“Facebook defriending NASDAQ “was a headline displayed on CNBC’s morning program, a few days after the poorly executed Facebook (NASDAQ: FB) IPO that was fraught with technical problems (read more on if Facebook is a Good Investment Now?). Now the question for the exchanges is will the NASDAQ see a move toward its main competitor, the New York Stock Exchange (NYSE)? The exchanges have been undergoing a period of consolidation as competitive pressures from the likes of high frequency traders force stock exchanges to be more diversified and technologically advanced. In the past, the NASDAQ has been the go-to for tech companies looking to go public. However, NYSE, owned by NYSE Euronext (NYSE: NYSE), was quick to point out that it listed 13 new tech IPOs in Q1 (~59% of tech IPOs). Though NYSE listed Yelp, Millennial Media, and Vantiv, NASDAQ landed the high profile names Groupon, LinkedIn, and Zynga.
We take a closer look at the two dominant stock exchanges below:
NASDAQ OMX Group (NASDAQ: NASD) has seen volatility after the technical glitches that occurred during the FB IPO. The situation surrounding the trading glitch is still unclear and regardless of whether or not the NASDAQ is at fault, we believe the smart thing for the company to do is just put this episode behind it as fast as possible. Although NASDAQ’s legal liability is only $3 million, we think that NASDAQ’s Board will be willing to provide much more compensation to negatively affected parties.
While the size of the claim pool has not been decided, industry participants have indicated that $100 million is not out of the question. Should it come to sizable settlement, NASDAQ can access ~$1 billion in immediate liquidity, $624 million available on its revolving credit facility, and $339 million of cash (as of Q1). We think share repurchases would be paused in this scenario ($150 million remaining share repurchase authorized). We think that NASDAQ’s board will choose to pursue a make-whole resolution instead of risking upset clients from moving trading activity to a different platform. In fact, the Board has already petitioned the SEC to use ~$10 million in trading gains to add to its $3 million obligation under Rule 4626, a Limitation of Liability clause. The US equities business remains a central part of the company’s revenue stream and is a high-margin business, so we expect the Board to be accommodating and cooperative in the investigation and settlement process.
Has there been any anti-NASDAQ sentiment seen in orders? In the two trading days post-FB IPO, NASDAQ’s market share has been “consistent with its month-to-date average,” so no conclusive evidence has emerged. If NASDAQ does not compensate participants for the technical error however, we think that there could be a dramatic shift in sentiment. Somebody has to shoulder the blame after all, and between the lead investment banks and the exchange, it’ll probably fall somewhere in between. NASDAQ’s optimal course of action is to expedite any regulatory actions to minimize stock overhang. We would wait to see the extent of the downside in the next few months given headwinds from a potential SEC investigation into the trading glitch that may impact trading activity.
NYSE is the other major US-based exchange, a product of the 2007 merger of NYSE Group and Euronext. The combined entity operates New York Stock Exchange, NYSE Arca, and NYSE MKT (formerly NYSE Amex), in addition to the five European exchanges that make up Euronext: Paris stock exchange, Amsterdam stock exchange, Brussels stock exchange, Lisbon stock exchange and LIFFE (derivatives markets in London, Paris, Amsterdam, Brussels and Lisbon). It is held by Martin Sass, Shane Finemore, Jeffrey Tannenbaum, and Scott Scher.
The company indicated, during the conference call following Q1 results that it had hit a “temporary air pocket,” meaning a time period of low trading volumes and low levels of new listings. The hope is that its pipeline of 118 deals totaling ~$19.9 billion will pull through and that the cost savings from Project 14 (projected to save $250 million annually through the end of 2014) will support the share price. And while cutting costs is a positive, we continue to believe that declines in revenue and profitability cannot be discounted. The markets recognize revenue growth more than cost containment .
We want to spend a moment touching on the non-controlling interest of NYSE, which we think is glossed over by many investors. There are two components of the NCI: Liffe US and NYSE MKT. NYSE owns 58% of Liffe US and 47.5% of MKT. Liffe currently operates at a loss, generating net operating losses. MKT on the other hand, is profitable (so we need to exclude the profits from MKT that don’t flow to NYSE shareholders). The thing is, that once Liffe becomes profitable, which we believe it will, NYSE won’t be able to apply NOLs against MKT’s profits. This will cause NCI back-out of profits to become larger, reducing EPS.
We value NYSE at ~6.0x 2013E EBITDA and at ~10.0x 2013E EPS. The publicly-listed exchanges in Europe and North America trade at ~7.0x 2013E EBITDA and ~11.0x 2013E EPS. However, we think it’s fair to apply a discount to NYSE due to its reliance on cash equities. Accretive M&A activity would be beneficial for the company both in terms of diversification and growth but that notwithstanding, we favor NYSE over NASDAQ.