BATS' core business solid, future growth uncertain

BOSTON/NEW YORK Mon Mar 26, 2012 7:48pm EDT

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BOSTON/NEW YORK (Reuters) - Orders flowed normally through BATS Global Markets on Monday, sending a sigh of relief that the core trading business of the nation's third-largest stock exchange remains on track despite a high-profile trading snarl on Friday.

Questions remained, however, about whether BATS can move ahead with its plans to make acquisitions, provide primary listings for companies and expand abroad after the company was forced to pull its own initial public offering late Friday.

If traders feared a meltdown on the BATS exchange Monday, they didn't show it. Trading volume in BATS' bread-and-butter business of executing stock and equity-option trades was virtually unchanged from levels before Friday's hiccup.

It appeared unlikely that the other parts of the company's business plan would recover so quickly. BATS had been holding introductory talks with chief financial officers and heads of investor relations from several dozen companies about listing on its exchange, BATS spokesperson Randy Williams said.

While BATS didn't have companies in its immediate IPO pipeline, the botched IPO probably will deter companies from listing on the exchange, even at the cut-rate prices BATS charges. That would prevent it from stealing business from rivals Nasdaq and the New York Stock Exchange.

"What company will risk their IPO going to BATS?" said Diego Perfumo, an analyst with Equity Research Desk. "Who is going to take that risk?"

Similarly, the incident could derail plans for BATS to make more strategic acquisitions. Its own IPO was not going to raise significant cash for the company. But having public shares would have helped it finance deals.

Another relief for the company: Regulators didn't see Friday's debacle as a major catastrophe or an issue of ongoing concern, such as was the case for the May 2010 "flash crash." In contrast with that sharp plunge in share values, which vaporized nearly $1 trillion in market capitalization in minutes, what happened in this mini-crash appeared to be much clearer and posed no lingering issues for regulators.

Regulators plan to examine the BATS incident in more detail, but they don't at present see it connecting to other issues that they are investigating, such as high-frequency and algorithmic trading.

"Although the effects of Friday's technical problem at BATS were contained, and do not appear to raise the broader types of market structure concerns associated with the May 6 flash crash, staff is continuing to review the incident," U.S. Securities and Exchange Commission spokesman John Nester said.

That leaves BATS, based in Lenexa, Kansas, with its trading business and the possibility of getting back on track in the months ahead.

Since its founding in 2005, the company has grown quickly with a strategy that takes a page out of Amazon.com's play book. BATS' computers constantly scan the market, dynamically changing the fees charged and rebates offered to trade in each different stock and attract traders by offering the most competitive prices.

And just like Amazon, BATS has been willing to sacrifice profits by offering occasional deals to trade hot stocks, betting that new customers who come for the bargains will stick around for the long haul.

With the high-tech pricing model still in place, BATS disastrous attempt to list its own IPO as a way to kick-start a new listings business has not reduced the appeal of its popular trading platform, market participants said.

"Most transactions are routed electronically. There are not too many humans pushing buttons to go to BATS," said Larry Tabb, chief executive of capital markets research firm TABB Group. "The reliability and speed of their platform is good."

BATS' main business, the source of about 90 percent of its revenue, is trading U.S. securities listed on major exchanges such as the New York Stock Exchange and Nasdaq. In February, BATS captured nearly 11 percent of the market share for trading U.S. stocks and was the largest European equities market operator by overall value traded. It plans to move ahead with that expansion.

The problems that hit BATS' IPO, whose price dropped to pennies a share because of a software bug, would not affect the sophisticated traders who rely on the firm's trading platform.

"We have control over price execution because we always use limit orders so we are not worried," said Paul Weisbruch, vice president of ETF/Options sales and trading at Street One Financial, an ETF trade execution firm.

BATS' future growth plans, however, partly hinged on winning new listings for its own two U.S. stock exchanges.

The company likely is targeting smaller, more price sensitive companies for its listing business, analysts said, offering annual fees of $20,000 to $35,000 for companies whose stock trades fewer than 2 million shares per day. Bigger issuers will not be charged an annual fee. That compares with $38,000 to $500,000 a year on the NYSE and $35,000 to $99,500 a year on the Nasdaq.

"Anyone who is cost sensitive will evaluate BATS, but then again you don't get the prestige of a NYSE or a Nasdaq," said Adam Honoré, research director of the institutional securities practice at Aite Group. "There's a cost to that too."

Several of the companies BATS held preliminary talks with about listing were from the Kansas City area, where the exchange is located, BATS' Williams said.

"It would make sense for them if they really want to target company listings to possibly start in their own backyard first and build up a portfolio before they expand," said John Hense, managing director at Kansas City-based CC Capital Advisors, which is not working with BATS.

BATS may also be eyeing technology companies as potential issuers on its exchange as it has tried to market itself as a technology firm that forced the NYSE and Nasdaq to modernize their own platforms, said an underwriter.

BATS started operating a primary listings platform earlier this year on which BlackRock listed eight iShares ETFs.

"We want to bring more ETFs and some corporate issuers but we understand, particularly from corporate issuers, we have some work to prove ourselves to them," said BATS' Williams.

But fumbling its own IPO probably will make it harder to attract other IPO business.

"They were their own guinea pig and they failed," Tabb said.

It is unclear when BATS might try to go public again. BATS co-founder and board member Dave Cummings said Sunday it should aim for a listing in the second quarter. But its CEO, Joe Ratterman, didn't offer any time table.

Tabb said BATS should try to win an IPO listing from another company with the promise of putting a big marketing and advertising push behind it.

BATS' other growth initiatives include acquisitions, entering new markets, such as Brazil and Canada, and expanding into new asset classes, possibly trading U.S. Treasury bonds. It aims to enter at least two new markets by the end of 2014.

BATS' operations last year generated $48.2 million in net cash. At the end of 2011, BATS reported $254.2 million in cash and cash equivalents and financial investments.

Distractions from the IPO setback could delay BATS' pending strategic investments, Tabb said. "Rivals could scoop up any acquisition BATS may have been looking at," he said.

(Reporting By Tim McLaughlin, Olivia Oran and Sarah Lynch; Additional reporting by John McCrank and Jessica Toonkel; Editing by Aaron Pressman, Alwyn Scott.)

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