CME: Electronic trading will propel growth

It's hard to believe the little Chicago Merc Exchange has become the biggest and possibly the best exchange in the world. They trade over $5 trillion a day and now have a market value of over 28 billion dollars. They began their history as a motley crew of livestock traders and now have the respect of all traders. They have made this expansion through good decisions and increased technology. The decision to go electronic was the most important. It was hard to say goodbye to the floor traders, but it was important for margins to do so. They went public and merged with their largest competitor, making in my opinion an unbeatable combination. It was surprising that they were allowed to merge, as they have a monopoly of sorts with respect to futures contracts. With all of their changes they have increased daily volume from a little over 2 million to 14 million per day. Their monopoly has shown to help keep prices constant as competition doesn't seem to be able to push them lower. It has kept margins unbelievably high, operating was over 60%. The stock has quietly increased its stock 18 times over the past six years. The CME has slowly changed over the years. It use to be a venue for farmers and bankers that through outcry would lock into rates, or pig prices. It began as the Chicago Butter and Egg Board one hundred and ten years ago. A little fewer than 7000 seats are available here, and in 1971, a year before I was born a seat changed hands for one hundred dollars. Now it costs one and a half million. Its operation generates revenue through the actions of contracts. It collects from the buyer and seller per transaction. It still is a place where a trader can hedge prices but now speculators use the Board to profit from other people's losses. If the transaction is completed before the length of the contract they will pay an additional fee. This trading floor has been an area of blue collar ideals for quite sometime. It was not out of the ordinary, while jockeying for position for a fight to break out. One of the past chairmen even knocked out one of the other members in the midst of a trade. The switch to electronic trading has changed all that. As computers have replaced people there not only more profits, but less pugilism. This was not without its difficulties. The Board ran into major problems in the four year period starting in 1994. A massive drop in volume had almost crippled the organization. Computerization was a tough sell, but the chairman convinced everyone after a drop in seat worth from almost a million to a little over a quarter million, and 18000 shares per seat. With this the company had went public and is not printing its own money. By going public they raised the money to buy the computers to do the trading. To show you how much it has saved them, they have spent almost a billion and a half on the systems the last eight years, and margins are still good. They ran into further difficulties when half of its revenue was threatened by a push from a competitor to remove floor traders all together. They were trying to steal the most profitable part of the business so the CME removed the traders to keep up. It saved their one and a half million trades per day. Duffy pushed it through even with stiff competition, and virtually saved the company. The majority of the board hated the idea, but now have conformed. The Euronex Liffe now only trades a small portion of these contracts as the CME made the right move. Then the Chicago Board of Trade was under pressure by the Eurex of Frankfurt to sell. The CBOT made a deal with the CME to move its trades and everyone was happy. Except Frankfurt which filed suit but the fight is long over. Since then the Eurex sold most of its interest to the Man Group. To seal the deal, CME tried to by the CBOT. Even though they were sharing the floor, cultural differences were large. Most of the CME was founded and run by Jews of Northern Chicago, while the CBOT by South Side Irishmen. They fought over profits, and stayed away from the other's areas. It was a type of mutual segregation. The initial purchase was scoffed at by the Chicago Board of Trade, but after they went public they changed their tune. Under a merger they believed they could make things better for everyone by working together. They had six billion reasons to do it. Just when they thought the deal would be done a counter offer by the Intercontinental Exchange. They offered a billion more. The CME went to $11 billion and sealed the deal, keeping the Chicago exchanges together. The Justice Department OK'd the deal. With in the sector, futures traders by far, have the most upside. The consolidation is taking place because of the huge growth in the industry due to getting rid of the human factor. With computers handling all the trades it makes things much faster as deals can be done quicker and increase revenue. The current sell off has made this company a total steal with respect to its intrinsic value. During a bear run like we have, volatility increases. With increased volatility there are more trades and hence more profit. The stock has fallen form 715 to 533. The PE is 35 and forward is 23. The chart shows that this stock is a buy at 630 as this would move it above its 50 day moving average. Their fourth quarter profit doubled. They beat the analysts by 13 cents a share. Revenue is up 88%. Trading volume is up 23%. For this year volumes are up 65% showing that volatile markets are better for business. There are rumors they are also going to buy the Nymex. The five year PEG is just over one and looks very cheap on a growth basis. I would buy this stock as they look to have great growth in an area that consolidation is taking place.