Majestic Research

Bloomberg.com

Takes 213-Year-Old NYSE Public, Faces Nasdaq

Published: March 08, 2006

The New York Stock Exchange ends 213 years of private ownership today, clearing the way for Chief Executive Officer John Thain to complete a push into automated trading with the acquisition of Archipelago Holdings Inc.

Thain, 50, is conducting the biggest overhaul of the NYSE in almost three decades. His effort culminates at 9:30 a.m., when shares of NYSE Group Inc. begin to trade. Thain will ring the opening bell.

As Thain transforms the exchange, he has been unable to prevent Nasdaq Stock Market Inc. from taking more of the trading in NYSE-listed companies. The Big Board’s share of trades in its own stocks fell to 71.7 percent in January, the lowest since the exchange began collecting data three decades earlier, from 79.6 percent a year earlier, according to the NYSE’s Web site.

“You can’t sit back and let the prestige of 213 years carry you through,’’ said Edward Wedbush, president of Wedbush Morgan Securities Inc., a 51-year-old Los Angeles-based brokerage that trades shares listed on the NYSE and Nasdaq. ``The exchange needs to be pretty aggressive. It’s going to be a real challenge, and it starts today.’’

Thain, a former Goldman Sachs Group Inc. president, also needs to please shareholders, who will demand profit growth—just as they do for the 2,800 companies listed on the NYSE, the world’s biggest stock exchange. To start, he’s pushing NYSE Group deeper into options, a market where trading is rising faster than for common stocks, and preparing to more than quadruple the number of corporate bonds traded on the exchange.

Modernizing the NYSE
A graduate in electrical engineering from the Massachusetts Institute of Technology, Thain is relying on new computer systems to modernize a trading culture that dates back to the NYSE’s founding under a buttonwood tree in 1792.

Thain has another incentive in the U.S. Securities and Exchange Commission’s Regulation NMS, which requires brokers to send orders to the exchange that can instantaneously execute the trade at the best price. Reg NMS takes effect in June.

Nasdaq, founded in 1971, is already all-electronic. In an effort to take an even greater share of trading in NYSE-listed stocks, it started offering discounts last month. Nasdaq pays a rebate to customers who send certain orders for NYSE-listed stocks through its Brut brokerage unit.

Nasdaq’s Inroads
Brut started trading Big Board stocks a year ago and now handles about 7 percent of the volume in NYSE-listed shares, according to the NYSE’s Web site. By 2007, the exchange may be left with only a 60 percent share compared with 20 percent for Nasdaq, according to Richard Herr, an analyst at New York-based Keefe Bruyette & Woods.

“The big risk on the horizon is Nasdaq’s crusade to take market share of trading in NYSE-listed stocks from the Big Board,’’ said Doug Atkin, whose New York-based firm, Majestic Research LLC, turned pessimistic on shares of Archipelago and Nasdaq this month after recommending them to clients in 2005. “These stocks have run up and Nasdaq is taking on the NYSE, so you better be careful.’’

Even Archipelago, which like Nasdaq trades electronically, recognized the NYSE’s vulnerability. After the two companies announced their combination in April 2005, Archipelago was forced to pull advertisements in New York’s subway depicting the Big Board as a fossil.

Relative Values
The NYSE’s adherence to tradition and not-for-profit status had a cost. The exchange earned $65.2 million last year, excluding expenses it said were related to the Archipelago purchase, on revenue of $1.12 billion, for a profit margin of about 6 percent. Nasdaq’s margin for 2005 was almost 10 percent.
Still, shares of NYSE Group are about twice as expensive as those of Frankfurt-based Deutsche Boerse AG, Europe’s biggest exchange by market value. The exchange’s initial value of $10.1 billion was third behind Chicago Mercantile Exchange Holdings Inc. and Deutsche Boerse.

NYSE Group is trading for about 35 times projected 2007 earnings, according to Bloomberg calculations based on data from a November regulatory filing.

The Standard & Poor’s 500 Index fetches 15 times its projected earnings.

The stock is benefiting from a global rally in shares of securities exchanges that’s now in its fourth year. Exchanges have benefited from rising markets, increased share trading and the ability to charge higher prices. Archipelago’s shares more than tripled after the deal with the NYSE was announced.

Membership Payouts
Each of the NYSE’s 1,366 members received about $5.45 million in cash and stock of the combined company. Each member will also receive a one-time dividend of about $70,600, the NYSE said yesterday. Shares of Archipelago were swapped one-for-one for those of NYSE Group.

NYSE memberships climbed to as high as $4 million last year from $1.05 million at the end of 2004, which was close to a 10- year low. The price declined as electronic trading undermined opportunities for floor traders.

Thain’s first step to compete better is a project he endorsed soon after arriving at the NYSE from Goldman in January 2004. The so-called hybrid market marries the floor traders’ world of shouted orders with fully automated buying and selling.

Under the hybrid system, floor brokers have the option of completing trades through NYSE specialists, individuals who make markets in certain stocks, or routing them electronically. The result may be big reductions in the 3,000 brokers and clerks who work on the Big Board’s floor each day.

For now, the hybrid market will co-exist with Archipelago.

Profit Goals
NYSE Group expects to increase profit fourfold over the next two years as it reduces costs and expands into new business such as options trading, according to a November filing with the SEC. Its operating margin, or pretax profit as a percentage of revenue, would climb to 30 percent in 2007, up from about 8 percent in 2005 for the Big Board alone.

“One would think that it has the stature and finances to just about do whatever it wants to do,’’ said Ted Weisberg, president of Seaport Securities Corp., an NYSE brokerage.