Shares of NASDAQ OMX Group (NDAQ) took a serious beating in Tuesday's trading session. The global exchange which offers trading, clearing, technology and regulatory services among others, announced the acquisition of eSpeed on Monday after the market close. Shares of the company traded with losses of up to 13% during Tuesday's trading session, closing a little below $28 per share.
Nasdaq OMX announced that it has agreed to acquire the eSpeed platform from BGC Partners (BGCP). The company will pay $750 million in cash plus additional contingent issuances of stock, which offers tax benefits to Nasdaq. As part of the deal, Nasdaq anticipates to offer 1 million shares per annum (this is contingent) over the next fifteen years. This would bring the deal value more towards $1.2 billion, at current prices.
In a response to the deal, shares of BGC rose almost 50%, closing at $5.72 per share. This increased the market value of the firm by some $300 million, to just under the $1 billion mark.
eSpeed operates a central limit order book for trading in US Treasuries, thereby providing Nasdaq with a strong entry point in the electronic fixed income business.
Following the completion of the deal, eSpeed will become part of Nasdaq's Transaction Services business which offers a marketplace in equities, derivatives and exchange traded products and commodities. CEO Bob Greifeld commented on the deal:
We are building a diverse, customer-centric portfolio of corporate, trading, technology and information solutions. We view the eSpeed platform as a compelling extension of NASDAQ OMX's strategic direction as eSpeed is a major player in the U.S. Treasury market, has a derivative-industry margins, 70 percent of its revenue is derived from fixed contracts and it has a long-standing presence on trading desks around the world.
eSpeed generated revenues of just under $100 million in 2012, valuing the business at over 7.5 times annual revenues. Despite the high revenue multiple, Nasdaq believes that the deal will be accretive to its earnings per share within twelve months after closure of the deal. This guidance excludes certain transaction costs related to the deal.
The deal will be financed with cash on hand and a short term bridge loan. Nasdaq plans to issue new long term debt in the summer of this year, in order to pay off the bridge loan. The deal will furthermore be subject to common closing conditions, including regulatory approval and is expected in the middle of 2013.
Nasdaq ended its fiscal year of 2012 with $720 million in cash, equivalents and short term investments. The company operates with $1.93 billion in total debt, for a net debt position of approximately $1.2 billion. For the full year of 2012, Nasdaq generated annual gross revenues of $3.1 billion, resulting in a gross profit of $1.66 billion. Net income for the year fell to $352.0 million, or $2.04 per diluted share.
Factoring in a 12% decline in Tuesday's trading session, the market values the exchange at roughly $4.6 billion. This values the firm at approximately 1.5 times annual revenues and 13-14 times annual earnings. The company currently pays a quarterly dividend of $0.13 per share, for an annual dividend yield of 1.8%.
Some Historical Perspective
Shares of Nasdaq have been depressed over the longer term as the market crash of 2008 has scared retail investors away from the markets, which put pressure on trading volumes. Shares peaked at around $50 in 2007 and fell to lows in the high-teens in 2009 and 2010. The initiation of a dividend and the steady share repurchase program send shares back towards the low thirties in recent months, as trading volumes continue to be under pressure.
Over the past four years, Nasdaq has consolidated its annual revenues in the $3.0-$3.5 billion region. The company reported profits around $300-$400 million per year. Earnings per share did increase as the company retired roughly a fifth of its shares outstanding between 2009 and 2012.
Shareholders in Nasdaq react extremely disappointed to the deal which is a bit surprising. For starters, the deal structure is rather complicated. Nasdaq will pay a $750 million cash component, while the additional contingent 15 million shares to be issued to BCG are completely offset by lower income taxes.
As such the $750 million net deal value, values eSpeed at 10.9 times EBITDA for the year of 2012, compared to a valuation of 8.1 times for Nasdaq itself. Based on this valuation multiple, Nasdaq is putting an almost 35% premium on eSpeed, or roughly $200 million.
Yet the market capitalization of Nasdaq takes a serious beating, declining by almost $675 million. Investors point out that the company might lose its investment-grade status, but management is not so concerned. The debt/EBITDA ratio will increase to little over 3 times, but is expected to drop to comfortable levels around 2.5 times within 12 months. Nasdaq will suspend its share repurchase program to improve the financial position of the firm in the meantime.
Overall, I cannot conclude otherwise than investors appear to be overreacting. Nasdaq will diversify into a new $500 billion per day trading market which stands to benefit from increased electronic trading and possibly a return to "normal" volatility levels.
While the deal price is anything but a distressed sale, it seems that investors in Nasdaq are overreacting as the market capitalization losses of roughly $675 million are more than twice the gains in the market capitalization of BCG Partners on Tuesday.
I conclude that investors are overreacting, given the potential for long term cross-selling and technology synergies following the deal. This dip might be an interesting moment to pick up some shares as the overall valuation at 13-14 times annual earnings seems fair.