Inside Value recommendation Nasdaq (Nasdaq: NDAQ ) recently decided that it had too many irons in the fire, deciding to take one out and concentrate on another. Nasdaq ended its frustrating attempt to acquire the London Stock Exchange, focusing instead on its bid for Nordic exchange OMX, which was recently trumped by holding company Borse Dubai. For Nasdaq stockholders, I'd view the news as both good and bad.
First, a quick primer. Securities exchanges have engaged in an arms race to bulk up and consolidate, thanks to the synergies created when two networks merge. Rule Breakers pick NYSE (NYSE: NYX ) bought Archipelago and Euronext, Nasdaq bought Instinet, and the CME (NYSE: CME ) beat out the InterContinental Exchange (NYSE: ICE ) to buy the CBOT. It's become a jumbled-up alphabet soup of merger activity.
Nasdaq's financial results will immediately benefit from its liquidation of the LSE stake, and the company estimates a $0.30-$0.35 EPS boost in 2008. As of the latest quarterly report, Nasdaq owned about $1.56 billion worth of LSE's stock, which the company financed through debt.
Thus, Nasdaq paid almost $100 million in interest expenses, but it couldn't book "income" to represent its stake in the LSE, which understated Nasdaq's true earnings power. The company could use about $1 billion of proceeds to retire debt and buy back shares, which should help more accurately demonstrate Nasdaq's true earnings power.
On the other hand, competitive auctions make me nervous. The Borse Dubai trumped Nasdaq's bid for the OMX by about $300 million. Although I haven't done the research to know what a reasonable price tag for the OMX would be, if Nasdaq counters with a higher bid, I'd worry that the company may be overpaying. I understand that exchange mergers, unlike most mergers, actually result in substantial synergies, thanks to overhead reductions and cross-selling opportunities. However, the higher the OMX price tag gets, the more value flows to OMX shareholders, and away from either Nasdaq or Borse Dubai's owners.
I'll have to wait for it all to shake out before deciding whether to enter the fray. My version of the ideal scenario involves Nasdaq walking away from the OMX and using its substantial excess capital to buy back its own shares. Hopefully, at that point, Nasdaq will still be trading in the low $30s.
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Fool contributor Emil Lee is an analyst and a disciple of value investing. He doesn't own shares in any of the companies mentioned above. Emil appreciates your comments, concerns, and complaints. The Motley Fool has a disclosure policy.