Don't Bet Against the House - Barrons.com

Don't Bet Against the House - Barrons.com

http://online.barrons.com/article/SB121582923928948059.html?mod=b_hps_9_0001_b_this_weeks_magazine_home_right&page=sp

MONDAY, JULY 14, 2008
FEATURES MAIN
Don't Bet Against the House
By SANDRA WARD
Nasdaq OMX shares are a steal, unless global stock markets tumble.

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IT'S HARD NOT TO GET A LITTLE QUEASY when it comes to the U.S. stock market these days. The major indexes have fallen into bear- market territory, and initial public offerings have all but disappeared. Merger and acquisition activity worldwide was off 35% through the end of the first half of the year. Financial stocks have become the land mines of the investing landscape and continue to hit new lows. Each day brings a steady drumbeat of higher energy prices, dismal corporate outlooks and increasing layoffs. Now the buzz at cocktail parties is about picking a market bottom, not the next highflying stock.
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Monika Graft
Nasdaq is now home to 3,900 listed companies with $5.5 trillion in market value.

The best evidence of the current malaise is in the share performances of the companies that make the markets: NYSE-Euronext, CME Group and Nasdaq OMX have each seen their share prices plummet from their 52-week highs set late last year -- by almost half if not more -- on concerns about pricing, transaction volumes and the dearth of IPOs.

No exchange appears so glaringly mispriced as the Nasdaq OMX Group (ticker: NDAQ), the former Nasdaq Stock Market, which was founded in 1971, went public on its own exchange in 2005 and then changed its name this past February following its acquisition of Norway's OMX Group. At $23.70, the stock has lost more than 50% of its value since hitting a high of $50.47 last November.
Table: Spreading Its Wings

It trades at a multiple of 12.5 times estimated 2008 earnings of $1.89 a share and less than 10 times estimated 2009 earnings of $2.41 a share, even though earnings growth is estimated at close to 35% this year and 27% next year. On top of the misery felt by the entire industry, Nasdaq's shares have been hit by concerns that it overpaid when it agreed to shell out $4.2 billion for OMX.

It's a mistake to still view the exchanges solely through the lens of the U.S., where competition is brutal and conditions are soft. Today only 15% of Nasdaq OMX's revenues come from U.S. equity trading. Truth is, financial markets are booming worldwide on the back of the tremendous wealth created by the rise of China and India, the global demand for commodities and the emergence of capitalism as the dominant economic system. The big U.S. exchanges are racing against their European counterparts and each other to get a bigger piece of global action, as evidenced by the NYSE's acquisition of Euronext in 2007 and Nasdaq's pact with OMX after it failed in its bid for the London Stock Exchange (LSE.U.K.).

The U.S.-based duo have lately set their sights on the Middle East -- flush with petrodollars and ambitions of creating international financial centers -- with NYSE Euronext (NYX) paying $250 million in cash for a 25% stake in Qatar's Doha Stock Exchange on the heels of a Nasdaq pact with Borse Dubai that resulted in the company owning one-third of the exchange for $50 million.

Exchanges have become enormously attractive businesses -- think of them as tollbooths -- often operating as monopolies and doubling revenues every few years. Stock exchanges have mushroomed on every continent but Antarctica, many in the past 10 to 15 years, including both the obscure, such as Papua New Guinea's Port Moresby Stock Exchange, with five listings, and the established giants such as Nasdaq OMX, with its 3,900 listings representing $5.5 trillion in total market value.

Unless you think the expansion in global stock markets is destined to be short-lived, Nasdaq OMX shares represent an extraordinary opportunity to buy a leader in a rapidly consolidating industry with huge global growth potential, as traders and investors clamor for faster and faster trades on a wide range of products at the best possible prices anywhere in the world.

Indeed, "the revenue-growth prospects dwarf any other time in my history at the Nasdaq," says Chief Executive Robert Greifeld, the architect of the "new" Nasdaq. "Our master plan is to develop massive scale against an efficient low-cost platform." To achieve this, the company has been making acquisitions that give it greater geographical and product diversification and a stronghold in the high-margin options and derivatives market. It has been taking share from the NYSE Euronext.

IN SEPTEMBER, NASDAQ will launch a Pan-European market to take advantage of regulatory changes that will lead to increased competition. Nasdaq's goal is to capture 20% of the trading volume in the 300 most active shares in Europe. To achieve its goal, Nasdaq plans to discount transaction costs by 70% to 90%, a move that its low-cost trading platform makes possible.

Greifeld notes, too, that "on an operational basis, we could not be doing better," despite challenging times. Year-over-year volume numbers in U.S. equities were up 43% in June, though down from the prior quarter. In the past two years, Nasdaq has increased its share trades executed on the NYSE to about 25%, from zero two years ago.

Though the IPO market remains effectively "frozen," the blow has been moderated as more than 30 American Stock Exchange companies switched their listings to Nasdaq this year. Some high-profile companies also have helped out. For instance, CME Group, a futures and options exchange, switched from a dual listing with the NYSE to a single listing on the Nasdaq.

Greifeld dismisses concerns about the price he paid for OMX, saying, "We have a habit of underpromising and overdelivering, and where we are in the OMX integration is part of that pattern." Synergies targeted from the OMX deal are exceeding expectations, and Greifeld now expects the $25 million to $35 million of costs it estimates can be cut by the fourth quarter will prove to be conservative.

"This is a very inexpensive stock," says Mark Boyar, president of Mark Boyar & Co., longtime value investor and adviser to the Boyar Value Fund, who has been adding to a Nasdaq position that now stands around 2% to 3% of his portfolio. "From these levels, it should increase by 50% over the next two to three years on increased market share and increased earnings. This company's earnings power relative to its stock price is very attractive."
[Nasdaq packge]

Of particular attraction to Boyar is Nasdaq's powerful franchise, relative pricing power in what he calls a quasi-monopolistic business, recurring revenue stream and big exposure to the high-margin and fast-growing derivatives and options business.

Quoc Tran, a portfolio manager at Lateef Investment Management, one of the biggest holders of Nasdaq OMX, echoes that assessment. "For a company without credit risk, revenue growth in the mid-teens and operating-profit growth in the mid-to-high teens, we believe Nasdaq OMX should trade at 25 times our 2009 estimate of $2.50 a share, a $62.50 a share value," he says.

Tran insists, as does Greifeld of Nasdaq, that the company should be valued along the lines of transaction processors such as Visa and MasterCard, which tend to be accorded multiples 25 times or higher. Consider, too, he says, that Borse Dubai bought about 30% of Nasdaq OMX at $49.20 a share in February as part of Nasdaq's merger with OMX Group.

The Bottom Line
The stock, down sharply since last November, could climb by 50% over the next two or three years as the world's securities exchanges continue to consolidate.

Nasdaq is almost unrecognizable from its former self. Rather than simply collecting fees from U.S.-listed companies and U.S. stock transactions, as it did for so many years, Nasdaq has been busy transforming itself the past few years into a global juggernaut that through its merger with OMX can now boast connections to more than 70 exchanges around the world and trading in an increasing number of asset classes, including derivatives, options, bonds and structured products.

On the domestic front, Nasdaq is expected to soon complete acquisitions of the Boston Stock Exchange and the Philadelphia Stock Exchange, pending regulatory approval. Cost savings from the Philadelphia deal are expected to total $50 million within two years of closing. Nasdaq should realize $14 million in synergies from the BSE's clearing business.

Greifeld has promised to refrain from more major deals until investors begin to realize the value from those already in the works. With some savvy stockpickers expecting the stock to more than double from here, that value could be enormous. We'll take that trade.

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SATURDAY, JULY 12, 2008
Spreading Its Wings
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Nasdaq OMX, like its peers, has moved beyond U.S. securities and into global markets for a variety of instruments. Yet its stock trades at a valuation below its rivals'.

Recent 52-Week Market Earnings P/E
Company Price High Low Cap (bil) 2008E 2009E 2008E
CME Group $309.70 $714.48 $305.00 $16.9 $17.45 $21.91 17.8
NYSE Euronext 43.82 95.25 43.10 11.6 3.29 4.06 13.3
Nasdaq OMX Group 23.70 50.47 22.76 4.7 1.89 2.41 12.5

E=Estimate.

Source: Thomson Reuters