Majestic Research

Crain's New York Business

Nasdaq Rises to Worldwide Powerhouse

By Aaron Elstein
Published: February 24, 2008

Nasdaq Stock Market Inc. is about to undergo what could be called Extreme Makeover: Wall Street Edition.

On Wednesday, the nation’s second-largest stock exchange is slated to complete its $5 billion merger with Stockholm-based OMX Group, a move that will boost Nasdaq overnight into the top ranks of exchanges operating across the globe. That’s just the start. By midspring, Nasdaq will wrap up its acquisitions of exchanges in Philadelphia and Boston, spending $700 million to broaden its product lineup.

When all is said and done, Nasdaq will bear little resemblance to the current exchange. It will morph from a marketplace primarily for technology stocks to one that trades the whole gamut of equities—plus options and futures—while becoming a leading provider of computer systems powering exchanges everywhere from China to Iceland. The organization will swell to 3,000 employees from its current 900.

In the process, Nasdaq will take on a big new investor, Borse Dubai, which is owned by the United Arab Emirates. The stock exchange operator will hold 20% of the shares and will have two seats on the board.

Until now, Nasdaq’s only big acquisition was its $1.7 billion deal in 2005 for Instinet Group, a Manhattan-based electronic trading firm. Analysts wonder if Nasdaq Chief Executive Robert Greifeld and his team will be up to the task of managing—much less integrating—OMX, which runs exchanges in Nordic and Baltic nations.

“This is different, by several degrees of magnitude, from anything Nasdaq has ever done,” says Sang Lee, managing partner at consulting firm Aite Group.

Shareholders seem to be firmly behind Nasdaq’s plans, at least for now. They have bid up its share price by 20% over the past 12 months.

But the recent experience of archrival NYSE Euronext shows how fleeting such gains can be. News hit earlier this month that the Big Board would take longer than anticipated to realize the $250 million in promised savings after last year’s merger with Europe’s largest exchange. The company’s share price plummeted 14% in a single day.

Nasdaq officials readily concede that they face a monstrously large task.

Studying up

“We have a huge amount of work to do,” says Adena Friedman, the Nasdaq executive vice president of corporate strategy who orchestrated the OMX deal. She says that a team of top officials is studying how outfits such as IBM, Goldman Sachs and McKinsey evolved into worldwide powers.

Nasdaq’s record offers little reason for optimism. It has dabbled in overseas expansion before, with unfortunate results. Early in the decade, Nasdaq closed flagging ventures in Japan and Europe. Last year, it was forced to abandon its long quest to buy the London Stock Exchange in the face of unwavering opposition.

Though merging with OMX was plainly Plan B, Nasdaq officials say they have ended up with the ideal partner. They insist that they will be able to grow overseas with their new Swedish and Middle Eastern colleagues in ways they couldn’t have with the London Stock Exchange.

For Nasdaq, the most alluring feature of OMX is the fact that it has forged relationships by developing trading systems for several of the world’s fastest-growing exchanges, including Hong Kong and Bombay. That business generated 40% of OMX’s 2007 revenues of nearly $700 million.

Nasdaq officials are betting they can turn the exchange’s tech customers into trading clients over time. In the near term, Nasdaq plans to use its new base in northern Europe to steal trading business from exchanges—including London and Frankfurt—that are just now opening up to cross-border competition.

“This is a case where the consolation prize is potentially better than the first prize,” says Doug Atkin, CEO of independent research firm Majestic Research and a former CEO of Instinet.

Stateside, Nasdaq expects to close its merger with the Philadelphia Stock Exchange in April and its deal with the Boston Stock Exchange shortly thereafter. The Philadelphia transaction will give a boost to Nasdaq’s business in trading options, a faster-growing and more profitable venture than trading stocks. Boston, meanwhile, will help Nasdaq expand the audience for its market data.

Archrival’s inspiration

The scale of the potential payoff was demonstrated earlier this month when the NYSE reported that despite some difficulties, its merger with Euronext helped double profit margins last year. In the latest front in the never-ending contest between the exchanges, the pressure is now on Nasdaq—whose operating margins were 15% last year—to catch up with the NYSE’s 22%.

“Nasdaq has a big chance to narrow the profit gap with the New York Stock Exchange thanks to the OMX deal,” says Andrew Bischel, CEO of SKBA Capital Management, which owns Nasdaq shares. “The opportunity is theirs to screw up.”