Dual Structure Would Work for Philly

Is the Philly in play?

Meyer “Sandy” Frucher, chairman and chief executive of the Philadelphia Stock Exchange, is keeping mum on reported merger talks with Nasdaq. But he makes no secret of the fact that a deal with another self-regulatory organization is in the best interest of the PHLX.

“If you want to broaden your market share,” Frucher told journalists during a press luncheon at the annual Options Industry Conference in San Antonio, “you need multiple market structures.”

A dual structure could result from any merger of the Philly’s options trading business with Nasdaq. The possibility of such a deal was first reported by the Wall Street Journal in April.

Philly’s options business, its primary operation, employs a specialist model that rewards specialists posting the best quotes with a large chunk of any incoming order.

That pro-rata model contrasts with Nasdaq’s stock trading model, which involves multiple market makers paying to take liquidity and getting paid to provide it. Nasdaq, which has promised to enter the options business later this year, is expected to deploy that maker-taker model on the options side as well.

Frucher told the assembled journalists that the Philly had held talks with the European derivatives exchange Eurex five years ago about a possible merger.

The merged organization would have operated two electronic books. Frucher said the Securities and Exchange Commission objected to the plan, stating that it would only allow one book under one exchange.

Now, Frucher points out, the regulator would tolerate two separate trading platforms under two related self-regulatory organizations. “I can see maker-taker and pro-rata side by side,” Frucher said, “with two SROs.”

So how much is the Philly worth? Some sources say $300 million, but a PHLX shareholder claims the relevant price is more than double that.

Chuck Sorsby, president of Chicago-based Sorsby Financial, which invests in exchanges and owns a piece of the Philly, says the exchange has a market cap of $552 million. That’s based on 441,504 shares outstanding at $1,250 a share.

Taking the price-earnings ratio of the publicly traded International Stock Exchange as a guide, Sorsby says the Philly is worth between $694 million and $867 million. The ISE is trading at 34.7 times earnings, and the Philly’s projected 2007 earnings are between $20 million and $25 million.

Another source maintains that’s too much to pay. He says Nasdaq would be better off starting its own exchange from scratch instead of purchasing one. The main reason is that there isn’t any barrier to entry and that any exchange can trade almost all options products. “It’s not a big deal to create an options ECN,” he says. “What does the Philly have that’s unique? They don’t control their pricing and they don’t control their product.” In his view, the Chicago Mercantile Exchange is the only exchange worthy of its high valuation because it has proprietary products and clears its own trades.