Exchange Mergers–Avoiding the Growth Dead End!

In terms of growth, stock markets appear to have hit a dead end. By the same token, futures and options markets seemed to be on a roll. It seems that North American stock exchanges are facing some tough decisions in the years ahead. The billion dollar question is what are they doing about them?

Well, the New York Stock Exchange’s chairman, John Thain, seems to be on the right track. He cleaned up well after Dick Grasso–he bought Archipelago, which is the U.S. electronic exchange, and he finally took the exchange public. This last move converted the NYSE from a dead asset into an acquisition powerhouse, enabling Mr. Thain with the tools to go on a shopping spree to beat the measly eight to 10 percent growth rate of stock markets.

Apart from knowing how to run the business on a day-to-day basis, Mr. Thain is also a man of vision. He understands that complying with the Sarbanes-Oxley Act is going to cost him an arm and a leg. Meaning, new acquisition targets are going to be hard to come by in North America. So, he switched to Europe, where regulation is much more lax. Hence the $10 billion bid for Euronext, the operator of exchanges in France, Belgium, the Netherlands and Portugal. If Mr. Thain is successful, since Deutsche Boerse is also bidding for Euronext, he could create the first transatlantic stock and derivatives market, valued at about $21 billion.

But, what is the top dog of the Toronto Stock Exchange doing to battle the stalled growth rate in his backyard? Well, Mr. Richard Nesbitt is aware that futures and options markets are the key to double digit growth rates. But, the Montreal Exchange, Canada’s only derivatives market, is playing hard to get, and with good reason.

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In 1999, Canada’s stock and derivatives markets went through an overhaul, whereby stocks are traded on the more senior Toronto Stock Exchange and on the junior marketplace, the TSX Venture Exchange, while all derivatives were transferred to Montreal. Ever since the overhaul, the Montreal Exchange has been expanding as if on fire, and currently, it is valued at CDN$500 million. Note that the Montreal Exchange is not publicly listed, but still owned by a handful of shareholders, though there is a somewhat of a limited market for its shares.

The CEO of the Montreal Exchange, Mr. Luc Bertrand, is in a very snug position right now. He appears really amused by Mr. Nesbitt’s beating around the bush. In three years, the original agreement among the three Canadian exchanges will expire. At that point, anything will be game, including Toronto’s bid for Montreal’s derivatives market. If Mr. Nesbitt wants to go ahead and catch that growth train, he’ll have to produce a really big check, the kind that will make Mr. Bertrand and his shareholders very, very happy.

Adding to Mr. Nesbitt’s predicament is the fact that the Montreal Exchange is under serious pressure to go public as well and convert its growth rate into hard cash. To illustrate, the ME grew about 32% in the last year. So far in 2006, it is up 50%. For the first quarter of 2006, the ME reported CDN$4.9 million, in contrast to CDN$700,000 reported for the same period last year. Such a performance made its shareholders very happy, after the exchange delivered a special dividend of CDN$13.7 million.

The third option is that the Montreal Exchange buys out Toronto. Why not? The ME could get the cash to pay for the trip by going public, and make a successful bid for the older, but somewhat slow and annoying sibling.

In any event, it is going to be interesting to see how things will develop in Canada. So far, we at Lombardi Financial have profited immensely trading commodity stocks on the Toronto Stock Exchange. We cannot say for sure, but Mr. Bertrand looks like a much cooler player than Mr. Nesbitt. So, it might be a good idea to be on the lookout for the Montreal Exchange going public, and perhaps catch a profit train of our own.