CME's Hot BOT

There seems to be no limit to the valuations for stock and options exchanges. But even the plucky IntercontinentalExchange (NYSE: ICE  ) got vertigo, deciding to back off its attempt to scuttle the $11.9 billion merger of the Chicago Board of Trade (NYSE: BOT  ) and Chicago Mercantile Exchange (NYSE: CME  ) . As a result, rivals CBOT and CME will now join forces.

And the combination is a strategic slam dunk. The CME/CBOT will be the world's largest exchange and clearinghouse, with benchmark products in every major asset class and distribution in 83 countries. According to a CME proxy filing, the deal is expected to result in revenues of $2.6 billion and profits of $1 billion in fiscal 2008.

With its massive scale, the CME/CBOT plans to expand its footprint into other product categories. One lucrative area is the over-the-counter market (OTC), which involves customized investment vehicles. These have been popular with hedge funds and other sophisticated investors that need to find ways to manage risk.

Unfortunately, CME was forced to boost its bid three times because of ICE's overtures. As a result, it's paid roughly $3 billion more for the CBOT, or about 30 times EBITDA.

Crazy valuation? It seems so. But keep in mind that there has been tremendous consolidation in the industry, with firms like NYSE Euronext (NYSE: NYX  ) , Deutsche Borse, and others shelling out billions on deals.

In the case of CME/CBOT, the combined firm will be a 400-pound gorilla in its sector. It will command about 85% of the U.S. futures market, and be nicely positioned to benefit from the growth in dynamic derivatives markets. So long as the trading volume continues apace, and the company can achieve its synergies, there is probably more upside to the CME/CBOT merger for Foolish investors.

We trade in Foolishness:

NYSE Euronext has tripled since it was recommended to Motley Fool Rule Breakers subscribers. To find out what other potential blockbusters the Rule Breakers team has in store, check out an all-access, 30-day free trial to the newsletter service today.

Fool contributor Tom Taulli, author of The Complete M&A Handbook, does not own shares mentioned in this article. He is currently ranked 2,478 out of more than 60,000 in Motley Fool CAPS. The Motley Fool's disclosure policy sits wherever it wants.


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