Kenneth Hill, CFA of Barclays PLC (NYSE:BCS) (LON:BARC) is reinstating his rating of NASDAQ OMX Group, Inc. (NASDAQ:NDAQ) at Overweight with a price target of $39. His Overweight rating is predicated on the firm’s attractive valuation, solid cash flow generation and diversified business model. Looking at the exchange he notes that NASDAQ OMX Group, Inc. (NASDAQ:NDAQ) scores relatively well in the capital returns portion of our analysis (despite temporarily halting share repurchases), on par with peers in fundamental section and not as attractively in the risk section of the analysis. That being said, we do not believe that the company’s relative score warrants the steep discount the shares trade at relative to peers (13x vs. 21x and the broader market (S&P500 at nearly 15x). Based on the exchange’s relative valuation and our proprietary capital market’s framework, the analyst is applying a 15x multiple to our 2013 estimate of $2.58, translating to a price target of $39. Details from the report below:
NASDAQ To Resume Its Share Repurchase Plan
On capital returns, NASDAQ OMX Group, Inc. (NASDAQ:NDAQ) is well positioned given the firm’s implementation of a quarterly dividend in early 2012 and strong history of share repurchases. That being said, we believe with the company’s current debt-to-EBITDA ratio running above 3x (higher than NDAQ’s targeted 2.5x), NASDAQ OMX Group, Inc. (NASDAQ:NDAQ) will not be in position to resume share repurchases until early 2014. We would anticipate the free cash flow the company generates (which we expect to average around $125mn per quarter for the remainder of the year) to be used to pay down debt over the near term. Once the company gets back to the 2.5x debt-to-EBITDA ratio (something we anticipate will happen early in 2014), we expect NDAQ to resume its share repurchase plan. We would look for the dividend to stay relatively steady over the next year, with the possibility of an increase limited by the debt-to-EBITDA ratio over the near term.
NASDAQ OMX Group’s Position Relative To Peers
On fundamentals, NASDAQ OMX Group, Inc. (NASDAQ:NDAQ)’s position relative to peers looks somewhat mixed, but overall on par, we believe. We believe the recent capital market headwinds have weighed on the budgets of NDAQ’s technology /service customers, slowing spending patterns, which we believe may take some time to recover. On the trading side, NASDAQ OMX Group, Inc. (NASDAQ:NDAQ) remains predominately tied to equities, equity derivatives and Nordic activity. While we have seen NDAQ’s products produce decent results, activity levels remain under the levels we have seen in other asset classes, most notably rates. We highlight that despite the challenging macro headwinds,
NASDAQ OMX Group, Inc. (NASDAQ:NDAQ) continues to produce a best-in-class free cash flow yield (9%), which helps balance out the exchange’s score in the category. Lastly, on risk, NDAQ came in with a score below peers given a combination of industry headline risk and firm specific issues. We do note that sentiment around these issues continues to improve, but remains at a higher level than we see for peers. On an industry level, we believe the firm faces a slightly higher level of scrutiny given the focus on cash equity exchanges / market structure companies after issues like the flash crash, KCG trading errors, and IPO hiccups. Broader market structure issues are still debated in the public forum and progress continues to be made, but we believe the state of market structure and the future of cash equities trading will be a focus for regulators and market participants for some time to come. For the firm specifically, we note the company’s higher leverage levels relative to peers is something that could give regulators pause and create some headline risk, but we do not believe it is an issue that will be an impediment to the company’s day-to-day operations.
U.S Cash Equities
Despite being labeled a legacy cash equities exchange, NASDAQ OMX Group, Inc. (NASDAQ:NDAQ) derives only ~10% of net revenues from cash trading globally (roughly equally split between the U.S. and Europe). Starting with the U.S., we note that industry volumes remain at rather tepid levels as compared to what we saw just 5 years ago. In addition to a challenging volume environment, we note that market share trends also remain a headwind as we have seen a proliferation of exchanges, and more recently dark pools / internalizers, chip away at NDAQ’s market share.
Given current trends, we would expect revenues to stay somewhat stable with no material moves in market share or volumes expected over the near term. While we note a litany of market structure issues up for debate (high frequency trading, dark pools, circuit breakers, tick sizes, etc.), we believe this likely requires a holistic review of market structure, which will likely take some time to undergo before any changes / improvements are proposed that could have an impact on volumes and the trading venues. We are forecasting revenues of $25-26mn per quarter through 2013, with low single digit growth over the 2014 and 2015.
NASDAQ OMX Group, Inc. (NASDAQ:NDAQ)’s options business has been a solid contributor for the company, and we believe it continues to have a bright outlook. NDAQ currently runs one of the largest multi-listed options platforms in the U.S. by market share. NDAQ’s three platforms (Nasdaq Options Market, Nasdaq OMX PHLX, and Nasdaq OMX BX Options) comprise roughly 28% of the U.S. multi-listed options market share in the U.S. Given the pressure to crack down on dividend trading strategies in the options market (NDAQ’s PHLX exchange being a top venue for the activity), we could see market share on NDAQ decline to some degree. That being said, we note that while dividend activity is earnings positive for NDAQ, it is a very low-margin business so would expect any declines in market share to be nearly equally offset in an increase in rate per contract. From an industry perspective, we continue to view options as an attractive asset class and believe growth rates will continue to move higher for the foreseeable future. We are currently forecasting 6% growth in industry options for 2013, making options one of the highest growth asset classes on NDAQ’s platform.
Given our underlying expectations, we are forecasting $47mn in revenues for 2Q13 and $186mn in revenues for the full year.
European Cash Equities Despite a relatively soft 2012, European cash equities has been a decent performer for NDAQ as of late, expected to take in roughly as much net revenue as the company’s more visible U.S. cash equities business. We expect revenue trends for the business to remain relatively consistent for the foreseeable future, anticipating longer-term growth catalysts like an increase in trading velocity and high frequency trading will take some time to play out. Given our expectations, we expect quarterly revenues to run around the $23-25mn level through this year, increasing by a mid-single digit growth