The Nasdaq Stock Market
Nasdaq reported second-quarter earnings of $16.6 million, a 19% increase year over year. However, earnings per share fell 19%, to $0.13 per diluted share. The weighted average shares outstanding, used to calculate diluted earnings, have increased 32% because of convertible security and share offerings related to the acquisition of INET and Nasdaq's investment in the London Stock Exchange (LSE). Although diluted EPS fell year over year, it remained well above the consensus estimate of $0.08 per share.
Revenues rose 87% to $411 million, driven largely by a more than 100% increase in Market Services revenues. The Market Services segment covers order execution and data services, representing more than 80% of Nasdaq's revenues on a trailing-12-month basis. However, the cost of revenues rose even more sharply, and the gross margin fell from 59% to 41%.
Finally, operating expenses increased 29% to $134.8 million, yielding GAAP operating income of $36.3 million, up 38%. The company also reconciled GAAP and normalized operating income by adjusting for one-time expenses linked to its cost-reduction program and its investment in the LSE. On that basis, normalized operating income is $66.9 million, up 69%. Investors should view this number with some caution; supposed "one-time" costs may recur, particularly if the Nasdaq does acquire the LSE.
All in all, this was a very respectable quarter. But however good the numbers were, a couple of other things caught my attention.
First, although there were no related developments during the quarter, I have to mention Nasdaq's investment in the LSE. Despite repeated questions from analysts, CEO Robert Greifeld was mute on this subject, citing the U.K. takeover code. After a failed takeover bid for the LSE in March, Nasdaq now has a 25.3% stake. Under UK takeover rules, the Nasdaq must wait until Sept. 30 to make another bid.
Acquiring its current stake in the LSE was a masterful tactical move for Nasdaq, blocking what looked like a natural alliance between the NYSE and the LSE, and pushing the NYSE into an admittedly promising shotgun wedding with Euronext. Expect Nasdaq to mount a second bid once the waiting period expires; success here would be a real coup for the upstart exchange.
Second, Nasdaq is competing aggressively with the NYSE in its own backyard. Matched market share for NYSE-listed stocks in the second quarter was 8.3%, up from 7% during the first quarter of the year. (Matched market share represents the volume of NYSE-listed stocks transacted on one of Nasdaq's electronic platforms as a percentage of total NYSE market volume). The Nasdaq also markets a Nasdaq listing to NYSE-listed companies, as it did successfully with Liberty Media
Finally, while the NYSE maintains its floor-based specialist system, the Nasdaq is moving forward with a single electronic platform. On July 14, the company received SEC approval to consolidate its different execution systems into a single order book, with a staggered implementation to begin on Aug. 28. Management expects this single platform to free up $70 million-$75 million in working capital. My hunch is that a single order book will also increase liquidity, making the Nasdaq Stock Market more attractive to investors and issuers alike.
Between the push for global scale and an enormous domestic market, don't expect competition between the NYSE and the Nasdaq to abate any time soon. Last quarter's results are further proof that upstart Nasdaq is a game opponent for the venerable New York institution.
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Fool contributor Alex Dumortier has no beneficial interest in any of the other companies mentioned in this article. He welcomes your (constructive) feedback. NYSE Group is a Motley Fool Rule Breakers pick. The Motley Fool has a strict disclosure policy .