Nasdaq Shares Dive

The Nasdaq falls 7% on a bad day for exchange stocks.
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Exchange stocks took a pummeling on Friday, as economic worries and an analyst downgrade weighed on the sector.

The

Nasdaq Stock Market

I:IXIC

plunged more than 7% after one analyst gave a fairly pessimistic outlook for the exchange. Shares of

NYSE Group

(NYX)

, the parent of the New York Stock Exchange, also fell $2.26 to $97.84.

Even the normally red-hot derivatives and options exchanges were having an off day. The

Chicago Mercantile Exchange

(CME) - Get Report

fell $5.60 to $530. Shares of the

Intercontinental Exchange

(ICE) - Get Report

fell $2.16, to $97.08, while the

International Securities Exchange

(ISE)

fell $1.07, to $52.11.

Some of the selling in the exchange sector was to be expected given the big run-up in the stocks this year. Overall, financial stocks were under pressure Friday, after a weak report on the health of the manufacturing sector fed fears of a coming economic slowdown.

But the big loser in the exchange sector was the Nasdaq, which is embroiled in an increasingly hostile $5.2 billion bid for the London Stock Exchange.

Rob Rutschow, an analyst at Prudential Equity Group, cut his rating on Nasdaq to "underweight" -- the equivalent to a "sell" rating -- from "overweight" on Friday. He also lowered his earnings estimates by 15 cents for next year, to $1.50 and by 20 cents for 2008, to $1.85.

The potential loss of market share combined with the unlikelihood that Nasdaq will be able to follow through on its intent to purchase the London Stock Exchange -- at least in the near term -- are Rutschow's top concerns.

While Nasdaq has successfully taken market share away from the New York Stock Exchange, the analyst says it is not "protecting its own house" from several electronic rivals.

Starting this quarter, Nasdaq is expected to experience a loss in market share as it makes changes in its trading system. In addition, Nasdaq is getting a run for its money from Better Alternative Trading System, or BATS, an upstart electronic communications network formed by a consortium of Wall Street firms. Nasdaq's also facing a growing challenge from the ISE's new stock-trading platform.

Further, Nasdaq faces a rough battle to obtain the London bourse.

Nasdaq said last week that it would pay $5.2 billion to obtain the 71% of shares of the LSE that it didn't already own. The exchange had previously offered $4.2 billion in the spring, but the bid was snubbed by LSE board members. Nasdaq's latest bid was also rejected.

"We feel a deal is unlikely in the near term," Rutschow writes, given that LSE shareholders will not receive any shares of Nasdaq in the deal, the LSE's stock is currently trading above the bid price, the LSE board has already rejected the offer, while some London politicians are also opposing the offer.

"At this point we feel shares reflect most of the good news and little of the potential bad news," Rutschow writes.

Shares of Nasdaq were down $3.19, to $36.96.

The Big Board, meanwhile, announced late Wednesday that it was eliminating commissions for specialists, opting instead for a revenue-sharing plan for the seven specialist firms on its trading floor. The exchange also expects to reduce specialists' fixed costs through the elimination of their trading and allocation fee.

For the next six months, NYSE plans to pay $53 million to the specialist firms based on certain performance metrics, it says. After that, "the amount of money the specialists share or earn will be based on providing liquidity," says Nelson Chai, NYSE's chief financial officer. "It's a much more pay-for-performance type of model."

Critics say the move is simply short-term relief to a longer-term problem concerning the overall business models of the specialist firms.

"While the NYSE specialists appear to have gained a very short term win with the six-month revenue-sharing program, beyond that, it's anyone's guess," writes Rich Repetto, an analyst at Sandler O'Neill & Partners.

Chai acknowledges that those specialist firms that are better equipped to trade electronically "will continue to do very well," but noted that all the specialists are "an important part of our business model."

"We are trying to create an incentive to align pay-for-performance, if you will, and we're simplifying our fee structures," he says. "This will be an all-in cost reduction, if you will, for the majority of firms that trade on the New York Stock Exchange."

NYSE is also getting rid of the $750,000 monthly transaction fee cap for members and instead will establish a flat fee of less than a penny per share for NYSE-listed transactions.