The latest twist in the battle for the Chicago Board of Trade occurred Wednesday morning as the Intercontinental Exchange (ICE) and Chicago Board Options Exchange (CBOE) announced that the two have entered an exclusive agreement regarding CBOE Exercise Rights as part of ICE's proposed merger with the CBOT.
As part of the agreement, full CBOT members holding CBOE exercise rights would receive $500,000 in value for each right. The $500,000 payout will be split between the ICE and CBOE. Each exchange will offer $250,000 in cash to CBOT members holding rights or debt securities convertible into stock. On the ICE side that would be stock in the newly combined CBOT/ICE and on the CBOE side, common shares of CBOE after a demutualization. The agreement is contingent on the completion of a merger between the CBOT and ICE.
The package is worth up to $665.5 million, which is equal to the outstanding 1,331 exercise rights times $500,000. Only those CBOT full members eligible to use their exercise right qualify for the consideration. That means they must hold their Class B-1 membership, the exercise right privilege (ERP) and 27,338 Class A common shares. Those that hold the first two and have sold off stock can qualify if they purchase enough stock to bring them back up to the 27,338 threshold by a certain date.
After the most recent compromise between the CBOT and CBOE preceding the CBOT IPO, the ERPs were allowed to trade separately. The CBOE bought back 68 in a Dutch auction and retired those ERPs. Prior to yesterday’s announcement the most recent ERP sale was for $175,000, yesterday an ERP sold for $230,000 and the bid ask was $250,000 at $290,000.
As part of the agreement, ICE and CBOE also have agreed in principal to a broad commercial partnership where they will work jointly on technology, product development, and access to each exchange’s distribution.
The agreement puts pressure on the Chicago Mercantile Exchange, whose enhanced offer to the CBOT, which was unanimously approved by the CBOT board of directors, was still lower than ICE’s offer as well as the market price of the CBOT.
Why take less?
With the CBOT board of directors deciding to endorse the revised CME offer despite it not only being below the ICE offer but also the market price of CBOT stock, perhaps it was only a matter of time before a lawsuit was filed over the whole process. The CBOT has often been bogged down by time consuming expensive lawsuits as it has attempted to transition it business over the last several years.
Turns out a suit was filed in Delaware Chancery court in March shortly after the ICE bid was announced. The Louisiana Municipal Employee’s Retirement System (Lampers) filed a suit seeking class action against CBOT Holdings, its board members and CME Holdings for breach of fiduciary duties and aiding and abetting a breach of fiduciary duties. Lampers sued on behalf of itself and other similarly situated public shareholders of CBOT Holdings. There is a preliminary injunction hearing scheduled for June 29.
While the suit appears to be filed by an obscure group of shareholders, many CBOT members are still dissatisfied with the CME offer. Perhaps it is because every argument for why the CME and CBOT are the best match is also an argument for why the CBOT is more valuable to the CME than anyone else, yet they are offering less.
While the CME makes strong points regarding better synergies and in questioning the viability of all the synergies ICE claims, these also are arguments for the CME to raise its bid. Since a combined CBOT/CME will offer greater synergies, requiring a lower capital investment to successfully integrate the two exchanges it should be able to bid more for the CBOT and still realize a better return because of those synergies. It also has something to lose that ICE does not, the CBOT clearing business. That is another reason why the CBOT should be worth more to the CME than it would to ICE. While CME may be correct to note that the fact that CME/CBOT is a better fit than CBOT/ICE means that the stock will perform better once a combination is complete, these are also arguments for CME to be more competitive in bidding.
One CBOT member and former board member noted that the difference in value of the deal for a full member with all the underlying Class A shares is more than $700,000. It is hard to take a $700,000 hit.
As of the May 30, close the ICE offer stood at $211.68 and the CME offer at $184.75. That is a difference of $736,212 for a full member retaining all Class A shares.
Former CBOT Chairman Pat Arbor said following the CME management team’s meeting with CBOT member in March that the CBOT member and shareholders would vote with ICE unless the CME upped it s bid. He said the CME would need to up its bid to “at least” give CBOT members 0.35 shares in the combined company. Well the CME met that minimum, just.
Mike manning, head of futures commission merchant Rand Financial still sees the CME’s proposal as superior. “I concur with Charley Carey and the board of Directors, it is a superior offer. I am surprised with some of the stories I am reading because I don’t think they reflect the majority opinion. It is an ever-changing landscape.
Manning likes the Merc deal because of potential integration problems between the CBOT and ICE. “If you are going to keep your stock whether it is CME stock or ICE stock I think the majority of the member think the integration of the CME and CBOT will go smoothly. News coming out of that merger will be good and conversely if the board of trade goes through with ICE there will be huge hurdles that need to be overcome. It is very difficult for those things to go smoothly even when you have bright people working on them and throw tens of millions dollars at it,” Manning says, adding, “You are not out the day of the merger be it the Merc or ICE. If you are in it you’re in it. Which stock is going to be a better stock to own six months, 12 months, 18-24 months after the merger? I don’t think it is any question that it is the Merc stock.”
In their most recent S-4 filing with the Securities and Exchange Commission endorsing the enhanced CME offer, the CME and CBOT provided answer as to why the CBOT board didn’t accept the ICE offer.
“The reasons for the determination of the board of directors of CBOT Holdings that the proposal from Intercontinental Exchange, Inc., or “ICE,” to merge with CBOT Holdings was not a “Superior Proposal” within the meaning of the original merger agreement, included the following material factors:
• the belief that a combination with ICE would take longer to integrate and would involve significantly greater execution risks than a combination with CME Holdings;
• the belief that a combined CBOT Holdings/CME Holdings would be better able to compete in a rapidly changing industry than a combined CBOT Holdings/ICE;
• CME Holdings’ longer operating history and history as a public company;
• the relative experience in the futures industry of the board members and management at CBOT Holdings and ICE, and that under the ICE proposal the combined business would be overseen and managed by a board comprised of a majority of ICE directors and ICE management;
• under the ICE proposal, CBOT Holdings’ stockholders would own a majority of the stock of the combined company but CBOT Holdings’ directors would constitute a minority of the combined company’s board of directors;
•a combination with CME Holdings would create the world’s most diverse global exchange, offering a broad range of derivatives products based on interest rates, equity indexes, foreign exchange, agricultural and industrial commodities, energy and alternative investment products;
• the fact that the market prices of CME Holdings Class A common stock and ICE’s common stock fluctuate for a number of reasons, including reasons unrelated to operating performance, making a comparison of short-term value less certain; and
• the belief that a combination with CME Holdings in accordance with the terms of its revised proposal offered greater overall benefits to CBOT Holdings stockholders than a combination with ICE in accordance with the terms of its proposal.
While the leadership of Chicago’s leading futures exchanges offer compelling arguments, cash often speaks loudest. ICE Chairman and CEO Jeff Sprecher will be addressing CBOT member later today and will make his case. On his side is the fresh news that he has offered a possible solution to one most vexing issues facing both the CBOT and CBOE in the evolution of those exchanges. An issue that has led to near constant litigation. An issue that, now that one possible solution is on the table, will probably need to be resolved before the CBOT closes a deal with anyone.