ICE – Intercontinental Exchange

I am suffering from an abundance of stock ideas.
The recent market downturn has created so many opportunities, I am reluctant to choose.
But, as always, capital is limited, So let’s start at the top of considerations.

ICE – this has been on the list for some time. The rich cash generation and durable competitive advantage – in the form of regulatory licensing – make this a strong company with a wide moat around its business. ICE has been eating into the business of it’s main competitor, CME, for years. Keep in mind, I am bullish on CME as well, together these companies have a duopoly of energy and soft commodity trading in the US and most of Europe.
But ICE is the fast growing new kid on the block.
I am currently more bullish on Brent crude volumes, which are primarily traded on ICE’s systems, than WTI crude volumes, which are primarily traded on CME’s system. The WTI is currently a “land-locked” crude – and prices are being discounted because the oil stored at Cushing, Oklahoma is not available for easy transport to refineries at the Gulf. All pipelines from the Gulf are pumping oil from the Gulf to the inland, and there are currently none the other way. So, WTI has been dealing with a price depression because of the glut of oil accumulated at Cushing with nowhere to go.
What does this mean for ICE? Brent crude (ICE’s benchmark oil product) is carrying a price premium right now because of its sea-borne nature – it is based on North Sea oil – and easy transportability. Further, speculators are pushing up Brent prices because of unrest in the Middle East – a bet that Europe may have to depend less on Middle Eastern oil in the future, increasing demand for Brent crude.
The fact that Exxon and BP have both been eyeing the Arctic circle for new exploration activity also bodes well for Brent Crude volumes. Any new exploration in the Arctic circle is sure to have crude that is priced relative to the Brent benchmark, and should increase volumes for that product as the producers seek to hedge their prices.
I will confess, I am a little uneasy about ICE’s CEO, Jeffrey Sprecher. Sprecher is a seemingly incourigible optimist, but the attitude has served him very well in his time at ICE. However, I was rattled by ICE CEO Jeffrey Sprecher’s decision to join with Robert Greifield of NASDAQ in making a rival bid for the NYSE Euronext exchange. While the Liffe business (the part of NYSE for which ICE was bidding) has a durable competitive advantage – the LIBOR product traded on the Liffe platform is widely tracked across the banking industry – I felt that the offer was high relative to the value of the business. I also was slightly worried that ICE’s balance sheet might tip too debt-heavy, though, as Sprecher was eager to point out, ICE’s rich cash flow can handle a substantially larger debt load than it currently does. I was glad this deal did not go through, and that instead, ICE will be looking to invest elsewhere.
Another reason this rattled me so much is that it happened so quickly I wondered whether ICE management was accurately weighing the risks of the transaction.
However, I do respect Sprecher’s willingness to continue to invest in acquisitions to grow ICE, and his forward-looking vision that allows ICE to take risks to enter profitable markets well ahead of competitors, as long as ICE is not taking on serious amounts of leverage to do so.
I believe, in addition to its energy Futures, over-the-counter (OTC) energy, soft commodities, metals, and forex markets, ICE is primed for massive growth in a couple of new markets. ICE owns the largest carbon credit exchange in the world by volume (1). California has recently pushed through cap and trade legislation, and the European Union Emission Trading Scheme has been in effect since 2005. Though this market currently contributes only a small amount of revenue, in future years it holds the potential for growth.
ICE is still the ONLY service cleared by regulators for Credit Default Swap trading. Now, the rules are still being sorted through with regulators as to how this market will be governed, but one thing is for sure: CDS trades will be transferred onto a transparent exchange and clearing service, and, as a first-mover into this industry, ICE has set itself up to have the advantage over rivals like CME and whoever else chooses to enter the market. However, there are still risks I am worrying about related to this business. For example, ICE has a Guaranty Fund to cover the default of up to 2 of the largest Clearing Participants. However, if a major credit default event occurred, would ICE be liable for defaults over and beyond the 2 largest? Granted, this could only happen in a second “financial armaggedon” type scenario, but it is something good to know. I will have to comb over some conference calls to see if this has been covered. For more information on ICE’s CDS clearing business, see (2).
Another exchange battle with CME is occurring in Brazil. CME has traded stock with BMF Bovespa, the leading Brazilian exchange, in a 5%/5% swap. This has primed CME for the explosive growth that Brazil is experiencing. However, ICE has bought into Cetip, a second Brazilian clearing firm, and plans to create competition to BMF Bovespa in electricity trading. this could be a potential source of growth, but, of course, is nothing to count on.
ICE management recently acknowledged that they may begin a more rigorous share buyback program, as the market has not yielded any more prime deals.
But, as rumor would have it, the London Metals Exchange is being courted by a possible suitor. It is not wise to believe every rumor that you hear, but if this is true, I think this would be a great complement to ICE. LME still conducts much ots trading by the open-outcry system, complete with a trading pit and floor traders. Such a system is unnecessarily costly to operate. As ICE demonstrated with its 2001 takeover of the International Petroleum Exchange, conversion from the open-outcry system to an all electronic system can save money and widen margins for the exchange while lowering spreads and reducing transaction costs for market participants. If the rumors are true, and if ICE can get its hands on LME, it could hold a great potential upside.

As far as exchanges go, my favorites are still the two competitors*, CME and ICE. Recent declines in CME have offered tremendous value in that stock as well. But ICE remains the stock with the largest potential upside, and management that is focused on continual growth.

I currently own shares of CME, but would like to purchase shares of ICE soon, definitely before ICE reports on November 2.



(3) ICE’s latest 10-Q

* I am currently investigating the Singapore Exchange (SGX). The net profit margins for this exchange are VERY wide, and the exchange looks attractive, as Singapore is rapidly becoming a trading hub. As it is a foreign stock, I would have to purchase over the counter, which makes me a little more cautious.


Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s