NASDAQ-NYSE Deal: A Revolution?

On Friday, NASDAQ OMX Group Inc. (NDAQ) and IntercontinentalExchange Inc.’s (ICE) initiative to acquire NYSE Euronext Inc. (NYX) for $42.50 per NYSE share in a joint bid blew in as a wind of change. The transaction would be one-third in cash and two-third in stock, making the deal worth approximately $11.3 billion. This is about 15% higher than the earlier proposed merger between NYSE and Deutsche Boerse of $10.0 billion.

NASDAQ and ICE plans to finance the cash portion of the deal through cash on hand and a combined financing of $3.8 billion. Additionally, the proposal by the companies have been well-received by a group of banks including Bank of America Corp. (BAC) and Wells Fargo & Co. (WFC) given the companies’ strong cash flows that ensures timely repayment of the debt.

While ICE is expected to take over NYSE’s European futures markets (Liffe, Liffe U.S.) and the over-the-counter clearing business (NYPC), NASDAQ is expected to take care of the remaining businesses of NYSE, such as the NYSE Euronext stock exchange in New York as well as the U.S. options business. However, NASDAQ and ICE will continue to operate their businesses as separate entities even after the proposed merger.

Following the successful closing of the proposed NASDAQ-NYSE deal, this transaction is expected to generate $1.8 billion in revenues and create net synergies worth $740 million that will be fully realized by the end of the third year. Moreover, the deal is expected to be accretive within 12-18 months and will achieve double-digit growth beyond that period.

Apprehensive About NYSE-Deutsche Deal

Since the NYSE-Deutsche merger announcement in February this year, NASDAQ has been desperately hunting for a partner to make counter-bid to acquire NYSE, in order to retain its market value and strength in the industry.

NASDAQ fears that the culmination of NYSE-Deutsche deal will diminish the former’s size and global footprint. The prospective deal’s combined exchanges and clearing houses would generate an annual €4.0 billion ($5.5 billion) in revenues, more than any other exchange group.

Additionally, this would out beat all the exchange operators with the largest derivative business, representing 37% of net revenue against NASDAQ’s 17% of net revenue as reported in 2010. Even the next biggest operator, CME Group Inc. (CME) in the US, with €2.3 billion in revenues and holding 98% market share of the US futures trading, would lag far behind the NYSE-Deutsche combination.

While NYSE amalgamates several exchanges such as those in Paris, Brussels, Amsterdam and Lisbon, NASDAQ owns the NASDAQ stock market and the Scandinavian exchanges. A merger would help NASDAQ tap all these European markets as well.

Diversion to Derivatives

Moreover, the rapidly developing infrastructure and technology has pushed down the cost of trading and security in the exchange industry. This has also been narrowing the ambit of expansion in the equity stock trading, which was previously supposed to be the primary business of the exchange operator. The industry has now evolved to expand its growth opportunities by trading in the futures and options or the derivative market.

For these reasons, NASDAQ has been losing its market share, which is more concentrated towards equity stock trading. Hence, it has made a joint bid with ICE that will be able to take over the derivative business of NYSE.

Recently, the stock exchange industry has aligned itself with the changing market needs and has consequently become a hub for M&A activities. While London Stock Exchange (LSE) is on its way to complete a merger with Toronto Stock Exchange owner TMX Group, the Singapore Exchange and Australia’s ASX is also undergoing rigorous reviewing of its own merger plan.

Also, BATS, one of the most successful American stock exchanges, completed its deal to buy Chi-X Europe to bolster its presence in Europe early this year.

NYSE Bid: A Precarious Scenario

Meanwhile, the NYSE-Deutsche merger is facing intense probing due to its anti-competitive vertical silo model. This is also expected to delay the final execution of the deal, paving way for other exchange operators to bid for NYSE.

However, a counter-bid in the NYSE-Deutsche deal appears to be slightly restrictive since the agreement of the deal includes a $337 million break-up fee in case the deal is spoilt by a new bidder and tax issues, among others. Even a joint bid from NASDAQ and ICE further involves lot of regulatory, political and commercial hurdles, since merger of NASDAQ and NYSE would mean erosion of competition in the industry as they both are the primary peers.

Concerns about the bulk layoffs have been raised, which could adversely impact the unemployment index. Alongside, the debt burden associated with the proposed deal also drove rating agencies Moody’s and Standards and Poor’s to down their outlook on NASDAQ from stable to negative.

On the other side, though, the NYSE-NASDAQ merger is also seen as an employment raising mode with increased capital gearing coupled with enhanced transparency and liquidity.

This combination of the global top two exchanges would also become one giant force in all major business lines by innovating and uniquely handling competition, which are the intrinsic qualities of a healthy business. The combination could also prove favourable for ICE, who is also weighing its M&A options in the ongoing industry furor.

However, we believe that uncertainty prevails over most of the exchange operator’s future course of action. The sudden business restructuring in the stock exchange industry reflects the rapid need to respond to the changing dynamics of modern finance. These are primarily driven by the increased demand for greater international services and intense competition, which have led the traditional exchange companies to dig in opportunities for gaining scale and services.

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