With the Chicago Mercantile Exchange (CME) raising its bid to acquire the Chicago Board of Trade (CBOT) last week to break the Intercontinental’s Exchange’s chances of winning the bidding war, there is speculation as to whether the upstart electronic energy market and soft commodity exchange will up the ante, or allow the CME to prevail.
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Last Friday, the CME raised its offer by 16 percent from $7.9 billion to $9.2 billion, which is still below the ICE deal, which is valued at $10 billion.

William Cline, CEO of Acai Solutions, an industry consultancy, said the CME had to close the gap. “I don’t think the CBOT Board could have continued to recommend the CME offer given the magnitude of the gap in the bids,” says Cline.

"They also needed to do a better job of selling the deal,” continues Cline. “They did that by highlighting the cost savings with more granularity by talking about revenue synergies which they hadn’t done previously,” says Cline.

A good chunk of the cost savings will come from the consolidation of the two trading floors into one. Although he ICE CEO put forth its faster electronic trading platform as part of the value proposition, “It’s not clear that this was enough to put it over the top,” says Cline.

Besides raising the original offer, the CME came back with $25 million in incremental cost savings — which total $150 million beginning in the second year after the merger closes, and also detailed $75 million in revenue synergies, notes Cline. And on the CME’s Web site, there’s a new tag line, “Better together – financially, strategically, operationally,” notes Cline.

In addition, the CME’s revised terms include giving the CBOT more seats on the board of the combined company. CBOT shareholders will own approximately 34.6 percent of the outstanding shares of the combined company, up from about 31.2 percent in the original agreement. CME also offered to buy back $3.5 billion in stock at $560 a share.

In response, ICE said it was reviewing the CME’s announcement and was evaluating its options. “ISE continues to believe the combination of CBOT and ICE offers CBOT shareholders and members immediate and long-term value as well as better growth prospects than its acquisition of CME.”

Cline believes the CME will prevail because the two largest futures exchanges have been working on the merger for months and have a much more granular idea of what the combined entity will look like, he says. “They had working committees and were retaining people to help with the merger integration,” he says.

“The bottom line is the gap in the bids had to be closed. It was always evident that the CME and CBOT preferred to combine with each other. And the ICE was very much the outsider that spoiled the party,” he says.

The question is what will be the ICE’s next move. “To me, that is the wildcard,” says Cline. “I would fully expect (Jeffrey) Sprecher (the ICE CEO) to play another card now in the ongoing global consolidation and of course he may make a counter offer. But it’s pretty clear to me that the Chicago guys are pretty tight,” says Cline.

However, the CME is not out of the woods yet given the uncertainty over regulatory approvals. The U.S. Department of Justice is examining the transaction’s impact. There are concerns that a combination of the two dominant futures exchanges would have too much pricing power and essentially hold a monopoly with 85 percent market share.

“Both the CME and the CBOT have expressed confidence that they are in compliance and that they will obtain the regulatory approval,” says Cline. On the other hand, there’s no question that the $28 billion combined company will be the dominant derivatives exchange across asset classes, he says. If the number one and number two futures exchanges were to combine, they’d have much greater pricing power, so there is more risk there. But if the ICE and CBOT combined they would not have that type of pricing power, says Cline.

Unlike the U.S. cash equity markets where participants feared the dominance of two exchanges and invested in regional exchanges and built up alternative trading systems and dark pools, there is no hedge here. In derivatives this is harder since the futures transactions must take place on exchanges, and so exchanges are more immune than cash equities from competition, he adds.

Yesterday, CME said it had established May 29 as the record data for the July 9 shareholder vote. Investors will vote on its proposed merger with CBOT Holdings in a special meeting of shareholdings on July 9, 2007. Both exchanges expect the regulators to weigh in before that.

Regardless of what happens, the ICE has raised its profile at a time when the global dance of exchange consolidation is continuing. In addition, the ICE has swiftly integrated the NYBOT soft commodity contracts onto its electronic platfrom. In April, 60 percent of NYBOT's soft commodity futures contracts were traded electronically on the ICE platform.