it is only fitting to look at the state of publicly traded exchanges around the world.
Does an IPO of an established company rising 125% on its first day of trading sound bubbly to you? It does to us. That's what NYMEX did yesterday and some are still calling it a screaming buy. Were the issuers and underwriters really that dumb setting the offering price? They sold only about 7.5% of the company, but why leave $34 million on the table if you don't have to? Will the rapid profits growth due to the recent bull run on energy and metals continue year-after-year to support the very high NMX P/E?
Investors are bidding up the US exchanges far more than the non-US exchanges. While large US exchanges may deserve large market capitalization due to the size of profits, it does not necessarily mean that they should have outsized price-to-earnings ratios. P/E ratios are highly dependent on the perceived future growth rate of a company's profits, not the amount of profits they make.
US exchanges currently carry P/E ratios that are approximately twice that of the major non-US exchanges. Unless you believe that revenues and profits will grow twice as fast for US exchanges than for non-US exchanges, it would be difficult to justify the P/E ratio difference.
These 6 US exchanges currently carry an unweighted average P/E of 46.5:
Chicago Mercantile Exchange - (NASDAQ:CME) 46
New York Stock exchange - (NYSE:NYX) 58
Chicago Board of Trade - (BOT) 48
Intercontinental Exchange - (NYSE:ICE) 41
NASDAQ - (NASDAQ:NDAQ) 50
International Securities Exchange - (ISE) 36
[source: Reuters FactBox]
These 8 non-US exchanges currently carry an unweighted average P/E of 25.0:
Deutsche Borse - 20
Euronext - 29
Hong Kong - 35
London - 25
Australia - 23
Singapore - 27
Toronto - 23
Sweden - 18
[source: Reuters FactBox]
Korea is in on deck to go pubic next.
Mergers of exchanges within the US are active. The Chicago Mercantile Exchange recently agreed to acquire the Chicago Board of Trade, and NYMEX Holdings indicated that it may be interested in acquiring the Chicago Mercantile Exchange. With the growing interest in non-US securities, we think international mergers are likely too.
While we think the P/Es on the US exchanges are too high and that they will eventually come down with corresponding stock price declines, there is no telling how high they will go before they capitulate. That makes a short position potentially suicidal.
On the other hand, the consolidation and merger craze among exchanges along with the dramatic P/E differentials between US and non-US exchanges suggests the non-US exchanges may be takeover targets (although local national regulations may be prohibitive in many cases). For example, the London Stock exchange has a market cap of $US 6.0 Billion and a P/E of 25 whereas the New York Stock Exchange has a market cap of $US 14.9 Billion and a P/E of 58. Those are the kind of relative sizes and valuations that make a takeover feasible.
A current example is the proposed merger between the New York Stock Exchange and Euronext. Euronext has the highest P/E of the non-US exchanges listed here, probably because it has been the acquisition target of Deutsche Borse and is now endorsing the takeover by the NYSE. The current Euronext P/E is significantly lower than the NYSE P/E, making the proposed transaction accretive to earnings per share for the NYSE. With favorable earnings per share mathematics upon merger, as well as the usual herd instinct behavior of companies within an industry, we could expect more takeovers like this one.
Balancing both risks with opportunity, we would favor owning non-US exchanges which may be takeover candidates rather than US exchanges that depend on continued enthusiasm and high P/Es for investors to profit further. We like the risk-reward ratio on the side of the prey better than on the side of the hunters.
If you are a momentum investor/speculator, then perhaps piling on the US exchange bandwagon is for you. If you are concerned with fundamental valuation and risk, then you should stay away or take profits -- and maybe rotate to foreign exchanges in anticipation of either a takeover or other exchanges catching the same wave the US exchanges are now surfing.
Disclosure: We do not have any stock positions in any securities exchanges.
NYX on first day of trading, Friday: