Updated from 7:11 a.m. ESTWall Street's old boy network will die another death Wednesday, but it's still too early to pronounce the species extinct. With Richard Grasso still hectoring from backstage, the New York Stock Exchange takes a giant step into the future with its debut as a publicly traded stock and shareholder-owned institution. The NYSE Group will begin trading this morning on -- where else? -- the New York Stock Exchange, under the symbol NYX. After 213 years as a nonprofit, member-owned exchange, the Big Board emerges from its merger with Archipelago as a power that even its adversaries would concede still commands respect. Among other things, the exchange will be the site of fully half of all U.S. stock transactions, according to Morningstar. Still, not everything is solved by the coming of the stock, which is being effected through a reverse merger that has enriched existing seat-holders. For one thing, Grasso, the antic former chairman who was ousted in 2003 when his $193 million pay package came to light, refuses to stop making news. He was reportedly deposed for several hours Tuesday by lawyers for New York Attorney General Eliot Spitzer, who sued Grasso in 2004 seeking the money's return. Grasso told reporters that it's "way too late" to settle the complaint. John Thain, the current chairman of the NYSE, has so far made good on his promise to change the Big Board's bad ways, of which Grasso's pay was just the most noticeable symptom. Scandals in 2003 revealed that the position of specialist firms who conduct trading on the floor of the Big Board was riddled with conflicts. Not only the specialists, but the system that feeds them has been fodder for critics. The NYSE has to this day remained committed to an archaic system of trading -- the open-outcry auction -- while most of the rest of the world has embraced the all-electronic format that goes on at the Nasdaq. Archipelago will go some of the way to altering that.
With Archipelago's electronic trading, the NYSE will be able up to speed up transactions and lower their costs for most investors. Another modernization could be a merger of the NYSE's regulatory oversight of floor trading with that of the National Association of Securities Dealers. Thain is also considering expanding trading hours, which would boost volume. But it remains to be seen if the former Goldman Sachs executive has the critical mass to overcome entrenched interests and push his initiatives through. Another question involves the NYSE's stock. Given its already rich valuation, is there anywhere to go but down even if Thain does succeed in bringing the company into the 21st century? Right now, would-be shareholders must consider what they are paying to own a piece of history. The NYSE's own listing on Wednesday isn't an initial public offering -- it's a relatively complex transaction with an existing (albeit smaller) public company that already has a market valuation. And that valuation, like most publicly traded exchanges nowadays, is high. Shares of Archipelago have surged 260% since April 20, 2005, when the deal was first announced. On Tuesday, shares of Archipelago fell 4.3% to $64.25. The new NYSE stock opened Wednesday at $67, and was recently trading at $70.60. As of Wednesday, each share of Archipelago becomes a share of the NYSE. Current Archipelago shareholders will retain 30% of the new company while the NYSE's more than 1,300 seat-holders will inherent the remaining 70%. A secondary offering is expected later this month or in April. Many observers, including Barron's, have noted that with a price-to-earnings ratio of 49, NYSE Group will be richly priced. For Morningstar analyst Philip Guziec, the stock's fair value is about $10 below its current quote. He is positive that the NYSE's revenue growth will stay in the midteens over the next five years, in line with the growth in U.S. equity transaction volumes. With 50% of market share and the group expanding into new trading areas such as bonds and derivatives, operating margins should expand "significantly," Guziec writes in a recent report.
However, he sees risks to his valuation estimate coming mainly from competition from other electronic exchanges, which would put further pricing pressure on transactions. In addition, equity transaction volumes can be volatile, and this also affects the stock of the firms that process them. "Listing stocks is a brand-driven, wide-moat business, with an NYSE listing considered the gold standard," Guziec says. "However, trade execution is a narrow-moat business, generating a per-share trading fee." As it tries to expand into new products, the NYSE's biggest competitor will be the Nasdaq ( NDAQ), the king of electronic trading, especially after its acquisition of Instinet. Not coincidentally, Nasdaq announced Monday that investors will have a commission-free access to the popular Nasdaq 100 Trust ( QQQQ) exchange-traded fund through broker-dealer MyStockFund Securities. "The NYSE has not been a global leader in getting new types of products on its exchange," writes Roger Nusbaum, portfolio manager with Your Source Financial, and a RealMoney.com contributor. "The fact is the NYSE was not first with a gold ETF, was not first with an oil ETF, and there are other markets not easily accessed through NYSE listings." Hedge funds are increasingly interested in futures-based products, not domestic equities. Meanwhile, the cost of regulatory oversight is leading some foreign firms, such as Australia's Cole Myer, to delist from U.S. markets, Nusbaum notes. He sees the London Stock Exchange offering more value to investors, with its gold and oil ETFs and its international footprint. NYSE's Thain has made no secret of his ambitions to fight back by expanding, and he's widely thought to be eyeing another big exchange, perhaps in Europe. Some even view the exchange's high valuation as evidence people expect it to make a monopolistic, domestic acquisition. "The market may be signaling that the country may end up with a single dominant, concentrated equity and options market, the NYSE, regulated as a public utility by the SEC -- an event that I view as ill-advised and most unfortunate," Ohio State University Law Professor Dale Oesterle wrote on his blog in May 2005. In that case, the regulatory troubles symbolized by Grasso at the NYSE might not be relegated entirely to the past.