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Don't Go Bats for This IPO

By Alex Dumortier, CFA - Apr 14, 2016 at 10:58AM

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Bats Global Markets, Inc. will try to fly its initial public offering tomorrow for the second time. This plucky exchange operator has built a decent franchise in just over a decade, but is the stock a buy?

NASDAQ MarketSite TV studio, Times Square. Image source: Luis Villa del Campo, republished under CC BY 2.0.

U.S. stocks are roughly unchanged in late-morning trading on Thursday, with the S&P 500 (^GSPC -0.20%) and the Dow Jones Industrial Average (^DJI -0.13%)  down 0.17% and up 0.07%, respectively, at 11:22 a.m. ET.

Second time's the charm? Plucky exchange operator Bats Global Markets is hoping to bury the bad juju of its failed attempt to go public four years ago on its own exchange due to a technological glitch -- a classic feat of negative publicity.

Bats is now set to launch its initial public offering, selling 13.3 million shares with a pricing range of $17 to $19 (15.3 million if the underwriters exercise their "green shoe" option). The underwriting banks are expected to price the shares later today, with the stock to begin trading tomorrow. At the top of its range, the offering would value the company at $1.8 billion.

Founded in June 2005, Bats has taken on the major U.S. exchanges to become the second largest exchange for U.S. cash-listed equities and the largest for exchange-traded funds (ETFs) and other exchange-traded products (ETPs). Last year, the company generated 85% of its net revenues from transaction fees, with market data fees contributing just 9% (that lopsided breakdown compared to its major competitors suggests market data fees could be a growth opportunity).

This Fool thinks that Bats is an interesting story and it has managed to build a limited competitive advantage around its technology platform and its upstart/ start-up culture. The company is profitable on the basis of net income and operating cash flows and has been since at least 2009.

Bats is much leaner than its larger competitors, too, with just 268 employees worldwide, which bodes well if it can continue to scale its activity.

Finally, at $19 per share, Bats is valued at 22.1 times its 2015 earnings per share. That doesn't seem outrageous for a growth company that is profitable.

However, for a long-term investor, the existence of a competitive advantage is not enough; it must be durable, too. The best example of the uncertainty regarding the durability of Bats' advantage is Bats itself. Starting from nothing and in the space of less than a decade, it was able to compete as an equal with the New York Stock Exchange (now part of Intercontinental Exchange (ICE 0.95%) and the NASDAQ (part of NASDAQ Inc. (NDAQ -0.68%)) in U.S. equities trading.

In an industry in which the effects of technological and regulatory change are rapid and unpredictable, is it really so hard to imagine another upstart rising up and hurting Bats' franchise? Perhaps IEX, which Michael Lewis touted in his book on high-frequency trading, Flash Boys trading is the next Bats Global Markets. IEX is in the process of seeking SEC approval to become a registered national securities exchange.

Bats Global Markets is, in my judgment, a speculation, not an investment, but one that may be worth a second look from growth investors.

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Stocks Mentioned

Dow Jones Industrial Average (Price Return) Stock Quote
Dow Jones Industrial Average (Price Return)
$31,459.27 (-0.13%) $-42.97
S&P 500 Index - Price Return (USD) Stock Quote
S&P 500 Index - Price Return (USD)
$3,903.99 (-0.20%) $-7.75
Intercontinental Exchange, Inc. Stock Quote
Intercontinental Exchange, Inc.
$98.84 (0.95%) $0.93
Nasdaq, Inc. Stock Quote
Nasdaq, Inc.
$158.19 (-0.68%) $-1.09

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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