Many analysts have laid bets on the likelihood that TSX Group Inc. finally will succeed in its ambition to acquire the Montreal Exchange Inc., now that the ME has announced plans to go public. But some observers suggest the ME may, in fact, become the hunter rather than the hunted. They suggest it may use its newly public shares as currency to go after second-tier U.S. exchanges.

Brendan Caldwell, CEO of Toronto-based Caldwell In-vestment Management Ltd. , says ME CEO Luc Bertrand isn’t sounding like a man wanting to do a deal with the TSX, although a takeover by the larger Toronto exchange is clearly a possibility.

Caldwell suggests the ME has its eye on secondary U.S. exchanges such as the Boston Stock Exchange or the Philadelphia Stock Exchange. The ME has a long-standing relationship with the Boston exchange and is its partner in the fast-growing Boston Options Exchange.

“Everyone thinks of the ME as being an acquisition target,” says Caldwell, whose firm purchased 100,000 ME shares in a private transaction in November. “No one is thinking of it as an aggressive expander in this space.”

Peter Dlouhy, a partner at Montreal-based Lester Asset Management Inc. , agrees the ME could become an acquirer, noting the large gap between the valuations of derivatives-based exchanges compared with traditional stock exchanges.

“It’s a reasonable proposition, given the higher valuations of non-traditional exchanges,” says Dlouhy, whose family owns ME shares.

Exchanges such as the ME that trade futures and options are in particularly high demand because they are in the fastest-growing segment of the industry. At least one brokerage analyst put the value of a publicly traded ME at $1 billion, almost double what the shares have been trading at in recent private transactions.

However, ME spokesman Jean-Charles Robillard says the ME’s focus is currently on continuing to grow the exchange organically.

And, he notes, exchanges aren’t cheap: “Look at what’s in the market. It’s very expensive, and I’m not sure there’s much choice.”

Bertrand has resisted TSX overtures in the past and he wasn’t sounding any more enthusiastic after the ME’s board decided on Nov. 30 to list the company’s shares publicly this spring.

“There’s no relationship whatsoever,” Bertrand bluntly replied when asked about possible merger talks. “Listing doesn’t mean you’re putting up a ‘for sale’ sign,” he told reporters during a conference call the day after the board meeting.

Bertrand has been under pressure from shareholders to take the fast-growing ME public. They have watched the value of exchanges soar amid a consolidation wave. The ME is privately owned by 307 shareholders, including investment dealers, banks, investment counsellors and individuals. The three largest shareholders, with almost 10% each, are National Bank of Canada, Swiss bank UBS and the Caisse de d»pŸt et placement du Qu»bec. Exchange employees own about 14% of the shares.

During the conference call, Bertrand said the time is right for the ME to go public: “The decision was based on the fact that the exchange has reached what we believe is a level of maturity that is a natural course to proceed with a listing.

“There’s a good window here to proceed,” he added. “Our sense is that there is continued strong demand from investors for the sector.”

Just a couple of weeks earlier, Bertrand seemed in no hurry to take the ME public, despite pressure from some shareholders. Many observers believe he wanted to hold out until the value of the exchange grew even higher.

The ME’s trading volume has surged by an average of 25% a year over the past five years and average trading volumes are up 43% this year. As a result, the exchange is flush with cash. The board declared a $1.50-a-share special dividend, the third special dividend in less than a year.

The exchange will be listing its existing 9.3 million shares for public trading, but will not be raising money through an offering of new shares. Bertrand says the exchange is generating more than enough cash to fund its operations and capital-expenditure needs. He says no decision has been made yet on where the ME’s shares will trade.

In private transactions, ME shares have moved up to about $60 each from $17 in June 2005. At $60 a share, the exchange would have a market value of about $560 million. Analysts say the ME will be worth much more as a public company.

@page_break@John Aiken, a Dundee Securities Corp. analyst in Toronto, says the ME could end up with a market capitalization of more than $1 billion, based on valuations being paid for other derivatives exchanges. At such a high price, he says, a TSX takeover of the ME would be dilutive to earnings. That increases the likelihood that the ME “would stay independent in the interim.”

Jason Donville, analyst with Toronto-based Sprott Securities Inc. , pegs the value of a publicly traded ME at $835 million. He says ME shareholders will be looking to sell as they see the non-compete agreement with the TSX coming to an end. On the other side, the TSX needs exposure to derivatives.

“We believe the TSX will do everything it can to buy the ME,” he says.

There is a significant obstacle to any bidder for the ME. Under the bylaws of the exchange, no single shareholder can own more than 10% of the shares. Any change in that rule would require the approval of Quebec’s securities regulator, effectively giving the Quebec government a veto over any takeover of the ME.

Analysts tend to play down this issue, but the Quebec government has intervened in the exchange’s business before. In 1999, the former Parti Qu»b»cois government unsuccessfully attempted to block the reorganization agreement between the ME and the country’s other exchanges.

The ME has turned into an outstanding success story, and the Quebec government will, at the least, want assurances it will continue to grow in Montreal.

In the nine months ended Sept. 30, the ME’s earnings increased 37% to $17.3 million on revenue of $59.7 million. For the year ended Dec. 31, 2005, the ME’s profit was up 69% to $15.1 million on revenue of $63.2 million. IE