International Securities Exchange
/(ISE - NYSE)
/$67.05
Note: This report contains substantially new material. Subsequent reports will have changes highlighted.
Reason for Report: 3Q07 Earnings update (5/6 brkrs. w. cvrg.); Prev. Ed: October 12, 2007: Estimate changes
Brokers’ Recommendations: Neutral: 100% (5 firms); Positive: 0% (0); Negative: 0% (0); Prev. Ed.:4, 0, 0
Brokers’ Target Price: $67.75 (↔ from last edition; 2 firms) Brokers’ Avg. Expected Return: 1.04%
Recent Events
On November 6, 2007, the Company reported its 3Q07 earnings. Highlights, as per the press release, are given below:
· Net income increased 32.7% to $18.5 million in 3Q07 from $14.0 million in 3Q06.
· Diluted operating EPS was $0.46 in 3Q07 versus $0.35 in 3Q06.
Overview
Analysts have identified the following issues for evaluating the investment merits of ISE:
Key Positive Arguments / Key Negative Arguments· Margins continue to trend higher
· Premium product revenue growth (higher margin) remains above Street expectations
· Increased trading volume and new products.
· ISE’s average net transaction fees earned per contract increased sharply. This will lead to higher revenue growth. / · Market share loss would prevent any material upside to stock
· Strong competitive environment, which is creating pricing pressure
· Weaker equity markets will drive lower volumes.
New York City-based International Securities Exchange Holdings, Inc. (ISE or the Company), through its subsidiaries, operates as an electronic exchange for equity options and related services, a stock exchange and an alternative markets platform in the United States. ISE Stock Exchange, launched in September 2006 with strategic partners, includes an innovative MidPoint Match platform, which offers investors continuous price improvement. ISE's alternative markets business currently consists of an events market trading platform known as Longitude. Longitude's patented and proprietary technology provides a unique pari-mutuel structure for derivatives auctions, which results in greater trading and pricing flexibility for market participants. Currently, ISE is the largest U.S. equity options exchange, and is among the leading options exchanges in the world. It also develops products, such as, options trading based on proprietary sector indexes and market-data related offerings based on data generated by market activity at its exchange. It serves market makers, broker-dealers, investors, and institutions. For more information about ISE, please visit its website at www.iseoptions.com.
Note: The Company’s fiscal year references coincide with the calendar year end.
Revenue
Revenue (stock option exchange business) by segment as compiled by Zacks Research Digest is provided in the table below:
($M) / 3Q06A / 2006A / 1Q07A / 2Q07A / 3Q07A / 4Q07E / 2007E / 2008ETransaction fees / $38.8 / $157.3 / $44.3 / $47.2 / $60.0 / $58.7↑ / $209.0↑ / $244.7↑
Member Fees and Other / $6.9 / $26.4 / $7.2 / $7.0 / $7.5 / $7.5↓ / $29.5↑ / $33.0↑
Market Data / $4.3 / $18.5 / $4.8 / $4.6 / $4.6 / $4.6↓ / $18.4↑ / $20.0↓
Total revenue as compiled by Zacks Research Digest is provided in the table below:
($M) / 3Q06A / 2006A / 1Q07A / 2Q07A / 3Q07A / 4Q07E / 2007E / 2008EDigest High / $50.1 / $202.1 / $56.4 / $59.2 / $72.2 / $70.8↑ / $256.9↑ / $297.7↑
Digest Low / $50.1 / $202.1 / $55.9 / $58.0 / $72.2 / $70.8↑ / $256.9↑ / $297.7↑
Digest Avg. / $50.1 / $202.1 / $56.2 / $58.8 / $72.2 / $70.8↑ / $256.9↑ / $297.2↑
YOY Growth / 29.6% / 18.4% / 15.0% / 44.1% / 32.85% / 27.1% / 15.9%
Sequential Growth / -2.0% / 5.5% / 4.5% / 22.8% / -1.9%
In 3Q07, total consolidated revenue increased 44.8% to $72.2 million from $50.1 million in 3Q06.
Transaction fee increased 54.8% to $60.0 million in 3Q07 from $38.8.0 million in 3Q06. Due to increased trading volumes on options exchange resulting from increased volatility. Member fees and other revenue increased 8.4% to $7.5 million from $6.9 million in 3Q06 due to an increase in connectivity fees, which are charged to market makers based on quote capacity usage. Market data revenue increased 5.7% to $4.6 million from $4.4 million in the same quarter of the previous year due to lower market share of trades.
For more details on individual analyst opinions on revenue, please see the Consensus tab of the ISE spreadsheet.
Margins
As reported by the Company, gross income or total revenue less cost of revenue increased 53.5% to $68.3 million from $44.5 million in 3Q06. Pre-tax income in 3Q07 increased to $32.8 million from $24.6 million last year. Pre-tax margin for the options exchange segment of ISE’s business stood at 45.3% in 3Q07.
Margins as compiled by Zacks Research Digest are shown in the table below:
FY ends Dec / 3Q06A / 2006A / 1Q07A / 2Q07A / 3Q07A / 4Q07E / 2007E / 2008EGross Margin / 88.8% / 88.4% / 89.7% / 94.6% / 94.6% / 94.4%↑ / 93.7%↑ / 94.0%↑
Operating Margin / 43.9% / 44.5% / 44.5% / 45.4% / 41.0% / 56.4% / 46.7% / 53.3%
Pre-tax Margin / 49.0% / 49.0% / 52.5% / 51.8% / 45.8% / 61.3%↑ / 51.7%↓ / 58.8%↑
Net Margin / 28.0% / 27.8% / 29.7% / 28.2% / 25.6%↑ / 34.9%↑ / 29.1%↑ / 33.1%↑
According to the Company, total direct expenses in 3Q07 increased to $38.7 million from $22.4 million in 3Q06. Compensation and benefits expenses increased 119.9% to $26.1 million in 3Q07 from $11.9 million in 3Q06, due to higher incentive compensation expenses resulting from increased profitability and increased headcount. Technology and communications expenses increased 4.2% to $4.3 million in 3Q07 from $4.1 million in 3Q06 due to increased capacity costs attributable to increased quoting activity and enhancements for the Company’s trading system. Professional fees increased 97.7% to $2.8 million in 3Q07 from $1.4 million in 3Q06 due to the increased legal fees. Marketing and business development expenses decreased 6.4% to $0.7 million in 3Q07 from $0.8 million in 3Q06 due to the timing of marketing programs. Depreciation and amortization increased 3.6% to $1.7million in 3Q07 from $1.7 million in 3Q06. Other expenses increased 43.9% to $1.6 million from $1.1 million last year.
For more details on individual analyst opinions on margins, please see the Consensus tab of the ISE spreadsheet.
Earnings per Share
The Company reported 3Q07 GAAP EPS of $0.46, up 31.42% y/y from $0.35 in the same quarter last year.
EPS as compiled by Zacks Research Digest are shown in the table below:
FY ends Dec / 3Q06A / 2006A / 1Q07A / 2Q07A / 3Q07A / 4Q07E / 2007E / 2008EDigest High / $0.35 / $1.43 / $0.42 / $0.45 / $0.62 / $0.63↑ / $2.11↑ / $2.43↑
Digest Low / $0.35 / $1.38 / $0.42 / $0.45 / $0.62 / $0.47 / $1.94↑ / $2.11
Digest Avg. / $0.35 / $1.41 / $0.42 / $0.45 / $0.62↑ / $0.55↑ / $2.01↑ / $2.29↑
Digest YoY growth / 47.2% / 31.3% / 28.7% / 77.1% / 36.8%↑ / 42.1%↑ / 14.2%↓
Sequential Growth / 0.0% / 3.7% / 7.3% / 37.6% / -10.6%↓
Zacks Consensus / $0.52 / $1.94 / $2.23
Highlights from the above chart are as follows:
· 2007 forecasts (total 5) range from $1.94 (Buckingham) to $2.11 (Fox-Pitt); the average is $2.01
· 2008 forecasts (total 5) range from $2.11 (Sandler) to $2.43 (Buckingham, UnionBankSwitz); the average is $2.29.
Firms increased their 2007 EPS estimates, primarily based on the strong 3Q07 results and higher transaction fees growth. One brokerage firm (Buckingham) raised its 2007 EPS estimates to reflect record transaction fees and lower than expected licensing and activity remittance fees. The firm increased its 2007 EPS estimate to $1.85 from $1.94, and its 2008 EPS estimate to $2.25 from $2.40.
For more details on individual analyst opinions, please see the EPS tab of the ISE spreadsheet.
Target Price/Valuation
Of the 5 analysts covering ISE, all have conferred Neutral rating on the stock. Target price for ISE ranges from $67.50 (0.67% upside from the current price) (Sandler, UnionBankSwitz) to $68.00 (1.42% upside from the current price) (BMO Capital, Fox-Pitt), with an average of $67.75 (1.04% upside from the current price).
Rating DistributionPositive / 0%
Neutral / 100%
Negative / 0%
Avg. Target Price / $67.75
Digest High / $68.00
Digest Low / $67.50
Number of Analysts / 5
Number of Analysts with Target Price / 4
Risk to target prices includes a severe downturn in the options market, which would have a severe impact on the Company’s business resulting in reduced trading activity and lower operating efficiency for the Company. The Company also faces possible pricing pressure on execution fees due to competition and the ongoing move to penny quoting. Apart from these, the Company’s venture into new product classes may also prove more challenging than anticipated.
Metrics detailing current management effectiveness are as follows:
Metric (TTM) / ISE / Industry / S&P 500Return on Assets (ROA) / 16.90%↑ / 6.65% / 8.75%↑
Return on Investments (ROI) / 19.95%↓ / 11.51%↓ / 12.79%↑
Return on Equity (ROE) / 23.63%↓ / 21.89%↓ / 21.67%↑
ROA, ROI, and ROE are higher than the overall market averages as measured by the S&P 500.
For more details on individual analyst opinions on valuation, please see the Consensus tab of the ISE spreadsheet.
Capital Structure/Solvency/Cash Flow/Governance/Other
Financial Position
On September30, 2007, ISE’s total assets were $446.9 million versus $396.4 million, and total liabilities were $92.9 million versus $101.8 million as of December31, 2006.
The Company has recorded $30.8 million of minority interest representing minority stockholder’s interest in ISE Stock Exchange as of September30, 2007.
Acquisition by Deutsche Boerse:
On April 30, 2007, ISE and Deutsche Boerse (DB) announced they have reached a definitive agreement for DB to acquire ISE for $67.50 per share in cash. The transaction will be implemented by way of a merger, and has been approved by the holders of a simple majority of ISE outstanding common stock at a special shareholder meeting held on July 27, 2007. The transaction is expected to close in 4Q07.
Reorganization:
The Company completed its reorganization on September1, 2006. As part of the restructuring, the International Securities Exchange, Inc. (“ISE Inc.”) merged into ISE. Then a newly formed entity and a wholly-owned subsidiary of ISE Holdings. As a result of this merger, the shares of common stock of ISE Inc. were converted into shares of common stock of ISE Holdings and shares of ISE Inc. Class B memberships were converted into trading and voting rights granted under ISE.
Potentially Severe Problems
There are none other than those discussed in other sections of this report.
Long-Term Growth
One analyst (Buckingham) expects the long term growth rate to be 31.9%. According to the Company, its most immediate growth opportunities lie with institutional investors, index options, international partnerships, and information and data services. Additionally, the Company is also considering introducing credit derivatives.
Analysts expect ISE’s growth to be facilitated by continued favorable secular trends as well as organic initiatives aimed at increasing the Company’s presence in the derivatives market and potential expansion overseas.
Going forward, management sees opportunity to benefit from the new rules around portfolio margining, which considers a customer’s holding holistically when determining margin requirements, instead of on a security-by-security basis. ISE also expects to reach agreements on alliances or other joint ventures with international partners in the coming year.
Upcoming Events
On February 5, 2008, ISE is expected to release its 4Q07 earnings.
Individual Analyst Opinions
POSITIVE RATINGS (0.0%)
None
NEUTRAL RATINGS (100.0%)
BMO Capital – Market Perform ($68.00) – 11/07/07: The firm has maintained a Market Perform rating and a target price of $68. INVESTMENT SUMMARY: The analyst has derived its target price based on Deutche Boerse’s cash purchase price for the Company.
Buckingham – Neutral – 11/06/07. The firm has maintained a Neutral rating. INVESTMENT SUMMARY: The firm is of the opinion that ISE shares no longer trade on fundamentals following the Company’s acceptance of the $2.8 billion take out offer from Deutche Boerse. The firm has maintained its Neutral rating with a view that ISE’s stocks will offer limited upside to its take-out price.
Fox-Pitt– In-Line ($68.00) – 11/06/07: The firm has maintained an In-Line rating and a target price of $68.
Sandler – Hold ($67.50) – 11/06/07: The firm has maintained a Hold rating and a target price of $67.50 based on the proposed merger price in cash from Deutche Boerse.
UnionBankSwitz – Neutral ($67.50) – 11/06/07: The firm has maintained a Neutral rating and a target price of $67.50
NEGATIVE RATINGS (0.0%)
None
Research Associate: Bishwaranjan Roy
Copy Editor: Oindrila Banerjee
Content Ed.: Swati Chamaria
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