MORNINGSTAR...from Yahoo Finance, written bout a couple months ago
Thesis 11-21-2006
The times they are a-changin' for the New York Stock Exchange. NYSE Group, as it is now known, is leading the industry consolidation charge and soon will facilitate trading in stocks, bonds, options, and futures across two continents. Partially as a result, and despite the industry's shift away from floor-based trading, we believe NYSE has been able to retain its narrow moat. Mergers with Archipelago and Euronext should create significant shareholder value, and we believe the firm's growth story is still in its early chapters.
The New York Stock Exchange's roots go back to 1792, when a group of traders met under a buttonwood tree near Wall Street to create America's first-ever exchange; 214 years later, the founders would hardly recognize what their idea has evolved into. The exchange went public in March 2006 via a merger with Archipelago, in the process changing its name to NYSE Group and gaining electronic trading capability as well as a stock option exchange. In May 2006 the firm announced another merger, this time with Euronext, a multicountry European exchange that trades financial future contracts as well as stocks. We view it as very likely that the deal closes in early 2007.
NYSE's recent changes highlight the upside potential of its business. By consolidating, the firm is taking advantage of the operating leverage inherent in its business model, especially as it shifts from floor-based trading to more scalable electronic platforms. Diversifying revenue streams reduces the firm's dependence on any one market and offers new trading opportunities, while adding a futures exchange benefits from the more monopolylike characteristics of that business. Lastly, by expanding internationally, NYSE is expanding its market in terms of both traders and trading hours.
Electronic trading represents a threat as well as an opportunity because it increases the portability of liquidity away from the listing exchange. We still believe NYSE's existing liquidity pools provide the firm's stock exchange business with a narrow moat. However, in addition to existing competition from regional stock exchanges and electronic communication networks, several option exchanges and investment banks have begun competing as well. Off-exchange trading venues also pose an increasing challenge, and we expect that NYSE will ultimately lose some share in the stock exchange business. Nevertheless, strong trading demand combined with the firm's diversification and wide moats around its listing and futures businesses bode well.
Valuation
We are raising our fair value estimate for NYSE Group to $128 per share from $65. This increase reflects the benefits of the Archipelago merger, the expected benefits of the Euronext merger, and cash-flow accruals since our last report. As a result of the two transactions, we estimate NYSE's revenue will grow at an average rate of 32% over the next five years. We believe we have been somewhat conservative in our assumptions for NYSE Group and Euronext as separate entities; the combination of the two firms should stimulate additional trading demand. In addition, with an expected $100 million of steady-state cost synergies from the Archipelago merger and another $275 million from the Euronext merger, the combined NYSE Euronext should reach operating margins near 50% by 2010. We are skeptical about the firm's bond exchange generating meaningful volume, but improvement in that business provides upside potential. We use an 11% cost of equity assumption.
MORNINGSTAR
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