CHICAGO/KANSAS CITY, Missouri (Reuters) - CME Group Inc (CME.O) on Wednesday agreed to buy the Kansas City Board of Trade for $126 million in cash, cementing CME's dominance in world grain futures markets and keeping rival IntercontinentalExchange (ICE.N) from gaining an important foothold.
It is CME's first exchange purchase in five years since it wrapped up a buying spree that put the Chicago Mercantile Exchange, the Chicago Board of Trade and the energy-focused New York Mercantile Exchange all under its control.
The deal comes as the Chicago-based giant faces one of the biggest challenges yet to its benchmark wheat, soybean and corn contracts: ICE's renewed efforts to build its agricultural markets business, including the launch this year of look-alike U.S. grain futures that opened a new front in the decade-long battle for commodity derivatives dominance.
So far, ICE's copycat contracts of ICE's electronic exchange have garnered little volume. But CME has responded swiftly to protect its lucrative grains franchise, a mainstay of global markets for decades, expanding trading hours to keep step with ICE in a move some floor traders have protested.
In Kansas City, a dozen or so traders, many clutching the electronic pads now used to execute most trades, gathered on the red and blue steps of Kansas City's modest trading floor to watch a single lot of the exchange's hard red winter wheat futures contract trade the old-fashioned way, with cries and hand gestures, rueing the likely closure of the pit next year.
And at the Minneapolis Grains Exchange (MGEX), which shut its futures floor four years ago, dealers speculated that it was only a matter of time before ICE made a bid for the last independently owned U.S. agricultural marketplace.
"The CME is taking an aggressive stance to firmly establish itself as the world leader in exchange-traded products, so this isn't a surprise," said Ken Smithmier, market analyst for The Hightower Report, a Chicago-based research and advisory firm.
But one thing did surprise him: "I thought Minneapolis would be the first to be gobbled up."
CME beat out several rivals before clinching the deal, KCBT President Jeff Borchardt told reporters on a conference call.
He did not name the other bidders, but most traders believe ICE was a leading contender. In 2007, ICE lost out to CME in a bidding war for the CBOT.
The deal will be a windfall for the owners of 192 seats on the Kansas City Board of Trade, with the CME paying as much as a 47 percent premium over their collective value, estimates Thomas Caldwell, CEO of Toronto-based Caldwell Asset Management, which owns 13 seats.
KCBT seats trade in a private market, with one membership recently fetching $480,000. CME's $126 million purchase price values each seat at $656,000. KCBT will also pay a dividend that Caldwell estimates will be $30,000 to $50,000 each.
Several traders gathered in the storied KCBT wheat pit on Wednesday for the closing bell, with many laughing and alternately cursing when only one lot of a December/March spread traded in the open outcry auction while the rest of the action took place off the floor via computers.
"It was inevitable," options trader Markus Groebner said on the KCBT floor. "It is a sign of the times. That is what it is."
Many on the floor were downcast, fearing lost jobs and lost tradition.
The deal will bolster volume in both CME's and KCBT's wheat contracts and provide new trading opportunities, CME Executive Chairman Terrence Duffy said. Soon to be added are options on spreads between the two contracts, CME's top commodities executive told reporters.
Kansas City's wheat contract is for "hard red winter" wheat, a variety that is grown on twice as much U.S. farmland as Chicago's "soft red winter" brand - but which has long lagged behind its more liquid rival in terms of volume.
Soft red winter wheat is used primarily to make cakes; hard red winter wheat for rolls.
Traders said that CBOT's contracts, which are a global benchmark, offer the best approximation of all the different types of wheat varieties that are grown around the world.
In September, CBOT wheat volume rose 5 percent from last year to some 1.5 million contracts, while KCBT's turnover fell more than 30 percent to under 290,000 lots. Current open interest in CBOT wheat is 462,288 contracts, nearly three times as big as KCBT wheat's open interest of 158,180 contracts.
The Minneapolis futures contract is based on a third variety, spring wheat, that is also a major North American crop - but futures trading is even less active than in Kansas City. Unlike the KCBT or CBOT, MGEX wheat is only traded electronically. Both exchanges already use CME's trading platform.
Spring wheat is used for pizza dough.
MGEX President and CEO Mark Bagan declined to comment on any possible merger talks, but said that his exchange will evaluate all opportunities.
News of the acquisition sparked speculation that the Minneapolis Grain Exchange could now be in line for a bid.
An ICE spokeswoman declined to comment on whether it had been in talks with KCBT or was in talks to buy the Minneapolis Grain Exchange.
Some traders said a deal seemed inevitable.
"You would think that MGEX would look like a ripe target for some type of merger or acquisition, if nothing else because we are essentially a North American spring wheat contract, and the combined North American spring wheat is huge, even bigger than the U.S. hard red winter wheat crop," Austin Damiani, an analyst at Frontier Futures in Minneapolis, said, referring to combined U.S. and Canadian wheat production.
Asked about the possibility of a bid for MGEX, a CME spokesman said: "We remain focused on completing this transaction, as we believe it will create significant value for customers and shareholders of both companies."
Caldwell, who owns 37 MGEX seats in addition to his KCBT seats, was dismissive of the suggestion that Minneapolis might be next, calling management there "myopic," and adding, "we're pretty annoyed at the bunch."
CME's purchase is expected to close later this year, subject to approval by KCBT shareholders and regulators.
The KCBT will make a special distribution of excess cash to members when the deal closes, CME said in announcing the deal. A KCBT official declined to give a figure, but said it would be substantial.
CME shares closed up 40 cents to end the day at $57.89 on the Nasdaq. ICE's stock dropped 83 cents to $130.59 on the New York Stock Exchange.
As part of the deal, CME has agreed to keep the Kansas City market's trading floor open for at least six months.
CME's Duffy noted that CME has kept its Chicago trading floor open for much longer than many observers had expected and said there were no set plans to shut the floor if it still provides value.
The trading floor at the KCBT is a fraction of the size of Chicago's. Until just a few years ago it was buzzing and bustling, packed with frenetic traders, who fought their way in and out of the packed circular pit.
Trading floor lore includes the story of an old-time trader who suffered a heart attack in the midst of a particularly busy trading session. He was attended to, but the pit action barely paused as fellow traders took orders out of his pockets and continued shouting and gesticulating to make sure his trades got filled.
One trader, who has been trading wheat futures since 1978, said the buyout by CME marks the end of an era.
"The floor used to be vibrant," he said. "Now, it is nothing in terms of volume. That is a sad thing to me. I'm not adverse to change. And I do most of my stuff on the screen now anyway. But we've got 156 years of history here. It's sad to lose that."
Additional reporting by Samuel Nelson, Chris Stebbins, Julie Ingwersen and Mark Weinraub in Chicago and Carey Gillam in Kansas City; Editing by Chizu Nomiyama, John Wallace, David Gregorio, Leslie Adler and Leslie Gevirtz