Nasdaq stock (ticker NDAQ) is in the same place it was 8 years ago, in late 2005. At the time, the stock had ripped from around $10 to around $40 in 2005 as the stock nearly doubled earnings from 0.39/share in 2004 to 0.73/share in 2005. That extraordinary earnings growth would quickly slow, and the stock is just now reaching those prior levels after years of stagnation:
Years of business changes and market transformations are encompassed by that simple stock chart. Exchange volumes have migrated from large institutional blocks to small high frequency orders, the trading mix has increasingly shifted away from cash equities towards derivatives, and the Nasdaq group has diversified away from its simple technology exchange (though that’s still the bulk of the business).
The Nasdaq group is split into 4 divisions:
- Market Services – This is the core division that still makes up more than 60% of revenues. The company’s description: Our Market Services segment consists of our U.S. and European cash equity, fixed income and derivative trading and clearing businesses and our Access and Broker Services business.
- Listing Services – This division helps to take companies public in the U.S. and European markets. It makes up less than 10% of revenues.
- Information Services – This is essentially Nasdaq selling its market data to the 2.5 million market participants who want detailed Nasdaq market data, whether institutions or retail traders. About 15% of revenues.
- Technology Services – Includes the recent purchase of Thomson Reuters’ Corporate Solutions Group. That corporate solutions group is designed to aid companies in board and executive management. The technology group within this division is, in the company’s own words, a leading global technology solutions provider and partner to exchanges, clearing organizations and central securities depositories. About 15% of revenues.
The fastest growing division in 2013 was the Technology division, due to the purchase of the Corporate Solutions group. The largest division, market services, actually saw revenues decline 0.3% year over year, while the other divisions only showed modest growth. Overall, earnings growth has been non-existent for Nasdaq for the past few years, hampered by a weak trading environment overall.
Nasdaq has earned around $2.50 per share in 2011, 2012, and 2013, driven by the Market Services group. The company’s characterization of the business environment in the most recent 10-Q:
Currently our business drivers are defined by investors’ and companies’ cautiously optimistic outlook about the pace of global economic recovery. As the global economy continues to avoid the intermittent crisis environments of 2010-2012, we are experiencing modest growth in many of our non-transactional businesses. Since a number of significant structural issues continue to confront the global economy, instability could return at any time, resulting in an increased level of market volatility, oscillating trading volumes, and a return of market uncertainty. In contrast, many of our largest trading customers continue to adapt their business models as they address the implementation of regulatory changes initiated following the global financial crisis, leading to lower trading volumes. In the third quarter of 2013, the U.S. and European cash equity trading and derivative trading and clearing businesses experienced a decrease in volumes due to lower industry trading volumes. Steady performances by major stock market indices and consistently low volatility during the third quarter of 2013 helped to boost the U.S. IPO market.
The key here is that they are only experiencing growth in their “non-transactional” businesses. They are struggling to stay even on the transactional side of the ledger. The IPO boom in the second half of 2013 has been a definite benefit, but the slide in trading volumes is an ongoing concern. More highlights:
Average daily matched equity options volume for our three U.S. options exchanges decreased 3.3% compared to the third quarter of 2012, while overall average daily U.S. options volume decreased 1.4%. The decrease in our average daily matched options volume was driven by a decrease in overall U.S. options volume as well a decline in our combined matched market share for our three U.S. options exchanges of 0.6 percentage points;
Average daily matched share volume for all of our U.S. cash equity markets decreased by 12.8%, while average daily U.S. share volume fell by 3.7% relative to the third quarter of 2012. Volatility, often a driver of volume levels, was lower in the third quarter of 2013 compared with the same period in 2012
In this context, what’s the reason for the stock’s nearly 50% gain in 2013? Well, in a generally prosperous environment for stock valuations as a whole, NDAQ’s P/E multiple finally bounced off of its low base:
[caption id="attachment_34174" align="alignnone" width="505"]
NDAQ trailing 12 month P/E, Courtesy of Bloomberg[/caption]
At 16.5x its trailing 12 month P/E, NDAQ still looks quite reasonably priced even after the strong 2013 performance. Moreover, analysts are actually modeling in 10-15% earnings growth for the next 2 years, though a lot of that depends on a continued strong IPO market and better trading volumes, both far from sure things.
Goldman Sachs, which has a sell on the stock, offered the negative view heading into 2014 in its research report in October after earnings:
NDAQ’s 3Q EPS of $0.66 beat our $0.59 estimate largely on lower costs (3% below GS). That said, NDAQ’s higher margin businesses remained under pressure with revenues from Market Services (ex-eSpeed) down 1.5% y/y (+4% q/q), and the recently acquired Corporate Solutions business will likely drive 2014 margins lower. While NDAQ’s cost management has clearly been solid this quarter, our estimates move up only modestly and we remain below consensus as the revenue backdrop remains soft.
NDAQ needs to see revenue growth in 2014, not just more cost control. However, at a valuation that is much more reasonable than most comparable companies in the market (both its own sector and otherwise), we do see a potential for strong stock performance for NDAQ even if the overall business remains tepid. For now, we have it on our watch list as a potential long.