Mixed Approach on NASDAQ - Analyst Blog

We have reiterated our Neutral recommendation on NASDAQ OMX Group Inc. (NDAQ) based on the current market volatility. NASDAQ's third quarter earnings of 50 cents per share beat the Zacks Consensus Estimate although it declined year over year due to modest top line growth coupled with moderate expense management. However, market data revenue and order intakes were on the downside. The new listings were also lower-than-expected.

Nevertheless, NASDAQ continues to drive its operating leverage through a strong expense management, headcount reduction, lower taxes and fewer charges. Additionally, successful integration efforts associated with NASDAQ's business combination with OMX and the Philadelphia Stock Exchange acquisition also contributed to expense reductions. As a result, the company had also contracted its expense outlook for 2010 although some additional expenses are projected on account of the recent SMART group acquisition.

Further, NASDAQ enjoys a healthy balance sheet based on strong cash flow and a diverse business model. Additionally, strong debt and credit rating upgrades in 2010 also reflect sound financial outlook and improvement in operating efficiencies. Besides, NASDAQ continues to return value to its shareholders through the ongoing share repurchase program, thereby retaining investors confidence in the growth potential of the stock.

However, NASDAQ continues to suffer from an eroding market share and weak trading volumes, which is directly affected by economic and market conditions, volatility of interest rates, inflation and price level. Besides, government regulations such as restrictions on high frequency trading and taxes on securities transactions could have an adverse effect on the overall trading volumes.

These factors are also weakening the market, transaction and issuer services exchange revenues that have been plummeting on lower average net fee per share, decreasing trading activity and market competition. Hence, NASDAQ has been experiencing sluggishness in its top line growth too.

Further, NASDAQ has been facing intense competition that tends to reduce the market share and the leverage of its business. While arch-rival NYSE Euronext Inc. (NYX) has been snipping off market share, more trading platforms such as CME Group Inc. (CME), CBOE Holdings Inc. (CBOE) and IntercontinentalExchange Inc. (ICE) launched over the recent years have been giving way to severe competition primarily on the OTC, futures and options market.

Despite these risks, NASDAQ's diversified business mix, cost, revenue and technology synergies will enable it to benefit from improving economic conditions in future. The outstanding technical performance, rating upgrade and latest SMART Group acquisition has enabled the company to enter new markets on a low cost and highly flexible platform, offering value addition to its clients and creating additional sales opportunities. As well, NASDAQ enjoys strong capital leverage that provides scope for stock repurchase and acquisitions. However, the ongoing low M&A activity and headwinds related to volume and pricing continue to limit the stock's desired upside.

We believe that NASDAQ's operations will gain momentum once the global economy stabilizes and rebounds to its historical highs. Hence, we maintain our Neutral recommendation on the stock with a Zack #3 Rank.

On Thursday, the shares of NASDAQ closed at $24.11, up 0.6%.

 
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