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Updated Research Report on ICE Group

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On May 14, we issued an updated research report on IntercontinentalExchange Group Inc. (ICE - Free Report) , also known as ICE Group. While the company’s strategic acquisitions and alliances are generating incremental revenues and long-term cost synergies, risks from higher debt, operating and capital costs amid regulatory challenges raise concerns.

Notably, this Zacks Rank #3 (Hold) stock delivered positive earnings surprises in 3 of the last 4 quarters with an average beat of 3.0%. The company’s first-quarter earnings also outpaced the year-ago quarter figure by about 28% and in line with the Zacks Consensus Estimate.

Opportunities for Long-Term Growth

ICE Group has been boosting efficiencies through strategic acquisitions, product novelty and expansion in emerging markets. The acquisition of NYSE Euronext in Nov 2013 has boosted ICE Group’s position as the second-largest global exchangegroup. Management also projects run-rate expense synergies of about $500 million, 40% of which has already been achieved so far, while 70% is likely to be earned by 2014-end and more than 90% by 2015-end. The planned initial public offering (IPO) of Euronext platform next month should further boost operating leverage and financials.

Further, the acquisition of SMX in Feb 2014 has enabled direct and swift entry in the rapidly growing financial hub of Asia, which would otherwise have taken the company 2 to 3 years. The latest revenue sharing agreement with LCH.Clearnet in Apr 2014 further enhances revenue sources.

Moreover, despite cash outlays, ICE Group holds decent liquidity with strong operating cash flow growth that accelerated at a CAGR of 20% for 2008–2012, followed by flat growth in 2013 and 246% year over year growth in first-quarter 2014.

Risks Ahead

However, one cannot overlook the sluggish volumes scenario that weakened significantly from historical highs to 1% growth in 2013 followed by 13% decline in both first-quarter 2014 and Apr 2014. Additionally, ICE Group has witnessed a rise in expenses, escalating at a CAGR of 16.4% for 2009–2013 followed by a 244% upsurge in first-quarter 2014.Management’s raised operating and capital expense guidance in 2014 further reflect higher operating, capital, debt and acquisition-related costs in the upcoming quarters.

Alongside, intense competition from global exchanges and regulatory compliances in both the U.S. and Europe pose operational and financial risks.Management also projected an increase in liquid regulatory capital requirements by $140 –150 million, as the European Market Infrastructure Regulation (EMIR) becomes effective in 2014.

Overall, an adverse risk-reward balance in the near term has led to negative estimate revisions for 2014 and 2015. As a result, the Zacks Consensus Estimate for 2014 and 2015 moved south by 5.9% and 4.7% to $10.35 and $12.80 per share, respectively, in the last 7 days post earnings the release.

Key Picks in the Sector

While we remain at the periphery with regard to ICE Group at present, better-ranked stocks in the financial sector like Ladder Capital Corp. (LADR - Free Report) , Euronet Worldwide Inc. (EEFT - Free Report) and Hallmark Financial Services Inc. (HALL - Free Report) are worth considering. All these stocks sport a Zacks Rank #1 (Strong Buy).

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