BATS makes more sense for TMX than Direct Edge

A couple of months ago a rumour shot around that TMX Group Ltd. was kicking tires on Direct Edge, a U.S. stock market operator. Here's an idea: buy BATS Global Markets instead.

Direct Edge would open up opportunities to get into the U.S., and Direct Edge's owners have been looking for ways to cash out, as the Wall Street Journal reported a couple of months ago when it broke news of talks with TMX. The Journal reported that discussions between TMX and Direct Edge were unlikely to come to fruition until the Maple takeover of TMX had cleared all hurdles, which it finally has with the last major approvals coming Thursday.

TMX would be looking at Direct Edge as a way to ramp up in the U.S. Direct Edge is fourth-largest stock market operator in the U.S., with a focus on high-frequency traders and the ability to become a full-fledged exchange. But that's about all you get.

BATS is a more intriguing platform. It's bigger in the U.S., ranking No. 3. It's also huge in Europe, after a recent acquisition there. With 25 per cent market share, it's the biggest pan-European stock trading system. That has to be compelling, especially if the TMX brain trust still believes any of the lines it put forward when it was pitching how great it would be to merge with the London Stock Exchange Plc to reach into Europe.

BATS' owners are also looking to take cash off the table. BATS planned an initial public offering in spring that would have valued the company at close to $800-million (U.S.). However, BATS was forced to pull the IPO when its own system crashed while doing the trading, giving the company's reputation a beating. Given that, and the way BATS stock traded in the hours before the IPO was yanked, the price could well be lower today.

Direct Edge would likely be a bit cheaper because of its smaller reach and market share. The Journal pointed out that in 2008 it was valued at almost $400-million. (U.S.)

On the surface, neither is a huge bite for a company like TMX, with a market capitalization of about $3.7-billion (Canadian). That said, TMX is going to have a stretched balance sheet in the wake of the takeover of most of the company by the bank and pension fund backed Maple Group. That deal involved a lot of borrowed money, and left many with the impression that TMX would not be able to do deals any time soon and as a result would be stuck milking the Canadian market.

If the new-look TMX wants to dispel that notion by buying a foreign player, and is willing to reach to do it, BATS might be money better spent.

As for financing, a deal could be done in stock. The big new shareholders could also fund a cash deal through new loans from the banks in the Maple Group, or perhaps a stock offering backstopped by the group's members.