NASDAQ OMX (NASDAQ:NDAQ) was already one of the most diversified exchange players in the U.S. prior to its acquisitions over the past year. Following these acquisitions, it is now an entity that is almost unaffected by the weakness in its most recognizable division, U.S. cash equity trading. NASDAQ reported its earnings for the third quarter on October 23, and recorded a 23% jump in its net revenue, primarily driven by the acquisitions. Organically, its revenue grew by 4% year-on-year as the U.S. cash equity trading business continued to lose market share and remained a drag.
Below we provide our take on the most important data released during the conference call. Our price estimate for the company’s stock is around $31, and we will update our model shortly.
Good Progress On Capital Plan
NASDAQ has spent over $1 billion in the last year to acquire fixed income platform eSpeed and Thomson Reuters’s corporate solutions business. The company had to take on a significant amount of debt for these deals, which initially raised concerns about its credit ratings. In Q2, its long-term debt obligations increased by $807 million from the end of 2012.
However, the company is committed to reducing its debt at an accelerated pace, and seems to be doing well on this front. It paid back $98 million of debt during the quarter, and remains on track to return to its long-term gross debt-to-EBITDA target of around 2.5x. As debt reduces, we expect NASDAQ’s financial flexibility to return, and the company is then likely to restart its share buyback program (read: NASDAQ Escapes Moody’s Review Without A Downgrade).
New Acquisitions Provide Diversification…
The hefty sum paid for Thomson Reuters’s business and eSpeed definitely seems to be benefiting NASDAQ in terms of diversification. Whereas the Thomson Reuters’s corporate business acquisition has strengthened its non-transaction based revenue, eSpeed has helped diversify transaction-based income by contributing fixed income revenues.
At the moment, cash equities trading accounts for just 9% of NASDAQ’s net revenue, while derivatives, fixed income, and access and broker services account for 14%, 4% and 13% respectively. Together, these segments comprise NASDAQ’s Market Services division, which is responsible for 40% of its topline. The other 60% comes from Technology Solutions (26% of revenue) and Information Services (23% of total net revenues), both of which provide recurring revenue from long-term client relationships (Press release, NASDAQ OMX, October 23, 2013). We expect the share of non-transaction based revenues to further increase as NASDAQ continues to roll out new products in the data and technology markets.
…And Are Likely To Drive Growth
In addition to providing diversification, the two new acquisitions also provide NASDAQ interesting growth opportunities.
According to NASDAQ’s management, the majority of its clients are currently using only one or two of its products in the corporate solutions market. With the acquisition of Thomson Reuters’s businesses, it has an opportunity cross sell to its clients and increase its revenue per client. The company has already started integrating Thomson’s platforms with its own, and is reorganizing its sales team to better serve its 10,000 customers globally. We expect NASDAQ’s corporate solutions revenue to grow rapidly as some of these initiatives start to have an impact.
The opportunity in the fixed income space is also large. With the acquisition of eSpeed, NASDAQ is now one of the leaders in the electronic government bond trading markets. During the quarter, over $3 trillion worth of U.S. fixed income products were traded on its platform every month, and the figure is likely to increase as it attracts new clients and launches new products. Since the close of the eSpeed acquisition, NASDAQ has already enrolled four new customers and expects to enroll another four by the end of 2013. The pace of new client enrollments could further increase once it finishes work on improving eSpeed’s responsiveness, a stated short-term goal.
Disclosure: No positions.