On Feb. 10, 2010, the CME Group—a derivatives exchange giant that operates the Chicago Mercantile Exchange, the Chicago Board of Trade and the New York Mercantile Exchange—entered into a definitive agreement to purchase Dow Jones Indexes in a deal valuing the company at $670 million.
The deal is structured as a joint venture, with CME Group taking a 90 percent ownership stake while Dow Jones retains a 10 percent ownership interest. The joint venture will own the index business and will have long-term license rights to the Dow Jones brand names, including the Dow Jones Industrial Average. Dow Jones itself will, however, retain ownership of the brands and trademarks.
Dow Jones’ parent company, News Corp., had been shopping the index company actively ever since it acquired Dow Jones in August 2007 as a means of gaining control of the crown jewel of the company: the Wall Street Journal. The indexing business, while profitable and growing, was never a good strategic fit for the News Corp. empire.
But while News Corp.’s incentive to sell the indexing business was clear, CME Group’s reason for purchasing the group remains a topic of debate in the index community. Why would the derivatives exchange giant want to get into the indexing business?
Reason No. 1: A Leveraged Buyout
First and foremost, the fundamental structure of this deal is a win-win: The terms of the deal were favorable to both sides.
Dow Jones wanted to divest from the business and raise cash, and in this it succeeded: As part of the deal, CME paid Dow Jones $607.5 million in cash. To sweeten the deal, Dow Jones retained rights to trademarks like the Dow Jones Industrial Average, and its editors will continue to maintain the headline index: a nice perk that puts them in a considerable position of power (and retains the editorial integrity of the index). In essence, Dow Jones managed to retain all the news value of the index business while monetizing the investable index side.
From CME’s perspective, things are a bit different. CME isn’t actually shelling out $607.5 million in cash. Instead, the new joint venture is issuing $613 million in debt, which will be used to pay Dow Jones. CME Group is guaranteeing that debt, but it lives on the books of the joint venture.
Interest rates on the debt are at 4.4 percent, and free cash flow from the venture should more than cover the annual interest payments. According to materials distributed by CME Group in the wake of the merger, Dow Jones Indexes posted $75 million in revenues in 2009, with a 61 percent EBITDA margin, suggesting free cash flow before interest, taxes, depreciation and amortization of $46 million. Debt service costs are estimated at $27 million.
And thus, just like a first-time home buyer, CME Group is acquiring the business at very little up-front cost by financing the asset.
Reason No. 2: The Business Case
The second, and most fundamental, reason that CME Group was interested in the Dow Jones Indexes purchase was that it is fundamentally a good business.
As mentioned, the company’s 2009 revenues were $75 million, putting the purchase price at a healthy 8.9 times revenues. The reason the payout was so healthy was that revenue and profits at Dow Jones Indexes have been growing.
Riding a boom in exchange-traded fund assets and institutional benchmarking, Dow Jones Indexes revenues have grown at a 16 percent compound annual growth rate over the past four years—a period that included the financial crisis of 2008-2009. If you exclude the worst of that crisis, and only look from 2006-2008, revenues grew at a 28 percent CAGR.
With that kind of growth, and with what CME describes as “relatively fixed, scalable costs,” it’s no wonder CME Group jumped at the deal.
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