Eye on NYSE-Euronext: The World's Stock Exchange

NYSE Euronext (NYX) is a hotly debated stock and it seems that many of the arguments lack any kind of real understanding of the company. Many of the other derivative exchanges have experienced huge returns as they are going through a period of accelerated revenue growth. A big problem with NYX is the general consensus that they will have decelerating revenue growth as competition and lack of pricing power will hurt them more and more each year. If this is what you believe, then you do not value the company based on the incredible growth numbers they have right now but on what they will be. However, if you believe they will be able to sustain above average growth either by acquisitions or the ability to differentiate themselves from the other exchanges, then this is a stock with a lot of upside from here.

Let's get to some quick numbers:

73.62 share price
265500000 Shares out
$19,546,110,000 Market Cap

1st quarter 2007 for the combined company

Rev 1.116 B
Profit 161 m
EPS .60

1st quarter 2007 for NYSE

Rev 703m
Profit 68 m
EPS .47

Year ago quarter NYSE

Rev 454.9m
Profit 30.3 m
EPS .24

1st quarter 2007 for Euronext (in euros)

Rev 310.1
Profit 99.4
EPS .89

Year ago quarter for Euronext (in euros)

Rev 268.1
Profit 104
EPS .93

Estimates for the combined company

Jun-07 0.63
Sep-07 0.61
2007 2.47
2008 3.36

At first glance at the year over year last quarter comparisons, it looks like NYSE has been experiencing rocket growth with more then 50% rev growth, over 100% profit growth and nearly 100% EPS growth. Euronext actually experienced revenue growth of only about 16% and an EPS decline of about 4%. The thing to keep in mind when looking at these numbers is that the NYSE growth is not sustainable while the Euronext growth is actually better then it appears. For one they had a one time gain in the year ago quarter of 15.5 euros and they had operating growth of 31%. Take the exchange rate of euros into dollars which currently stands at about 1.35 to 1 (that is a huge factor currently but one that can change at any time)

Another very important factor going forward is the estimated cost savings that will be generated by the merger.

Cost and Revenue Synergies Estimate - 375 million by 2009
Technology Synergies Estimate - 250 million by 2009

In my estimates I use a small amount of synergies realized this year and they increase year over year.

Also, if we look at some of the growth estimates going forward, I use both a low and middle ground estimate as I prefer to be conservative in my price targets. These come in at 18% and 25%. These numbers are not static and change with acquisitions, integration problems or better than expected synergies, etc.....

The Bear Case:

The traditional exchanges like NYSE are past their prime and soon the markets will be completely electric and all that will matter is transaction times. This opens up the field for a lot of competition where speed rules in a time when NYX is still playing catch up.

Competition: The major investment banks are doing more deals off the grid and could setup their own exchange. Players like BATS Trading, Direct Edge, CBSX and Liquidnet have come in response to the new technologically advanced world of trading. BATS came with an initial 2 million dollar purchase of some servers running proprietary software and achieved response times of less then a millisecond.

Reg NMS will continue to erode NYX market share. The most significant factor here is the trade-through rule, which states that all customer orders must be routed to the exchange with the best price at the moment the order is entered. This requires the exchanges to be electric and if your execution time (measured in milliseconds) is slower then the next guys it can cost you big money. The NYX hybrid system is not the fastest and is just a stopgap on the way to 100% computerized trading.

Bull Case:

NYX is going to be the world's stock exchange. The financial knowledge and expertise at this company is unmatched and will dominate the global markets.

Growth: Euronext growth will increase even faster now that they are part of the largest exchange and their friendlier regulatory environment will attract more and more business listings. The purchase of a major derivatives player will add the next dimension to the company and push growth higher then even the optimistic analysts are currently predicting. Each acquisition is another opportunity to gain extra top and bottom line growth as well as taking advantage of cost saving synergies.

Competition: It will be a short time before the systems to execute trades is just as fast as everyone else's and what then? The exchanges will have to distinguish themselves from each other in another way. This will give NYX an advantage as speed will cease to be an issue and things like market experience and customer service become the new differentiators.

Let's look at some estimates based on these view points. These estimates use 1x to 1.5x the growth rate for the yearly ranges and accelerated cost synergies in line with the numbers above through 2009. They also add in $2 per share for tangible assets which you can find on their last quarterly balance sheet (again a conservative number)

First the 18% analyst EPS growth estimate:

EPS estimates

2007 2008 2009
2.47 3.2096 4.707
0.25 0.78 1.31 Cost Savings
2.72 3.9896 6.017 Total
50.96 73.81 110.31 Price Low Range
75.44 109.71 164.47 Price High Range

Now the 25% growth analyst estimate:

EPS estimates

2007 2008 2009
2.47 3.4 5.225
0.25 0.78 1.31 Cost Savings
2.72 4.18 6.535 Total
70 106.5 165.37 Price Low Range
104 158.75 247.06 Price High Range

This should give you some numbers to think about as you watch what the company does. How well is the merger coming, what acquisitions will they do and what other exchanges are they buying stakes in? Is the market share erosion being stopped, is Euronext growth high enough, is the exchange rate staying favorable, is the Hybrid system fast enough, will people see value in the human element?

We will see.

I leave you to make up your own minds and with a few more numbers.

Rank Trade Date NYSE Group Volume in all Issues Traded

1 6/22/2007 5,194,963,971
2 2/27/2007 4,121,107,134
3 6/8/2006 3,853,137,605
4 6/30/2006 3,805,582,057
5 6/24/2005 3,628,163,970
6 2/28/2007 3,616,825,632
7 3/1/2007 3,616,626,850
8 9/16/2005 3,592,236,910
9 6/13/2006 3,431,464,134
10 11/30/2006 3,388,988,735

Short Interest 12.78 m
Short Ratio 2.4
Short %4.9

Yield 1.3%

PEG based on 25% growth: 1.19
PEG based on 18% growth: 1.65

Next resistance level - 80
Next support level - 72.50

NYX 1-yr chart

Disclosure: none

Comments

[frank baroukh:]

Great article!!!!!If we look at eps growth I get 48%.....not 18% or 25%.

2006 2007 2008 2009
EPS 1.64 2.48 3.40 5.22
GROWTH 51% 38% 54%

I feel like a raging bull. What am I doing wrong????

Frank

2007 Jul 05 12:47 PM

[Leonard the...:]

Thank you,

The eps growth rates I used were analyst estimates on average over the next 5 years not including the cost saving synergies as they are not factored into the current eps numbers. You make a good point that with the synergies factored in the EPS growth is very impressive. However if you believe as some analysts do that they will not be able to continue growing their bottom line by more then 18% then the stock range is about 50 to 75 with the synergies factored in for this year.

What makes this story so interesting is that there is so much uncertainty surrounding how NYX will continue to maintain a high growth rate going forward. There are also questions about how long it will take for the cost saving synergies to really take hold.

I don't think your doing anything wrong. If you believe in the story and the successful expansion of NYX then the stock is undervalued.

2007 Jul 06 08:25 AM