As if fighting a war for global domination weren't hard enough,
Nasdaq Stock Market
find themselves facing off in another arena: capital markets.
With merger speculation sweeping the industry, executives of the two biggest U.S. stock exchanges are preparing plans to woo institutional investors as part of efforts to sell large slugs of stock in an unusually competitive market. While the deals differ in size and key details, both are viewed as crucial steps in the larger ambitions of the two exchanges to expand their reach through Europe and possibly beyond.
According to people close to the deal, the Nasdaq was first out of the gate with details of its planned follow-on offering, with calls to institutional investors going out on Monday. The company plans to raise at least $750 million to pay down some of the debt the company incurred to buy 14.9% of the London Stock Exchange, with many expecting it to use the excess borrowing capacity buy more LSE shares.
A planned secondary offering by the NYSE, meanwhile, is a cornerstone of the company's corporate finance strategy, allowing longtime owners, including many seatholders of the exchange, to cash out in a relatively hot market for their shares. Because of the potential for share dilution, however, the deal must be virtually completed before the NYSE can push forward with its own acquisition battle plan.
With competition this pitched, investors could find themselves in an enviable position.
There is "plenty of stock available for exchange investors," Sandler O'Neill equity analyst Richard Repetto wrote in a research report. "Investors of exchange stocks will have plenty of opportunity to gain exposure to the two prominent U.S. cash equity marketplaces."
Both stock sales will require marketing, a so-called roadshow in which senior management presents updated company information to interested investors. The Nasdaq is expected to meet with potential buyers this week in order to fill its request to sell 18.5 million shares.
The main question for the Nasdaq involves its balance sheet. Can the company manage the growing amount of both debt and stock it is piling on to pursue its global ambitions?
On the more immediately urgent issue of share dilution, at least one analystbelieves the offering won't do undue harm. According to Repetto, the secondary offering could actually be "accretive" to the Nasdaq's earnings, meaning the money raised could be invested at a return that more than offsets the EPS-reducing impact of 18.5 million new shares.
What might that investment be? LSE shares. Repetto says that if the Nasdaq can find another seller and boost its stake to 20%, it would be permitted to recognize the investment as a minority stake for earnings purposes and actually generate a sufficient return on the stock sale to offset its dilution.
Part of the reason for Repetto's optimism is that, at current prices, the Nasdaq is getting top dollar for its own earnings when it sells stock. After falling $1.50, or 3.6%, to $39.50 on Monday, shares were trading at 59.3 times this year's Thomson First Call consensus estimate of 67 cents a share, and 25.3 times the 2007 estimate of $1.57 a share. The valuation doesn't bother some of the analysts --
and Sandler O'Neill both have buy ratings -- and getting a deal done at this price could be crucial to preserving the company's financing options.
Longer term, investors are going to be worried about the Nasdaq's plans to increase its debt level. If the company uses a $1.9 billion debt facility that
Bank of America
recently put together to make a move, its interest expense over the coming months could suffocate shareholder returns.
Beyond financials, the company faces a particularly cranky market. Using the Nasdaq's last equity offering as a proxy, selling this deal won't be easy. The company issued 14 million shares in early February at $40 per share, and watched the shares trade south soon after. Back then, of course, the equity market for new issues was coming off one of its hottest stretches in years.
Still, when compared with the NYSE, the Nasdaq has one thing going for it: transparency.
"This is an interesting time
for an equity offerings when all of this
speculation is swirling," said Howard Horowitz, director of research at the Arbitrage Fund. "I think that the investors have to focus on the fundamentals."
To date, the Nasdaq has been more forthcoming and relatively predictable about its business model -- cheap trading on purely electronic exchange -- something that equity investors will like when calculating risk. Conversely, the NYSE has avoided the market's questions about how it plans to set prices on its emerging "hybrid" market. In its most recent meeting with analysts last Friday, the company "did not disclose any materially new information," according to a report from equity analyst Richard Herr at Keefe, Bruyette & Woods.
According to Sandler O'Neill's Repetto, "Management was unwilling to comment on any potential changes to pricing, especially the caps on transaction fees that currently limit revenue growth." Repetto was speaking about fee breaks the NYSE gives to large broker-dealers in which the company limits charges for those who trade heavily on the NYSE.
According to NYSE insiders, the company tried to change those trading caps last year by approaching large broker-dealers to discuss lifting the fee incentives. One insider compared the situation to
asking people how much they wanted to pay for toilet paper. "It was a complete disaster," he said.
That fee challenge lies at the heart of the problem for the NYSE and what it will do about the fundamentals of its business in the future -- without any consolidations. For now, the NYSE wants to avoid those questions, asking investors for their trust in marketing the secondary.
To be sure, with John Thain and Jerry Putnam doing the marketing, the "trust us" strategy may work. The two men, both Wall Street veterans, know how to play to the interests of potential shareholders, and the team was obviously impressive in its first presentation to equity analysts on Friday.
"We were encouraged by Jerry Putnam's candor in discussing the challenges facing NYSE in rationalizing the legacy systems, and it seems to us he is taking a page out of the Archipelago playbook," said KBW's Herr.
On Monday, NYSE shares lost $3.81, or 5.2%, to $70.04, falling after the LSE put out a statement saying they had received no overture from the Big Board. The stock is now valued at 52.7 times this year's $1.34 earnings per share estimate and 34 times the 2007 $2.08 estimate, according to Thomson Financial.
Although the NYSE has said its secondary will be $100 million, technically far more shares could easily be sold. And now that exchange equity is going to flood the market, it is time for investors to make a decision.