Intercontinental Exchange Stock Warrants a Closer Look on New Developments

by: Mike Maher

Intercontinental Exchange (NYSE:ICE) a leading electronic exchange, announced a double dose of good news today. First, Brazilian financial regulator has allowed Brazilian firms to use ICE trading screens to access ICE Futures Europe products. Firms were already allowed to access ICE Futures US. Second, ICE announced record volumes in both the U.S. and Europe for the month of February. Given these new developments, shares of ICE warrant a closer look.

ICE runs a futures exchange, over-the-counter (OTC) markets, as well as a derivative clearing house. Its main products are energy related, and OTC Energy and Energy Futures accounted for 60% of 2010 revenue. Adjusted EPS grew 26% in 2010, to $5.65, Operating Margin increased to 57%, and a Sandler O'Neil analyst just raised his 2011 EPS estimate to $6.71 a share. That gives ICE a forward PE of just 19, despite its rapid growth and high profitability.

Exchanges make money as people trade contracts. The more contracts trade, the more money the exchange makes. This means that the volatility in the oil markets caused by Mid East unrest is a huge profit driver for ICE. February average daily volumes (ADV) was a record in both ICE Futures and ICE Futures Europe, and ICE Futures Europe set a monthly volume record.

On the ICE Futures Europe side, ICE Brent Crude and ICE Gasoil futures set records in daily volume, ADV, and total monthly volume. What makes these records even more remarkable is the fact that February is such a short month, comprising of only 19 trading days. Total Futures volume in the first two months of 2011 was 64,590,313 contracts, up 31.7% YoY. Unrest in Libya will keep volume elevated in the energy markets until the issue there is resolved, and every gyration in the oil market will help fatten ICE's bottom line.

The Brazilian news is less of a short term catalyst than February numbers, but is an important long term development. Petrobras's (NYSE:PBR) discovery of the massive oil reserves off the Brazilian coast will transform the world oil markets. According to the CFO of Petrobras, the company may be producing as much as 6 million bpd by 2017, which would make Brazil the 4th largest oil producer in the world, behind Russia, Saudi Arabia, and the US. This will make Brazil a dominant player in oil, and a hub for the futures contracts tied to oil exports. ICE's entry into Brazil now gives it the ability to help the futures market there expand, and positions ICE to drive volume growth as Petrobras begins to ramp oil production over the next decade.

ICE has also been in the news recently given the current consolidation in the industry. Rumors are that ICE could be an acquirer, either by teaming up with Nasdaq (NASDAQ:NDAQ) to buy the NYSE (NYSE:NYX), buying Nasdaq outright, or buying the CBOE (NASDAQ:CBOE). I do not think buying Nasdaq would be a good move for ICE or its shareholders, as stock trading is significantly lower margin than futures. A CBOE purchase would be expensive, but probably a good fit. A joint bid to take out the NYSE could be a positive or negative, based on how NYSE's business was divided between ICE and its partner.

Given ICE's history of acquisitions, as well as its attempt to steal CBOT from the CME a few years back, don't be surprised to see ICE make a move over the next few weeks. Its $9 billion market cap makes it big, but not big enough compared to a $20 billion CME and a $20 billion Deutsche Borse / NYSE tie-up.

ICE's future is promising, driven by strong volume trends and high profit margins. Violence in the Middle East has been a volume driver for the company, allowing it to benefit from increased volumes. The firm has been expanding rapidly, and looks well positioned to benefit as Brazil enters the top tier of oil producers in the coming decade. Shares are up about 5% since industry consolidation talks emerged, although given its size ICE is more likely to be an acquirer than a takeover. Shares may sell-off should ICE make a bid for a competitor, but that would provide investors an opportunity to buy shares of a fast growing, high margin company.

Disclosure: I am long ICE, CBOE.