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By Jeremy Glaser and Gaston F. Ceron | 03-01-2013 12:00 PM

What Does the Merger With NYSE Mean for ICE's Moat?

Morningstar's Gaston Ceron addresses the short- and long-term prospects for and opportunities in ICE's takeover of NYSE Euronext.

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. I'm here today with Gaston Ceron. He is an equity analyst. We are going to look at the IntercontinentalExchange and New York Stock Exchange merger and what it could mean for their moats.

Gaston, thanks for joining me.

Gaston Ceron: Thanks Jeremy. Glad to be here.

Glaser: So, let's take a look this merger. Why did ICE want to take over New York Stock Exchange Euronext? What was the impetus behind this deal?

Ceron: ICE had actually tried to take over the NYSE Euronext before. They had tried, they had attempted to do so earlier in a joint bid with Nasdaq that was unsuccessful. So this was really another attempt by them to come at the company, this time just by themselves, not with another co-bidder.

What ICE is most interested in, in this property, in my opinion, is that ICE is primarily a derivatives exchange; that's pretty much what they do. And so the NYSE Euronext has an attractive derivatives exchange property in Europe called NYSE Liffe, and that's what ICE, in my view, is really interested in. They will also get some other pieces of the company, such as the equity side, which we can talk about further, but the real impetus for the deal as I see it is for ICE to get this NYSE Liffe derivatives piece in Europe.

Glaser: Let's take a closer look at the moat around these businesses. I know exchanges can have a classic network effect. How does this help ICE's moat? What is it before the deal? What does it look like after?

Ceron: Right. I would say in the short term it's somewhat mixed. We generally think that ICE has a wide economic moat. The reason we think that is because ICE is a futures exchange, and therefore they enjoy more control over their products than, let's say, an equities exchange would, because typically what happens with futures--and especially with a futures exchange like ICE that also owns a clearinghouse--is that you basically have to work through that exchange if you want access to those products. So, you open a position there, it gets cleared there, and then you have to close it there. That is not the case, for instance, with equities. Equities are often traded in multiple venues and you can buy a share here, you can buy it there, there's very little difference for many equities.

Futures in that sense are more exclusive, if you will, generally speaking, and so that's why we tend to think that ICE has a wide economic moat, because as long as you offer attractive products that people want to trade, they have this degree of exclusivity that is not available to other exchanges that are not futures exchanges. In getting NYSE Liffe, they will get another futures business, and so in that sense, that part will augment their moat, because that futures business will now be bigger and it will also expand into an area that ICE has been wanting to expand in, which is these financial derivatives, specifically interest rate futures. And so that part will make their wide moat moatier, because, again, you are taking a company that specializes in futures, you are adding more futures to it, that will get moatier, if you will.

The reason I say it's a little bit mixed is because something else that comes with the deal is NYSE Euronext's U.S. equities business. They have an equities business actually in the U.S. and in Europe, but the company has indicated that they will contemplate spinning off the European portion at some point. So, I'm assuming that does go through at some point in the hopefully near future after the deal closes, but they are still left with this U.S. equities piece. And that piece we think is not a wide-moat business, that's more of a narrow-moat business. There are some network effects and there are scale advantages and things there that do help that business, but equities in general, in the U.S., equities trading for exchanges is certainly less moaty than futures because equities are typically fungible products, which means that other exchanges can trade them, there is little exclusivity, and so there is more of an all-out fight for market share.

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