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IntercontinentalExchange (NYSE:ICE) is one the fastest-growing exchange operators in the world. It owns multiple exchanges throughout the globe, and provides trading and clearing services in its derivatives and cash trading segments. It also provides a wide variety of market data and technology services to its clients, and competes with other large exchange operators such as CME Group (NASDAQ:CME) and NASDAQ OMX (NASDAQ:NDAQ). CME is ICE’s biggest rival in the derivatives market, whereas NASDAQ provides the strongest competition in the cash trading and listings business.
We are launching coverage of ICE with a price estimate of $241, which is about 15% above the current market price.
We have divided ICE into the following divisions which account for its value:
- Derivatives – As an exchange, ICE provides its clients a platform to trade interest rate, energy and commodity contracts, among others. The business recently expanded its product offerings and geographical footprint by acquiring NYSE Euronext. NYSE Euronext owns LIFFE, one of the two market leaders in the European derivatives market. According to our estimates, this segment accounts for around 60% of ICE’s value.
- Market Data and Technology – This division comprises of the data services traditionally offered by ICE through its subsidiary ICE Data, as well as the data and technology operations of NYSE Euronext. ICE Data provides real-time futures data, daily indexes, historical prices and end of day settlements and price data to customers such as Bloomberg and Reuters. NYSE Euronext’s data and technology business operates as NYSE Technologies, and provides transaction, data and infrastructure services, and other solutions to clients. Market data and technology services account for around one-third of the company’s value, according to our estimates.
- Cash Trading and Listings – When ICE acquired NYSE Euronext, it also became the owner of some market-leading cash trading exchanges on both sides of the Atlantic. However, these businesses remain a non-core asset for the company, accounting for just 7% of its value, according to our estimates.
Derivatives Growth Presents A Tremendous Opportunity
According to some estimates, the notional value of all derivatives traded throughout the world could be well over $1 quadrillion. In comparison, the combined market capitalization of all equity markets summed up to about $65 trillion at the end of 2013.  Given the enormous size of the global derivatives market, the G-20 nations decided in 2009 that systemic risks in the market must be reduced so that another global financial crisis can be prevented. To make this happen, they called for centralized clearing of over-the-counter (OTC) derivatives, a $693 trillion segment of bilaterally traded derivatives contracts.  Since then, governments around the world have been framing and implementing laws in order to mandate centralized clearing of OTC derivatives. The new Basel III norms also discourage banking institutions from participating in OTC derivatives that are not centrally cleared, and are therefore likely to fuel growth in the centrally cleared derivatives segment over the next few years.
This presents a great opportunity for derivatives exchanges such as ICE and CME. As two of the world’s leading derivatives exchange players, they are well-positioned to provide trading and clearing services for OTC contracts that come under the purview of centralized clearing. In order to make the most of this opportunity, both exchanges have been expanding their operations in financial centers where large volumes of OTC derivatives are traded – such as London, which accounts for 46% of the global OTC interest rate derivatives market. 
In London, CME is building its platform from the ground up, while ICE has acquired NYSE Euronext in order to get its hands on NYSE’s LIFFE business. As discussed earlier, LIFFE is one of the two dominant players in the European interest rate derivatives market, and its acquisition provides scale to ICE’s European derivatives business. While ICE can use LIFFE to quickly capture market share in this growing segment, CME seems to be having difficulty launching its London-based derivatives exchange – it was supposed to open its exchange in September, but postponed the launch indefinitely due to some technical issues (see CME Postpones Its London-Based Futures Exchange Again). Given the scale and head start enjoyed by ICE in the European derivatives market currently, we forecast its derivatives clearing volumes to increase at a rapid pace over the next few years.
Market Data Revenue Is Also Likely To Grow, While The Technology Business Is Likely To Be Restructured
The demand for market data has been increasing worldwide, as more financial products are launched and a greater number of customers are looking for specialized feeds. We expect this trend to continue over the next several years due to the increasing complexity in the financial world.
Another factor that could positively impact ICE’s market data revenue is the industry-wide revision of subscription charges. These charges have remained stagnant since the financial crisis of 2008, due to cost-cutting initiatives at financial firms who subscribe to this data. However, as the economy improves we expect the subscription rates to be revised upwards. ICE’s major competitor, CME, announced late last year that it plans to increase the monthly market data fees for its clients from $70 per user to $85 starting in 2014.
On the technology services front, ICE has expressed interest in selling off some assets that were acquired during the acquisition of NYSE Euronext, as management considers them to be non-core to the company. However, as nothing concrete has been announced, we include technology revenues in our model as a going concern.
Cash Trading And Listings Businesses Likely To Shrink
ICE has already announced plans to spin off its European cash trading operations into a new company, called Euronext, by mid-2014.  Within the U.S., the company seems to be unwilling to sacrifice profit margins in order to maintain its #1 rank. Speaking at an industry conference a few months back, ICE CEO Jeff Sprecher said that he would be willing to give up some of NYSE Euronext’s market share in the U.S. equity trading business in order to end the prevalent trading incentives (see ICE Will Focus On Profitability Over Market Share With NYSE’s Cash Trading Business).
One of the reasons for the reduced appeal of this business is the fact that it is a mature industry, with low margins and high competition. Additionally, trading volumes within this segment have been shrinking for the past several years due to the advent of alternative trading venues such as dark pools. The number of cash products handled by NYSE in the U.S. decreased from 827 billion in 2009 to just 421 billion in 2012. We expect volumes to continue declining in the near future as NYSE continues to lose market share to dark pools, followed by a gradual recovery if and when market structure reforms are implemented. NYSE and the Securities Industry and Financial Markets Association (SIFMA), the largest securities trading group in the U.S., have been in a dispute over how to implement the likely market structure reforms that will decide the future of dark pools.  However, volumes could continue declining if ICE decides to end its rebate program, as indicated by management earlier.Notes:
- Global stock rally: World market cap reached record high in December, and is 4% above pre-recession, pre-crisis level, American Enterprise Institute (data from the World Federation of Exchanges), January 2014 [↩]
- OTC derivatives market activity in the first half of 2013, BIS, November 7, 2013 [↩]
- Financial Market Series: Derivatives, The City of UK, November 2012 [↩]
- ICE Expects a Euronext IPO by Mid 2014, WSJ, November 19, 2013 [↩]
- Securities trading group and exchange butt heads on market structure, Facebook IPO, MarketWatch, August 1, 2013 [↩]