From the moment the Intercontinental Exchange (ICE) announced its unsolicited bid for the Chicago Board of Trade (CBOT) on March 15, it seemed within the Chicago Mercantile Exchange’s (CME) power to end the debate and close the deal by simply matching the dollar value of the ICE offer, but the CME stubbornly insisted its definitive agreement with the CBOT was superior. And despite all of its protestations that its bid(s) remained superior, the CME eventually came through with the knockout punch. On July 6, the Friday before the July 9 vote, the CME increased the stock-swap exchange ratio to .375, from .350, pushing the value of its offer to $11.8 billion, which was just above the ICE bid, and wrapping up the vote unless ICE anted up.
The CME and CBOT announced the day of the vote that preliminary results indicated shareholders from both exchanges approved the merger, though an official vote total had not been completed at press time.
The move was enough to get CBOT’s largest shareholder, Caledonia Investment Pty. Ltd. of Australia, to back the deal. Caledonia, which owns approximately 7% of CBOT, had indicated earlier in the week that it would vote ‘no’ on the merger.
Like many CBOT members, Caledonia saw the CME deal as the better fit but was not prepared to vote for a lower offer. “We have always supported this merger from a strategic rationale and long-term growth perspective,” said Caledonia Managing Director Will Vicars, in a CME release. “Now, with the CME’s latest enhancement, we fully endorse this merger and will vote in favor of this transaction,” he added.
CME Executive Chairman Terry Duffy was up all night July 5 negotiating the enhancement, which the CME described as its “best and final offer.” Duffy said that while they were confident previous enhancements had turned the tide, it was important to get the largest shareholder on board. “This vote was trending very highly in our favor and we were confident that we were going to get it, [but] the largest single shareholder of the Board of Trade was on the opposite side of the equation voting ‘no.’ It is always important to have the largest single shareholder
supporting your transaction.”
CBOT Chairman Charlie Carey wasn’t quite as confident before the final offer, referring to negotiations as a game of Texas hold-em. “I wasn’t convinced either way but it was going to be a tough one.”
Former CBOT Chairman Nickolas J. Neubauer says the CME played its cards well. “What the [CME] did was something that is a standard of good trading, namely: wait until the point at which you could actually seal the deal to make your final bid. They waited to the moment the deal could be sealed and there would be little or no opportunity for the ICE to increase their offer.”
Neubauer says, “[The merger is] something that has been talked about for 30 years or more and almost everybody at both exchanges is happy about it.”
ICE was unrelenting in its pursuit of the CBOT, addressing member fee concerns and negotiating a deal with the Chicago Board Options Exchange (CBOE) on exercise rights in the process (see “What about CBOE?” below). And ICE share prices climbed steadily as Chairman and CEO Jeffrey C. Sprecher announced deals to acquire the Winnipeg Commodity Exchange and OTC platform ChemConnect Inc., and then
ICE signed an exclusive deal with the Russell Investment Group, taking one of the CME’s largest equities based contracts.
Carey and the CBOT board steadfastly supported the CME proposals throughout the process mainly because of what it referred to as greater integration risk and ICE’s supposedly inferior technology. “Everybody affirmed the board’s decision that this was the best merger partner, it was all about getting a price that the shareholders would approve and that is exactly what happened,” Carey says, adding, “It was two great sets of traders trading against each other and they split the difference at .375 and now we can move on.”
A CBOT shareholder, member and former member of the CBOT governance said at the shareholder vote that the deal is in the best interest of both exchanges. “The CME is like anyone else, they are trying to buy low, and if not for the ICE intervention, it probably would have been for a lower price. We benefited from all that.”
This coup de gr ce followed several previous moves by the CME and CBOT to sweeten the deal, including a one-time $9.14 cash dividend payable to CBOT shareholders, conditioned on approval of the merger; a post-close tender offer of $560 per share for up to $3.5 billion of shares of the combined company, greater board representation; and a revision to clearing member minimum shareholder requirements. Combined, the moves closed the more than $1 billion gap between the ICE unsolicited bid and the CME’s first offer.
“The CBOT is worth more — a lot more,” says Chris Doll, managing partner at the Vernalis Group LLC, which has invested more than 18% of its portfolio in the CBOT. Although he supports the CME/CBOT merger, he still thinks the price was too low.
“It’s the right marriage at the right price and it’s going to pass,” said Jerome Israelov, shareholder, member and trader. “They flipped me from a ‘no’ to ‘yes’ last Friday with what most people consider a fair price.”
The Hail Mary bid that many expected from the ICE never materialized. “Despite our disappointment in the outcome, our proposal has brought many benefits for both CBOT and ICE stockholders,” said Sprecher to the press. “For CBOT stockholders, ICE’s involvement has created nearly $3 billion in additional value through our willingness to recognize the true worth of your company.” On the day of the vote, Sprecher offered his testimony on excessive speculation in the natural gas market before a U.S. Senate Subcommittee and closed the deal to acquire ChemConnect.
“We are pleased that shareholders of both companies have demonstrated support for this groundbreaking merger,” said Duffy in a press release. “The combination of CME and CBOT creates a strong international company better positioned to compete with growing global exchanges and the over-the-counter market.”
Carey says the focus now will move to integration that includes moving the CBOT products onto Globex and combining the trading floors at the CBOT building. “Globex integration first quarter [2008], floor integration second quarter [2008]. [I am] excited about the combination, excited about the opportunities going forward and very pleased that the business is staying here in Chicago where it belongs,” Carey says.
CASUALTIES OF WAR
Along the way the CME suffered greater casualties than just having to buck up for the CBOT in its battle with ICE. In June ICE inked an exclusive agreement with Russell Investment Group, parent of the Russell family of indexes.
The move ensures that ICE will snatch futures on the Russell 2000 Index, which have grown to be the second largest equity index product at the CME in terms of open interest, with more than 500,000 open contracts in its E-mini version. It also has been the fastest growing index product from January to May of 2007 with year-on- year growth of 37.5% according to the CME Web site.
“[The CME] just let this one walk out the door,” says independent trader John Stevens. “The CME downplayed it, but it’s a pretty big deal.” Stevens wasted no time, selling his CME GEM membership less than a day after the announcement, but says that it is far more expensive for him to trade the contract on the New York Board of Trade, the ICE subsidiary where the contract will list.
The CME is not going to simply let go without a fight. Its contract with Russell, which expires this year, allows it to list contracts out until September 2008. The CME has decided to do that and announced that along with Standard and Poor’s, it will soon list a new E-mini small cap stock index. The S&P small cap 600 index is highly correlated to the Russell 2000, but the announcement did not state whether the new futures contract would be based on the S&P 600 or an entirely new index.
The announcement did state that, following the expiration of the agreement with Russell, CME and S&P would provide incentives and encourage market participants to transfer open interest from the Russell 2000 to the new small cap benchmark. If they succeed, the ICE would be paying a lot of money for an empty shell. ICE paid $50 million plus royalties for the exclusive licensing agreement.
The decision reverses Russell’s strategy of licensing its indexes to multiple exchanges and letting them fight over liquidity. Kelly Haughton, strategic director for Russell Indexes, says they decided to stop multiple listing and now believe this is a better way to go.
Haughton says the transition into exclusive listing will take months but eventually ICE will be the exclusive home for Russell 2000 futures. “We feel ICE will be a strong advocate for our product line, we have been looking for the best way to have a successful 1000 contract,” adding, “Russell has been pleased with our relationship with the CME and the Russell 2000 has grown, but we decided to go with ICE to grow our entire family of indexes.”
