NYSE Euronext (NYSE:NYX)
Q4 2008 Earnings Call
February 9, 2009 8:00 am ET
Stephen Davidson – Vice President Investor Relations
Duncan Niederauer - Chief Executive Officer
Michael Geltzeiler - Group Executive Vice President and Chief Financial Officer
Jean-François Théodore - Deputy CEO
Larry Leibowitz - Group Executive Vice President, Head of US Market and Global Technology
Stephane Biehler - Chief Accounting Officer and Corporate Controller
Howard Chen – Credit Suisse
Dan Fannon – Jefferies
Rick Repetto – Sandler O-Neill
Ken Worthington – JP Morgan
Roger Freeman – Barclays Capital
Mike Vinciquerra – BMO Capital Markets
Rob Rutschow – Deutsche Bank
(Operator Instructions) Welcome to the Fourth Quarter and Full Year 2008 NYSE Euronext Earnings Financial Conference Call. I would like to now the call over to your host for today, Mr. Stephen Davidson.
Welcome to the NYSE Euronext fourth quarter and full year 2008 earnings conference call. Before I introduce today's speakers, let me remind you that comments on the call may contain forward looking statements within the meaning of the Private Securities Litigation Reform Act. These statements are based on NYSE Euronext’s current expectations and involve risks and uncertainties that could cause NYSE Euronext actual results to differ materially from those in the statements.
These forward looking statements speak as of today and you should not rely on them as representing our views in the future. Please refer to our SEC filings for a full discussion of the risk factors that may affect any forward looking statements. Except for any obligation to disclose material information under the federal securities laws, NYSE Euronext undertakes no obligation to release publicly any revisions to any forward looking statements to reflect events or circumstances after this conference call.
Please note that the results of operations of Euronext N.V. for the fourth quarter and full year of 2008 are reported under US GAAP and are incorporated in the earnings press release that we issued earlier this morning under the caption European Operations in the accounting tables. We will discuss non-GAAP financial measures during the call.
These non-GAAP measures are fully reconciled in the tables attached to the text of the release. We believe that these tables provide investors useful information about our business trends. However, our non-GAAP measures do not replace and are not superior to GAAP measures.
For the call today, Duncan Niederauer, Chief Executive Officer, will update you on our fourth quarter and full year financial highlights, review our queries of focus and conclude with some comments on the market. Michael Geltzeiler, Group Executive Vice President and Chief Financial Officer will review the financial results for the quarter and full year, update you on capital related issues and provide selected guidance for 2009. You will then go back to Duncan for closing comments, before we open the line for your questions.
Also on the call today for the Q&A session are Jean-François Théodore, Deputy CEO, Larry Leibowitz, Group Executive Vice President, Head of US Market and Global Technology, Stephane Biehler, Chief Accounting Officer and Corporate Controller. We are incorporating slides for the call today which are available on our website. Duncan and Mike will refer to the slides during their remarks.
Now I’d like to turn the call over to Duncan.
I’m going to start on slide three so for those of you who are following along with the slide presentation we’re on slide three. I’m pleased to share our fourth quarter and full year 2008 results with you, characterized by volume driven revenue growth both for the quarter and full year. Pro forma non-GAAP earnings per share were $0.52 for the quarter versus $0.65 in the prior year period.
The lower pro forma EPS for the quarter versus prior year reflects the foreign exchange effect of the strengthening US dollar, planned investments for NYSE Liffe and the new market model in the US cash business and MX which was still operating at a loss during the fourth quarter. For the full year, pro forma non-GAAP earnings per share were $2.87 versus $2.63 in 2007 an increase of 9%.
In the fourth quarter, pro forma gross revenues rose 21%, however, this was driven by changes to our pricing structure in our US cash markets. The revenue increase was partially offset by higher liquidity payments from our new market model which we pay to incent the DMMs and SLPs in the US and the tiered pricing structure introduced earlier this year at Arca.
Despite the higher liquidity payments and the decline in regulatory fees in 2008 we ended the full year with net revenue of $2.9 billion a 4% increase over 2007. On the expense front we continue to make headway with our tech and non-tech cost saving initiatives. Adjusting for FX, M&A and select initiatives our fixed operating expenses were down $61 million or 14% in the fourth quarter and down $146 million or 9% for the full year. We are not done here and in this challenging environment we remain focused on rationalizing our cost base beyond the targets identified at the time of the merger.
In the fourth quarter we also continued to execute against the many growth initiatives that will fuel our future growth while continuing to invest in new technology for the benefit of our markets and customers. Some example, while CDS is only the first of what I expect will be many OTC derivatives that move toward a more transparent and regulated model, I am pleased to report that we are the first to market with a real and practical solution.
We also rolled out the new market model in the US cash business which is stabilized and increased our market share in NYSE Classic and we are excited about the MTFs and other initiatives we are launching in the first quarter within our European cash business. We migrated all of the Amex ETFs and equities to our NYSE and Arca platforms within two months of closing the Amex transaction and options will migrate over in early March.
We have delayed the option migration by a few weeks due to some conversion issues. Be aware, this is a hot cut. So, on behalf of our customers and trading partners we need to ensure that this transition proceeds seamlessly because there’s no going back once we flip the switch.
We launched our first product European Bonds on the universal trading platform and will continue the UTP roll out throughout our markets in 2009. Next up is European cash which is scheduled for this weekend. Lastly, we have combined our transact tools, Wombat and Exchange Solutions businesses with our market data businesses to create a new integrated commercial technology offering NYSE Technologies.
Given the challenging market conditions and the importance of maintaining liquidity, we have temporarily suspended open market purchases of our stock, while keeping the $1 billion authorization in place. At the same time, the Board has decided to maintain the $0.30 quarterly dividend for our shareholders through 2009. By maintaining the quarterly dividend, which represents and attractive yield of just over 5% we feel that we are striking the right balance between prudent capital management and shareholder value.
Finally, there is little doubt that we are entering a period of almost unprecedented uncertainty. We remain committed to serving our constituents, our customers, shareholders and employees by pursuing long term value creation. I remain excited about the list of new initiatives we are pursuing that will drive future growth. Most of the investments that we are making are and will be offset by incremental revenues but there are some investments like our US Futures business, NYSE Liffe US that are in early stages.
At the same time that we are investing for growth we will continue to vigorously pursue cost savings initiatives throughout the company. While we expect 2009 will be a transition year for NYSE Euronext as we continue to deliver against our key areas of focus we will be well positioned to accelerate growth in 2010 and beyond. Our goal as a company and a team is to seize opportunities that periods of adversity will provide.
Now shifting to slide four, we’ve again detailed the key areas of focus for our business in 2009. While this is not everything we have on the whiteboard I want to drive home the fact that these represent our critical areas of focus and are what we must deliver against in 2009. I’m going to discuss our progress on a few of these items in the coming slides, however, these initiatives will be addressed in much greater detail at our Investor Day scheduled for this Wednesday, February 11.
Slide five, the migration of the Universal Trading Platform. Slide five highlights the milestones for our UTP rollout, probably our most important technology priority in 2009. We have made the first step in migrating our global businesses to UTP with European bonds as I mentioned earlier which was rolled out in December. This is a critical milestone because by moving our business to one universal platform we will not only be better positioned to compete in terms of speed, efficiency and scalability but UTP is also a key driver of achieving our cost efficiency goals.
Next up is the European Cash business which as I said is scheduled to migrate the UTP this weekend. Arca in the US will come in the third quarter and NYSE Liffe and NYSE Classic will transition in the fourth quarter. When the rollout is complete at the end of 2009 our businesses will operate on one of the fastest meshing engines of the world with ultra-low latency of between 150 and 400 microseconds roundtrip and increased throughput of 100,000 orders per second. In addition, we expect to have a world class network of customers, markets and data around the edge of those matching engine.
Shifting to slide six, we wanted to give a brief update on the Amex integration. We remain on track to achieve over $120 million in annual run rate cost synergies by the end of 2009. As of today, Amex headcount is at 225 down approximately 50% from the day we announced the deal. We expect to end up with final headcount of approximately 100. Equities moved over to the NYSE Trading Floor to a newly designed room in December, ETFs were migrated to Arca by the end of November. As I mentioned earlier, options will be moving over in two to three weeks, I think the first weekend in March.
When this happens we will be off all Legacy Amex platforms. With the Amex acquisition we also acquired a second options exchange license. We are working with a number of partners to create a model for trading that will be complementary to our existing NYSE Arca Options exchange. Between the two exchange platforms we aspire to garner 20% to 25% market share which approaches the leading exchanges share of market.
This is just one example of how we are looking at creative ideas to rebuild the franchise and address declining market share on the Amex side. Revenue degradation however will be offset by additional cost saves. Mike will be providing more guidance regarding Amex for 2009 but net net we expect the transaction to be accretive this year.
Shifting to slide seven, I wanted to talk a little bit about the new market model on the NYSE Cash side. This was launched in October and fully rolled out in November. As you know, one of our biggest challenges in 2008 was to turn around NYSE Classic market share and correct several flaws in the old hybrid model.
First, the new market model levels the playing field and eliminates the information advantage for the specialist who has been transformed into a designated market maker or DMM. DMM obligations remain and they are incented to maintain fair and orderly markets at rebates rating from $0.30 to $0.35 per 100 shares.
The new model also creates a second tier of new liquidity providers that have fewer obligations but other than quoting obligations and therefore receive a lower rebate of $0.15 per 100 shares. Right now we have three secondary liquidity providers and we are working through documentation now on number four. As a result of the implementation of this new model DMM participation increased from 3.6% in September to 7% in December and in January it ran about just over 8%.
SLP participation has gone from 1.3% in November when we had one SLP to 3.3% in December and in January we saw SLP participation rates in excess of 6%. While NYSE grew pay pay market share increased to 43.4% in December from just over 42% in September NYSE Classic pay pay market share increased 400 basis points during the same period driven by these increased levels of participation.
Obviously with these attractive rebate levels and the levels of participation we have experienced we have seen a significant increase in liquidity payments in Q4. This has continued in January with combined participation rates for DMMs and SLPs in excess of 14%. Given the aggressive pricing, this market share increase comes at a cost that will be remedied in March when we implement further changes to our pricing which coincide with reductions in our latency.
To further enhance our pricing strategy and rebuild liquidity at NYSE Classic, we are implementing new client pricing effective March 1 with a rebate of $0.10 per 100 shares and a take fee of $0.18 per 100 shares. This keeps our net at $0.08, keeps us among the lowest takes in the market and that higher volume and share levels we expect to offset the spike in liquidity payments to the DMMs and SLPs that came about as a result of the transition to the new market model.
With this model in place we begin 2009 able to focus on enhancing functionality, further improving the speed of our systems and developing more comprehensive approach to adding value for our listed issuers and trading customers on the NYSE.
Let’s now shift to slide eight, and talk about some of the strategic initiatives in the European Cash business. In our continuing drive to be the harmonizer of European cash equities we have made a single order book a reality which will allow our clients to see a single line of activity in each stock across all our aggregated markets. This is the final stage in harmonizing three original Euronext markets.
SmartPool received approval from the FSA and was launched just days ago and after clients asked us to postpone the launch of NYSE Arca into 2009 we are now set to launch in early March. We launched these platforms while leveraging on the scale and scope of the group, relying on our technology, our client connectivity and our branding. We believe that no other operator in the Euro zone can do this to the same extent.
Two key take aways with regard to our European operations. First, we are already electronic and our speed will improve and be a market leader with implementation of UTP later this month. Secondly, while we face competitors in our home markets we are well equipped to gain share and grow our franchise with our two Pan-European MTFs, the SmartPool dark offering and NYSE Arca Europe.
Shifting to slide nine, I also wanted to touch on the highlights around the launch of our new CDS Clearing product. It’s clear to all of us that one of the repercussions of the financial crisis will be that many products that have been traded opaquely and relatively unregulated environments will be forced by regulators to migrate to more regulated transparent venues.
In response to this market need, in December we were the first to market with the launch of our new CDS Clearing solution in concert with LCH.Clearnet. We are right now actively completing the integration process with our customers and the feedback we have received is positive. While volumes have been slow or non-existent it is important that we get it right the first time with our clients so a slower ramping up was expected.
We are focused on ensuring that we do not squander our first move or advantage with our buy side and sell side constituents. While the service is initially focused on European Index products we have received an exemption from the SEC and expect one surely from the CFTC regarding US index products which we hope to launch sometime later this month.
Keep in mind, however, that CDS trading does not lend itself the continuous matching style of trading in the exchange model but where we are adding value in the trade process for CDS is by providing access to a proven central counter party in LCH.Clearnet via our OTC service Bclear. This leverages our strengths, provides the market with greater security and does not disintermediate the dealers active in this market.
Initially we are focusing on the most liquid sectors of the European index CDS market with the investment grade cross over and high vol I-tracks indices. Pricing at 10 Euro per million Euro notional with caps is very attractive and designed to drive volume to the platform. While we are starting with indices both in Europe and the US we expect to come to market with a single name solution later in 2009.
We feel comfortable leveraging the existing guarantee fund for indices because even where the CDS market experience extreme swings in volatility with a default of a major investment bank in September the indices remained relatively liquid. We do not believe that this is the case with single names so a new guarantee fund may have to be established to support the clearing of that product. CDS is only the first of what I expect will be many OTC derivatives that move toward an exchange clearing model and represent a key area of future growth for us.
Shifting to slide 10, a brief word on NYSE Technologies which we talked about in previous calls. NYSE Technologies is our new integrated commercial technology growth engine. It combines our form ATS businesses with global market data. Over the past 18 months we have assembled an enviable combination of valuable technology assets through the acquisition of TransactTools and Wombat and the re-insourcing of the AEMS exchange solutions business.
Add these assets to a $400 million global market data business and you have a single customer facing commercial technology powerhouse with a global footprint that enhances our product development and delivery cycle and consolidates our corporate infrastructure.
The primary business units of NYSE Technologies are safety, our secure financial transaction infrastructure business, trading solutions, a provider of advance enterprise solutions for real time market data distribution, messaging, exchange connectivity and execution facilitation, exchange solutions, a leading global provider of technology solutions and managed services for exchanges, clearinghouse, banks and intermediaries, lastly, and global market data.
The mission of NYSE Technologies is two fold. First, to provide and maintain NYSE Euronext global leadership by providing cutting edge technology solutions to our global businesses and secondly to offer best of breed solutions to customers globally. These customers include the largest global banks and broker dealers, hedge funds, traditional fund managers, exchanges, ECNs, ATSs, and MTFs. Stanley Young, who heads this business for us will be providing an in depth look at NYSE Technologies on Wednesday, at the Investor Day.
Slide 11, I wanted to touch a little bit before I turn it over to Mike on the market environment and the general outlook. The structural issues in the financial services industry have clearly impacted us and our customers. During this period of dislocation there has been downward pressure on volumes, and it is difficult to predict volumes going forward. That being said, as many of you know, I recently returned from Davos where I had the opportunity to meet with world political and business leaders as well as our issuers, clients and other market participants.
We shared viewpoints and exchanged information on what people are seeing and hearing in the global marketplace across all industries and geographies. Despite the prevailing market conditions many executives are feeling much more positive about the market then just a couple of months ago when most were extremely pessimistic looking into ’09 or were just not looking forward at all.
My sense is that despite a January which was the worst ever recorded by the DOW and S&P people are starting to turn the corner. The first turn is a psychological one and you have to convince yourself that opportunity will present itself and then be poised to capitalize on it. We remain focused on reducing costs, enhancing our capabilities and rolling out value added services to our customers so that we are better positioned when the markets do stabilize.
On the regulatory front, with the new US administration and new leadership at the SEC and SFTC there is a real opportunity to move quickly on regulatory reform and apply the same constrict that is allowed regulated transparent markets that perform so well during this period of volatility to other markets that are more opaque like the OTC derivatives markets.
We are having active dialogue with the new administrations transition teams and regulators and we stand ready to provide central clearing, transparent reporting, and anything else that the markets and regulators require.
Before turning over the call to Mike I wanted to speak to the impairment charge we took in the fourth quarter. The non-cash impairment charge is a reflection of the realities of the market that we are operating in and their impact on our market valuation. In my mind it was the right thing to do. It was good governance and it puts our period end book value at $25.31 a share much more in line with our average closing stock price for the month of January 2009 of $23.76.
The charge will not affect our strong free cash flow generation or any debt covenants or our day to day operations. Again, while the exercise of taking this impairment charge certainly involves a close examination of future cash flows. In my view it tells us more about the psychology of current market conditions then it is an indicator of underlying growth prospects of our businesses.
With that I’ll turn the call over to Mike for a review of the financial results.
Slide 12 details our GAAP results for Q4 and full year 2008. In the quarter we reported a non-cash pre-tax impairment charge of $1.6 billion. I will discuss the impairment further on the subsequent slides. We also reported a $94 million charge to merger and exit costs for severance actions and retirement of selected IT processes. As a result of these charges we reported a GAAP loss of $5.06 per share in Q4 and a $2.78 loss for full year 2008.
Slide 13 provides an overview of the non-cash impairment charge we have recorded in the quarter. Again, the pre-tax charge totaled $1.6 billion. The company performs its annual impairment test of goodwill and indefinite life intangible assets in the fourth quarter of each year. Significant industry wide valuation compression coupled with the large April 2007 merger between Euronext and NYSE Group resulted in a disconnect between the company’s book value and our market capitalization at December 31, 2008.
For accounting purposes NYSE was the acquiring company at the time of the merger. Most of the intangibles related to the transaction were assigned to Euronext cash and derivative businesses. Having performed a comprehensive impairment review we believed it appropriate to impair or write down a portion of the goodwill and other intangibles related to this merger.
In summary, the businesses were valued at a level in 2007 which today has been significantly discounted in the exchange world. This impairment is non-cash and has no bearing on the debt covenants or in how we operationally run the business, nor is it a reflection of our 2008 performance. Both our European cash and derivative businesses grew their revenues in 2008. European pro forma revenues increased 13% over 2007. That said, the outlook for 2009 is more murky given the current financial environment and the increasingly competitive European cash markets.
Slide 14 provides our pro forma results for Q4 and full year 2008. Gross revenues grew 21% and 19% respectively. Revenue growth was driven by volume increases across all our markets. It is also attributable to market structure changes within the US cash markets. We introduced new pricing programs at NYSE Arca in July and NYSE Classic in November which improved gross revenues but also increased rebates for customers that provide liquidity.
Net revenues for the quarter declined 2% compared to Q4 2007. After adjusting for the $55 million unfavorable currency effect in the quarter net revenues were 4% higher than the same period last year. Fixed operating costs adjusted for liquidity payments routing and clearing grew on a pro forma basis. After adjusting for currency effect, M&A activity and other new initiatives fixed costs fell significantly from both the quarter and full year versus the same period the prior year.
Pro forma diluted EPS was $0.52 in the quarter a decline of $0.13 or 20% compared to Q4 2007. Foreign exchange variance accounted for $0.07 of the shortfall. Additionally, investments in NYSE Liffe and losses at Amex accounted for an additional $0.06. The full year pro forma EPS rose 9%.
Slide 15 we show our fourth quarter revenue by both product line and geography. For the fourth quarter of 2008 approximately 55% of our revenues came from trading activities. Our revenues remained diverse across geography as well with 56% coming from Europe and 44% from the US. Quarter over quarter global cash trading was up considerably supported by double digit growth in volume over much of the increase in transaction fees in the US was offset by increased liquidity payments due to the pricing changes I mentioned earlier.
Derivative revenues were higher in the US driven by volume growth and the addition of the Amex option business in October but declined in Europe, mostly attributable to the weakness of the British pound versus the US dollar. Software and technology revenues more than doubled as the result of the acquisition of Wombat and Exchange Solutions and increased capacity revenues for customer co-location.
Slide 16 shows the quarterly volume trends for our major trading operation. October was a record month across all our venues which drove high quarterly volumes in Europe and in the US for both cash and derivatives versus prior year. Volumes also grew sequentially versus the third quarter in all venues except European derivatives with a decline modestly.
Slide 17 details the comparative annual volume for our four main trading venues. The US and European cash businesses each reported a 23% growth in match ADV volume for 2008. For both businesses, this represents record annual volumes which are realized despite increased competition and market share compression.
Total Liffe derivative volumes rose 10% to 4.1 million contracts per day. Bclear ADV increased to 746,000 a 55% increase over prior year. Financial equity and commodity futures all reported annual increases in volume. US derivative volume rose 36% for the year. This is partially attributed to the Amex options business being acquired in the fourth quarter. Including Amex volumes, US option volume rose 23%.
Slide 18 provides a split of liquidity, routing and clearing fees between our US and European businesses. The European net revenues the chart also shows comparative currency neutral trading results. On a currency neutral basis European cash and derivatives both increased modestly over Q4 last year. European cash pricing was negatively impacted by the introduction of Pack Epsilon our special offering for high frequency traders. Approximately 35% total European trades took advantage of the Pack Epsilon pricing schedule in the quarter.
Net revenue in the US cash business declined versus Q3 2008 and Q4 2007 despite substantial growth in gross revenues. Variance to Q3 are mostly attributed to the higher mix of participation, designated market makers and newly introduced secondary liquidity providers and NYSE Classic following introduction in the new market model.
As Duncan mentioned earlier, we have implemented attractive rebates and invested in stabilizing and increasing market share during the quarter. We expect this investment to carry into the first few months of 2009 before we introduce a higher take fee and new pricing on March 1st to coincide with improved latency.
Versus Q4 last year net revenues were also impacted by the peer pricing change introduced at NYSE Arca in July 2008. US dollar strengthened against both the Euro and British pound in the quarter which negatively impacted revenues versus the third quarter and Q4 2007. Overall, foreign currency variations negatively impacted total company revenue variances by $55 million versus Q4 2007.
Slide 19 provides our harmonized view of fixed expenses. On an apple to apples basis pro forma fixed operating expenses declined $61 million or 14% versus Q4 last year or $146 million lower for the full year. Adjusting for foreign exchange, Amex and other strategic initiatives, adjusted fixed costs were $7 million above prior quarter mostly reflected in the seasonably low level of expenses during the summer months.
This quarter versus prior year fourth quarter we have added a total of $88 million of fixed costs from acquisitions including Amex, Exchange Solutions, Wombat and startups such as [Lun-x]. Amex fixed costs were $44 million for the quarter. Continue to invest in NYSE Liffe our US futures business and in our European MTF SmartPool. As projected, we spent approximately $13 million on NYSE Liffe during the year with $9 million incurred in the fourth quarter. European currency rates were weaker in the fourth quarter versus Q4 2007 reducing expenses by $26 million.
Turning to operating efficiency plans, slide 20 outlines the major initiatives we are targeting to dramatically lower our cost base and improve our operating efficiencies. These transactions are above and beyond $120 million plus we are targeting to save on the Amex transaction. With annual cost saves of $135 million in 2007 and $146 million in 2008 we are demonstrating our ability to remove both technology and people related costs from the organization. We expect further savings in 2009, will see an acceleration of technology related integration savings once we implement UTP and consolidate our new data centers.
The $250 million annual run rate technology cost savings are targeted to be realized by the end of 2010. During the quarter we implemented a 10% rate reduction across all our technology contractors, continued to aggressively replace expensive non-stop equipment, reduce the latencies for our floor trading systems through the common customer gateway, and continued to migrate old customer connections to the safety network. We remain on track and anticipate providing a more comprehensive update on our technology integration during our first quarter earnings call.
On the staffing front, we implemented a worldwide salary freeze for 2009, reduced annual incentives and are proceeding with plan to reduce approximately 200 positions each in the US and Europe. Savings on the US VRIP initiative were $6 million in 2008 with an incremental $13 million targeted for 2009. We are in the final stages of discussion with the European work councils and are targeting the second quarter begin executing our redundancy program. Expect this initiative to generate about $23 million of annual savings with about 50% realized in 2009.
Slide 21 summarizes our current financial position, status on pending M&A transactions, our dividend plans for 2009 and our share buyback program. The Board has announced that we will be maintaining our quarterly dividend of $0.30 per share for calendar year 2009. On an annualized basis this represents a 5% yield on Friday’s closing stock price. In these challenging times we understand that our dividend is important to our shareholders and felt it was a good use of our free cash flow.
On a related topic, management has decided to temporarily suspend our stock buyback program, although the Board authorization remains in place. During the fourth quarter the company purchased 13.4 million shares for $348 million for $26.04 per share. This repurchase coupled with our issuance of 6.8 million shares on October 1st, the Amex transaction, reduced our average shares outstanding to 264 million for the fourth quarter and decreased total shares outstanding to 259 million at December 31, 2008.
Total debt at year end improved slightly versus September 30, to $3.1 billion. Net debt was $2.1 million with cash on hand to be maintained at a conservative $1 billion level. The company continues to have ample liquidity and debt capacity to manage our operations. As we look to 2009 we have a €260 million Euro obligation to LCH.Clearnet scheduled for April 2009 which is when we expect to close the Liffe Fair agreement.
Regarding Qatar we are in final discussions with the Qatari to restructure our equity stake in the Doha securities market. We will report the outcome when it is finalized. It is likely that we will reduce our ownership stake to 20% and our costs to $200 million which will be paid over the next four years. The software and management services contract remain as previously communicated. We expect the transaction to close within a few months.
You’ve all sat patiently this morning I suspect, waiting for us to provide some guidance on 2009. Given the unprecedented instability in the financial markets and the potential effects on market volumes it is becoming increasingly more challenging to provide earnings guidance particularly over the short term. That said, we appreciate the need for greater transparency and have detailed on slide 22 and 23 what we are comfortable projecting for 2009 which we hope will help analysts and investors model our business to measure our progress.
Slide 22 addresses revenue assumptions. January volumes were better than December but below an incredibly strong January 2008. Market conditions remain volatile and challenging. We’ve seen a reduction in open interest within the Liffe business which is an indication of de-leveraging and customers reducing risk.
On market share we expect to continue the Q4 trend where we reported growth in Tape A market share led by a resurgence in NYSE Classic share attributed to the new model and a gradual share reduction in our European cash market. We expect these trends to continue into 2009 and our targets is secure at least 50% market share in pay pay trades by year end.
Pricing will remain competitive and we expect average net pricing to decline in the European and US cash markets versus 2008.
Foreign exchange remains a critical key performance indicator given our profitable European operations. As a guide, we have provided our average FX translation rate for 2008 and the sensitivity of a 1% change from these rates.
Lastly, we have a series of new initiatives listed on this slide which will generate incremental revenue for the company. We are not comfortable with quantifying these individually for you at this time but we are guiding that we expect these initiatives in aggregate to generate incremental revenues of $250 million to $325 million in 2009 over 2008.
Slide 23 addresses expense guidance. In 2008 we reduced adjusted fixed costs by $146 million or 9%. Each quarter we reconciled our fixed cost base versus prior period adjusting for foreign exchange variation, portfolio changes and a large discrete investment. We will continue this process in 2009. With this in mind we have detailed three key components of our 2009 fixed costs and the trends we expect. Although it is positive that we are adding incremental new revenue streams in 2009 most of these are accompanied by incremental costs.
Although we are not currently providing the incremental costs for each new initiative we have provided guidance on profitability. I will not address each of these as the comments on the slide are self explanatory. In addition, we expect to incur between $35 and $50 million in incremental costs in 2009 as we near the completion of our major technology harmonization efforts. These costs represent either duplicate data center costs incurred prior to moving into the new facilities or one time integration costs necessary to transition the new platforms.
Beyond these items we expect fixed costs decline a further $80 to $100 million in 2009 versus 2008. The savings is from lower IT costs, reduced headcount from initatives such as the European Social Plan as the US ERET. It may prove that this estimate is light for savings but this represents where we are at this point in time. We will continue to explore every opportunity to lower our cost base and increase operating leverage.
Our tax rate is somewhat contingent on the mix of income in the US versus Europe. For now we expect the rate will approximate last year’s 29%.
Lastly, on capital expenditures we expect CapEx in 2009 to increase significantly as we complete our two major new data centers in the US and UK. Excluding the data center spend we expect capital expenditure including software development to be around $200 million. Preliminary targets for 2010 capital expenditures return to normal which would be sub $200 million.
I’ll wrap it up and then we’re going to try to throw it open for the usual Q&A. That was a little longer than usual but we are wrapping up what’s been a very busy year and we’re also trying to continue our theme with transparency and give as much of an outlook as we can within reason for ’09.
As I look back on this year it occurs to me that it was a year ago that I was doing this for the first time and was barely in the seat. When I think about what we’ve done as a company through 2008 and my first year at the helm here I’m pretty proud of us to be perfectly honest. I think we’ve accomplished a considerable amount and when you think of what the environment was like around us I think it’s even more remarkable.
We reported higher revenues, profits and earnings in ’08 versus ’07. We’ve accelerated our cost efficiency programs and I think we really got some positive signs on some of the synergies that were promised in the NYSE Euronext deal and the ones that we also talked about in the Amex deal.
While we were busy doing that we acquired businesses like Wombat and the Exchange Solutions business along the way. We launched some new business initiatives such as NYSE Liffe in the US, SmartPool in Europe, the New York Block Exchange here just a week or so ago. NYSE Arca Europe which will launch in March officially but finally got the regulatory approvals for. Safety Europe, NYSE Technologies, BlueNext, the list is actually pretty lengthy.
We also created some very strategic technology partnerships and in some cases including an investment in places around Asia and India, Brazil, Qatar. We talked about being first to market with CDS products. We talked about finally reversing the NYSE Classic downward trend in market share. We’ve opened up a market access center for our issuing customers here in the US to make sure that we continue to be the home that we are today for the largest and most successful companies in the world.
I think we’ve done a very good job, if I do say so myself, of putting a management team around me that is I think many of you will see on Wednesday is a lot deeper than many of you probably think. Finally, I think we’ve also focused on the shareholders by raising the dividend and maintaining it at that level, getting the $350 million roughly of the buyback done.
We understand that it’s a big disappointment to see the depressed multiple and the depressed stock price but I think it’s not going to sway us from continuing to move forward in 2009. I think we’ve got a lot to get done that we’ve already outlined in the call and more of which we’ll outline on Wednesday that we think will position us very favorably for ’10 and beyond.
In 2008 we reported pro forma EBITDA in excess of $1.4 billion so that means our market cap right now is really less than five times that. When you couple that with a dividend yield in excess of 5% I hope that it’s a very attractive proposition for shareholders, I certainly think it is.
We have hurdles ahead of us but I’m confident that we’re up to the challenge and that we’re well positioned to deliver. We’re also prepared to do whatever needs to be done and to work with whomever necessary in America, Europe and throughout the world toward restoring confidence and stability in the global financial system and it will be bigger commitment of my time in the coming months. Easy for me to say.
I am encouraged by much of the work done to date and while not being so presumptuous to set a time table I think the economy’s on the long road to recovery and I think our company is very well positioned.
With that we will say thank you for your patience and we’ll open the line to some questions.
(Operator Instructions) Your first question comes from Howard Chen – Credit Suisse
Howard Chen – Credit Suisse
We continue to hear about buy side asset levels coming down, record levels of cash on the sidelines and yet first quarter to date US cash equity volumes are still averaging 9.5 billion shares a day. In your mind where’s all that volume coming from and what types of customers are driving that incremental flow.
The high frequency trading is still pretty active. I think retail trading hasn’t fallen as much as some of the other types of trading and is probably holding the weights for now. I think that volumes are down over December but still looking pretty good.
If you go back and you look at the averages for ’08 it was actually below 9.5 billion so I think we actually agree with you. I think we’re pleasantly surprised that a lot of the people we talk to are clearly still on the sidelines and yet you’ve got Tape A, B, and C volumes still running at somewhere between 9 and 10 billion and we had a couple of days last week where it was actually a good bit above that.
It’s not clear to us that that money has come into the market yet so we think there is some up side there. The only caveat to that is I think we’re all going to know a lot more about the status of the hedge fund part of the buy side industry probably not for a couple more months. I think we’ll have a little more clarity on that probably in the March, April timeframe.
Howard Chen – Credit Suisse
You spoke the company’s as much a technology company as it is an exchange so with the uncertain economic environment how does that change your broader outlook for that market data and technology services business? What happens to the pipeline here and does it put pressure on this business at all in your mind?
I’m pleasantly surprised because I thought it was going to. Its potentially just the opposite because if you think about who our primary customers in the technology business are, on the exchange side I think our value proposition is such now that we’re not just delivering a matching engine, we’re delivering a matching engine with all the peripherals around it that literally can put you in the exchange business with a huge network of customers and the ability to distribute data.
If you’re an exchange in an emerging market or you’re in a developed market that needs a revamp I think we’re a pretty attractive offering and we see no pull back on those kinds of investment decisions. Larry may have a different view but we’re hearing from some of our other technology folks is even the big banks who you think would be dialing it way down, in some cases consolidating some of this stuff is an opportunity to actually save money. A lot of them are still stepping forward and we view ’09, in spite of the environment around us as a pretty big growth year for NYSE Technologies.
Stanley will talk more about that on Wednesday.
What you’re seeing in a lot of the big banks is rather than try to invest in keeping up in some of this technology particularly the high frequency low latency market data stuff they are deciding to outsource and maybe they’ll change that after this cycle is over but for now we’re actually seeing some big contracts coming out.
Howard Chen – Credit Suisse
On the fixed expense outlook is the starting point for 2009 $1.74 billion in ’08 and is that step down guidance exclude the data center build out?
What I would suggest you do is use the fourth quarter as a starting point times four. If you’re looking to the guidance that we gave yes it was from the annualized this year.
Howard Chen – Credit Suisse
It excludes the $35 to $50 million of data center correct?
Exactly, that is incremental in 2009.
Howard Chen – Credit Suisse
On the revenue considerations I was unclear about your comment about stable pricing in derivatives. Does that assume any product mix shift? Historically Liffe revenue per contract has fallen as Bclear has been the overall business. Is that still the case or is there something offsetting that?
We separate the Bclear from the non-Bclear and even though the mix is different a little bit from the interest rate product versus financial the stability we’re talking about is the average price per contract pre Bclear.
Howard Chen – Credit Suisse
What about Liffe Clear is that also in that guidance that you have some positive contribution of whole Liffe Clear?
When we gave increment, Liffe Clear is part of that incremental revenue and incremental profit. As we mentioned it’s going to be accretive next year.
That comes online in April.
Your next question comes from Dan Fannon – Jefferies
Dan Fannon – Jefferies
On the regulator side particularly with CDS here in the US and in Europe as we go through the regulatory process when do you actually think these will turn into revenue opportunities where we’ll start to see volume flow through these kind of clear environments for CDS?
That’s the question a lot of the regulators are starting to ask us because, as I said, you haven’t seen us put out a volume press release on our CDS product in Europe because there wouldn’t have been much to talk about. Although we’re the first to market and no one else has actually come with a product there does seem to be some reticence on the part o the community to participate. That may lead the regulators to mandate some things unclear.
My stance continues to be what it’s been this idea that we’re going to run across the entire continuum and all these products are going to have the standardization that would be required to actually trade them on an exchange. I don’t think that’s going to happen overnight and that’s not what’s going to be mandated. The revenue opportunities are going to look more like a Bclear type opportunity on the clearing side because the solutions we’re coming up with are in conjunction with the London Clearing House and Bclear’s on the front end.
You could assume that if you had your own predictions about when volume are going to find their way to these platforms that gives you an interesting guide on what our opportunity there might be. The only other near term revenue opportunity if it goes in that direction is I’m also a believer that the next thing we’ll be asked to do is provide some kind of transparent reporting mechanism or as we do with our existing OTC equity derivative products, independent valuation service.
We’re still trying to figure out what the revenue opportunity there are but I don’t view this as a get rich quick scheme for exchange. Our role in this is more about trying to improve transparency and stabilize the markets. It’s a long time for a lot of these customized products are actually trading on an exchange. Hopefully that answers the questions. It’s more of a short term Bclear opportunity then a medium term kind of market data opportunity.
Your next question comes from Rick Repetto – Sandler O-Neill
Rick Repetto – Sandler O-Neill
On the new market model if you ran the new pricing that you announced last Monday how would that have impacted the last quarter? The participation rates continue to go up. Why didn’t we come up with this pricing all at once rather than have the four or five months of headwinds that we’re having here?
The way to think about it, every time a DMM or an SLP is one side of the trade obviously we’re paying them a pretty substantially higher rebate then we’re collecting on the take side. Back of the envelope if we keep the spread the same at eight but we raise the take from eight to 18 so that we’re getting paid 18 on the removing liquidity side when we’re paying out the kind of rebates we talked about I think it narrows that spread of the inversion. Our guess is it’s probably something like $5 million a month is the bottom line impact would be.
You could say we could have either waited to do all of this or done or accelerated those March 1st changes. It was our view here that if you’re going to offer a rebate to everybody one of the reasons we historically never did that was we didn’t think our latency was low enough that it was really going to attract the kind of volume we would need anyways. Some of those pricing changes are tied to other change we’re making to the infrastructure that we think makes more sense.
We got caught in the squeeze there. We implemented the new model as quickly as was available because we wanted to stem the loss of market share. Because of the latency not only would we not have attracted as much liquidity on the provide side but we wanted our take to be substantially lower then everybody else’s to ensure that we got first on their routers despite the fact that we were high latency.
We also wanted, by incenting these guys to get the rebates and to be quoting at the inside we think over time while there may be a lag effect it drives more volume to us because their experience here should be getting better and better and better as we have more depth in the inside.
Rick Repetto – Sandler O-Neill
The $250 to $325 million in incremental revenue can you tell us is that neutral to the expenses on those initiatives?
Because I’ve gone through each of those initiatives on the expense side, most of those incremental initiatives will be accretive next year so they will be profitable. The costs will be lower then the revenues compared with an incremental cost.
Rick Repetto – Sandler O-Neill
Taken in aggregate they’re accretive in total?
They will contribute to the bottom line in 2009 and maybe what we’ll try to do is give a little more guidance on that on Wednesday at the Investor Day.
Your next question comes from Ken Worthington – JP Morgan
Ken Worthington – JP Morgan
You’ve got a deepening evolving relationship with LCH.Clearnet. LCH is in merger discussion with at least two other firms or consortiums. What are the risks associated with an LCH sale and could Liffe Clear fall apart between now and April. What are the opportunities if DTTC or the dealer consortium merges with LCH?
Liffe Clear is done, its contractually obligated and all we’re waiting for now if FSA and SEC approval which we think is probably something like six to eight weeks away. I don’t think we’re going to make March 31st but I think we’ll be done by mid April at the latest having just talked to both regulators about it in the last week or 10 days.
You have to assume, to answer the second part of your question that we have Liffe Clear, our relationship with LCH and the derivative side is just managing the guarantee fund for us. Our relationship with them on the cash equity side is being the Clearnet affiliates biggest customer by far in terms of the equity that we clear.
I don’t really have a strong opinion on which one of the outcomes is better for us. I’m reading the papers as you are trying to figure out is DTC going to this or is the consortium going to get it. Our main concerns are going to be we’re the enterprises biggest customer, one would assume that whoever ends up owning it is going to want us to stick around. It’s hard to make a deal work without us sticking around as the biggest customer. As you would expect our interest in the derivative side is probably strategic, I would describe it as, where our interest on the cash equity side is a little more commercial.
I would want to make sure that whoever ends up owning it is going to run the operation efficiently so that our clearing costs on the European cash equity side are in line with some of our alternatives. It’s a little premature to say who is going to get it. Its not clear to me that either one of the proposals has a tremendous amount of traction at the moment.
Your next question comes from Roger Freeman – Barclays Capital
Roger Freeman – Barclays Capital
I want to come back on the US cash side. As I think about the floor, the pick up in the DMM if you look at the 8.3% right now as you see the participation rate pick up where do you see that going now? That gap in the pricing if you close it up somewhat now with the pricing but that could widen again as the participation rate picks up. How do you think about that offsetting and could you close the gap up with future pricing changes?
As you think about your projection on market share going to 50% this year. The 50% is kind of a bold outlook give the 43% currently. What are you thinking about, how do you get there?
You’re right, 50% is a stretch goal. What we’re thinking is that we are revitalizing the Classic platform first by getting liquidity providers out there in the DMMs and SLPs; I think there’s still room for growth there. Between that, lowering the latency and putting a rebate on the market we think we can attract posted liquidity that hasn’t been there before. There is significant room for growth there. Whether it’s the 50% or not I can’t say right now.
You’re right in that if DMMs and SLPs significantly increase participation that would widen a little bit although the lever has been reduced by putting the take at 18. We will have some room to tinker with some rates on both sides of the equation either on the DMM side or on the 10-18 side. We’re keeping a close eye on it, we watch this thing on a day to day basis and we’ll adjust it accordingly.
Your next question comes from Mike Vinciquerra – BMO Capital Markets
Mike Vinciquerra – BMO Capital Markets
Can I ask you on the debt side of things obviously you guys are in capital conservation mode, I guess that’s how I interpret the commentary. Can you talk about your debt servicing costs right now? We’ve obviously got our own estimates on EBITDA and so forth but is there a particular EBITDA to debt ratio you guys are looking to get to. Can you talk about what you’re overall annualized costs for servicing your debt today would be at today’s rates?
We have not really stipulated an overall leverage ratio but I would say two times debt to EBITDA is over time where we see ourselves comfortably being. We do want to retain our high investment grade rating; we believe that’s important to our business. That would be the target rate. This past 12 months has been a period where there has been some transactions and we’ve gone slightly above that level. We’re probably focusing on that.
In terms of our rate one of the reasons why we want to stay at that level is we have a very attractive financing situation now. We have about $1.8 billion of two long term bonds; we’re paying about 5.1% interest on. Beyond this UK bond that we have of €250 million pounds the rest of our financing is coming from the Commercial Paper market whereas you know the rates are very, very attractive. Maintaining a high investment grade status allowing you to realize the Commercial Paper market is affording us very attractive financing.
It’s with all of that in mind that we feel it is prudent to conserve some capital during this period of uncertainty and decided to maintain the dividend and temporarily suspend the buyback.
Your last question comes from Rob Rutschow – Deutsche Bank
Rob Rutschow – Deutsche Bank
I’m wondering if you can help us out with understanding what you feel the organic growth rate in expenses will be for 2009.
What I was trying to communicate with the guidance is have these two and arguably three anomalies. Our costs will probably be down because of the stronger US dollar so we’ve got the currency. Secondarily, have a bunch of new initiatives which are incremental, they’re either full year effect of acquisitions we made or new initatives that we’re launching like Liffe Clear, they will have expenses associated with them but they’ll be profitable so we will highlight those.
Thirdly, we have the, as we communicated when we announced the $250 million Technology save that there are some one time costs that we’re going to incur while we’re in a parallel processing mode and we’re establishing these new data centers that’s the $35 to $50 million. If you take all that out the core costs are coming down and that’s the main message. We don’t see organic growth, we actually see decline of $80 to $100 million. In the interest of giving you an overall guidance we do need to take in those other factors.
Rob Rutschow – Deutsche Bank
Looking ahead longer term are we looking at the low to mid single digit organic growth rate in your mind for the business as a whole?
You mean profits or costs?
Rob Rutschow – Deutsche Bank
Excluding new initiatives and growth opportunities there’s no reason why we couldn’t maintain to continue to probably introduce operating efficiencies for the next couple of years that could continue to bring our costs down year over year. I don’t see any reason to project that costs will be growing in 2010 or beyond unless we launch new initiatives or we grow our technology business where aspects of it aren’t all fixed cost oriented we may have some associated costs with revenue growth.
I would like to now turn the call back over to Mr. Duncan Niederauer.
I will thank everybody for being on the call. I’m sorry we didn’t get all the questions but hopefully any of you who didn’t get to ask a question today we will see you on Wednesday at the Investor Day and we’ll give you guys special dispensation on Wednesday. I would hope to see everybody here. It’s going to be a long but hopefully fruitful day for all of us on Wednesday where we really get to go into a lot more detail on all these topics. Thanks for being on the call this morning and we’ll see most of you on Wednesday.
Thank you for your participation in today’s conference call you may now disconnect. Have a wonderful day.
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