Nasdaq Accepts Credit Rating Risk in Quest to Expand
For Nasdaq (NDAQ) OMX Group Inc., the benefits of expanding into electronic bond trading justify the risk of a lower credit rating.
The second-biggest operator of American equity exchanges agreed yesterday to acquire eSpeed, a platform for U.S. Treasuries, from BGC Partners Inc. (BGCP) for $750 million cash, or $1.2 billion should sales goals be met. Moody’s Investors Service said Nasdaq’s Baa3 senior rating may be cut following the deal.
Robert Greifeld, Nasdaq’s chief executive officer, is joining other exchange executives using takeovers to boost profit amid declines in stock trading. Even if Moody’s takes action, Nasdaq is less vulnerable than rivals CME Group Inc. and InterContinental Exchange Inc., which depend on higher credit ratings for their businesses of guaranteeing trades.
“At the end of the day, the credit rating isn’t as vital as it would be for CME or ICE, which have major clearinghouses,” according to Chris Allen, a New York-based exchange analyst at Evercore Partners Inc. (EVR) “Nasdaq saw an opportunity to diversify into another asset class, fixed income, which has potential structural catalysts to drive growth longer- term.”
BGC shares rose 37 percent in trading after the market closed, paring a gain that exceeded 90 percent. Nasdaq will also issue about 15 million common shares over 15 years as part of the acquisition, pushing the potential value of the transaction to $1.23 billion, according to e-mailed statements by the two companies. ESpeed, founded by Cantor Fitzgerald LP in 1996, is used by banks worldwide to trade bonds and currencies.
The transaction, along with the purchase of a shareholder- relations unit of Thomson Reuters Corp. in December, will add about $1 billion to Nasdaq OMX’s debt, according to the statement by Moody’s. Nasdaq shares slipped about 0.3 percent in after-hours trading to $31.91.
“Moody’s will examine the capacity of Nasdaq OMX to reduce leverage which is partly a function of the execution risks facing the firm as it integrates these two acquisitions at virtually the same time,” Moody’s wrote. The company has “repeatedly shown a willingness to increase leverage” and will face more such decisions “in an industry prone to consolidation,” it wrote.
Rating companies “will come to their own conclusions” and Nasdaq has “communicated our commitment to maintaining our investment grade status,” Lee Shavel, the chief financial officer, said in a conference call with analysts yesterday. The company plans to reduce leverage over time, he said.
“We also get credit for being operationally strong and for integrating our transactions well,” he said. “Hopefully all these elements will come into play here.”
The acquisition price is about 10.9 times eSpeed’s earnings before interest, taxes, depreciation and amortization in the past 12 months, compared with Nasdaq’s valuation of 8.1 times, Shavel said. The multiple is similar to exchange companies with the fastest growth, such as derivatives venues, he said.
Swings in government bonds have been “artificially depressed” by Federal Reserve asset purchases, Nasdaq said in the release. Volatility in Treasuries as measured by Bank of America Merrill Lynch MOVE index has averaged 58.74 this year, down from 79.42 in the first three months of 2012.
Fully electronic volume on the eSpeed and BGC Trader system, including new products, was $48.2 trillion for the year ended December 31, 2012, down 15.7 percent from $57.2 trillion for 2011, BGC said in the 10-K. Combined voice-assisted and screen-assisted volume for the year for 2012 was $190.7 trillion, down 1.8 percent from 2011.
ESpeed will be a core asset for Nasdaq and allow the exchange operator to expand into other areas of fixed income, Greifeld said on the conference call. While the company expects the transaction to add to earnings in a year, that wasn’t the rationale for buying it, he said.
“We have a tremendous opportunity to cross-sell within our existing customer base that did not exist as eSpeed is buried into BGC,” he said. “The margins are high, so we don’t have to grow revenue by some ungodly amount to have a tremendous return for our shareholders.”
The company will move the eSpeed platform into its data center in Carteret, New Jersey, to reduce technology and operational costs, Greifeld said. It will continue to use the platform’s technology for Treasuries, he said.
Nasdaq OMX’s share of trading in equities has fallen since 2007, when 46.1 percent of volume in Nasdaq-listed companies occurred on its main market. About 23.3 percent was done on its main market in the last quarter, according to data compiled by Bloomberg. Altogether, Nasdaq OMX had 18.4 percent of all equities trading across its three exchanges in the first three months of this year.
While shares of Nasdaq have climbed 61 percent since the end of 2009, they remain down 36 percent from their 2007 high of $50 on Dec. 26, 2007.
BGC Partners was created in April 2008 when Cantor Fitzgerald LP combined eSpeed with its London-based broker- assisted bond trading unit. Cantor founded eSpeed during the dot-com rally of the late 1990s and took it public in 1999.
BGC’s stock dropped 59 percent over the last two years to $3.85 at the close of trading today, according to data compiled by Bloomberg. The shares jumped as high as $7.57 after exchanges closed and was trading at $5.26 as of 6:03 p.m. in New York.
The electronic trading platform for on-the-run U.S. Treasuries, including related market data and co-location businesses that Nasdaq is buying, generated about $100 million of revenue last year, less than 6 percent of BGC’s total, Howard Lutnick, its chief executive officer, said in the statement. The total sale may be about as large as BGC’s fully-diluted market value, he said.
“We think that the market was clearly under-valuing the assets of the company,” Lutnick said. “This transaction should better enable investors and analysts to place an accurate valuation on BGC’s assets post-closing.”
BGC, part-owned by Cantor Fitzgerald, has been diversifying into commercial real-estate by buying a series of brokerages as bond trading slows. It will keep its voice and hybrid brokerage and electronic business for off-the-run Treasuries and other fixed-income products, the company said.
“For BGC, this is a huge deal because their all-in price was higher than the market capitalization was,” Jillian Miller, an Atlanta-based exchange analyst at BMO Capital Markets, said in a telephone interview. “BGC saw this as an opportunity to sell off this piece that isn’t affected by the regulatory environment and realize some value for it.”
Fully electronic volume in the rates market, which includes Treasuries and European and Canadian sovereign debt as well as overnight repurchase agreements, interest-rate swaps and futures on eSpeed, declined 19.8 percent for the last three months of 2012 from the same period the year before to $9.7 trillion, according to BGC’s 10-K report filed March 12.
Total volume, including electronic and so-called hybrid volume conducted by BGC brokers, rose 15.6 percent to $44.4 trillion during the same period, the report said.
The number of fully electronic transactions in Treasuries declined 35 percent to 3.2 million in the last three months of 2012 from the same period the year before, while hybrid transactions grew 15.5 percent to 619,000 during the period.
The purchase comes as Greifeld seeks to push into European derivatives, dominated by Deutsche Boerse AG and NYSE Euronext (NYX) Liffe exchange. The company is setting up a London market called NLX, buying a 25 percent stake in The Order Machine, a Dutch alternative securities-trading system focused on stocks and equity derivatives, and seeking a greater share of energy products in Germany.
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