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Nasdaq's Red Zone Troubles

The exchange can't hit paydirt in its bid for the LSE.

The Nasdaq Stock MarketI:IXIC continues to fumble as it tries to take part in the consolidation sweeping the exchange sector.

Shares of Nasdaq rose more than 3% on Monday after news that the London Stock Exchange rejected its latest $5.1 billion bid for the European bourse -- suggesting investors do not want the deal to go through.

Nasdaq's bid, which had been anticipated, comes eight months after the London exchange rejected an earlier $4.2 billion unsolicited bid. Ever since, Nasdaq has been snatching up large blocks of the LSE's stock in an attempt to position itself for another takeover bid. It acquired a so-called blocking stake, which puts it in the position of rejecting bids from other suitors.

Recently, Nasdaq raised its equity stake in the LSE to about 29%.

Yet all the while, Nasdaq shares have woefully underperformed their peers, which have been some of the hottest stocks on Wall Street. Shares of the Nasdaq are down 3.6% over the last 12 months, while the

Chicago Mercantile Exchange

(CME) - Get CME Group Inc. Class A Report

is up 44%. Shares of the

NYSE Group


, which has been a public company only since March after its merger with Archipelago, have risen 48%.

For now, Nasdaq officials say they will press ahead with the takeover offer, even after LSE executives said it "substantially undervalued'' their operation and "fails to reflect its unique strategic position." LSE officials even rebuffed a request by Nasdaq management's to discuss the offer.

But some on Wall Street are beginning to worry that Nasdaq is wasting precious time trying to pursue a partner that clearly seems to want nothing to do with it.

Clearly, Nasdaq was unable to open a meaningful dialogue with LSE officials during the many months since its first bid.

Critics wonder whether the Nasdaq, by stubbornly focusing on the LSE, is missing out on other potential merger partners. Or, it could find itself acquisition prey for some larger exchange.

"We are concerned that a drawn out acquisition of LSE could be somewhat of a Pyrrhic victory, while other exchanges more easily merge and gain size," writes Rob Rutschow, an analyst at Prudential Equity Group, in a research note. "If Nasdaq is paralyzed by the LSE bid, they may become a takeout target themselves in a consolidating industry."

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Indeed, observers already have pegged Deutsche Boerse, the owner of the Frankfurt Stock Exchange, as a possible buyer of the Nasdaq -- particularly since it rescinded its competing offer against the NYSE for Euronext last week. Others are saying the



, fresh off its red-hot IPO, could emerge as a buyer now that its market cap dwarfs the Nasdaq's.

Meanwhile, as the Nasdaq keeps getting rebuffed by the LSE, some of its peers have been getting hitched. NYSE Group is on the verge of completing its deal with Paris-based Euronext. The CME is going ahead with the acquisition of its crosstown rival

Chicago Board of Trade



But Nasdaq does have a few things going for it.

The LSE faces new competition and that could drive it to do a merger. Last week, seven big investment banks said they plan to launch a European stock-trading platform that will circumvent the exchanges by providing efficiencies and lowering costs.

Others insist that the Nasdaq, by acquiring big blocks of LSE shares, is really in the driver's seat. At the end of the day, they say the LSE will have no choice but capitulate to Nasdaq's overtures.

James Angel, an associate professor of finance at Georgetown Univeristy's McDonough School of Business, says Nasdaq's strategy for the LSE has been "brilliant."

"If another exchange operator wants to buy

the LSE then they basically would have to buy out Nasdaq at a profit, so they would make a quick buck there," Angel says. "The real question is there anybody else willing to pay more than the Nasdaq?"

Angel says it's likely that Nasdaq will win the bid because no other suitor will want to pay more than Nasdaq's bid.

Brendan Caldwell, a portfolio manager of Caldwell Asset Management in New York, says the LSE will merge with some exchange, but it just may not be the Nasdaq.

"London is really going to merge with somebody, but I don't think it's going to be Nasdaq," says Caldwell, whose firm owns positions in both the Nasdaq and LSE. "If they were serious, you would think they would make a bid that's a premium to the market price."