In the wake of the Dick Grasso pay scandal, the New York Stock Exchange shed its old "not-for-profit" structure and became a publicly traded company. After a wave of mergers, including the one with Archipelago that launched it as a public firm, the company is now known as NYSE Euronext
Even though the global financial-exchange industry still remains highly fragmented, that's rapidly changing, thanks to mergers like these. And that's a primary reason why I'm on the bear side of this duel. As the big fish in the pond, NYSE Euronext has been and will likely continue to be on the buying side of future mergers. For example, the NYSE recently indicated an interest in purchasing a derivatives exchange.
The big problem with mergers is that to get one approved by the target company's stockholders, the acquiring firm typically needs to offer a premium price. In other words, to take control, the buying company typically pays more than the market thinks the company being bought is worth.
The ugly side of buyouts
A premium may be justifiable if the target firm is clearly undervalued. Looking at some of the rumored and in-progress exchange-related acquisitions, however, reveals a different reality. Take the competition between the InterContinental Exchange
In general, the market exchanges are not cheap. As they run around paying higher and higher premiums for one another, the justification for the purchase prices almost starts to look as stretched as the nefarious "dollars per eyeball" yardstick. Sure, there's a whole lot of talk about building a seamless, global market, and the efficiencies arising from a streamlined system. But people who want to invest internationally or in derivatives or commodities can already do so fairly easily. I fail to see how this acquisition binge will meaningfully enlarge the overall global securities market.
If there's not much growth likely to be created by the mergers, then the only true benefits will come from the efficiencies of eliminating duplicate overhead. Though there's likely fat to cut, electronic trading is eroding the exchanges' abilities to charge premium prices for their services. With valuations stretched throughout the industry, the big question is whether that's enough to justify the exchanges' valuations. Frankly, I don't see the benefits in merger mania, but I do see a lot of potential pain for shareholders of acquiring giants that pay top dollar for smaller rivals.
Past is not prologue
As an established market leader and likely buyer of its rivals, NYSE Euronext doesn't deserve the stratospheric valuations assigned to the companies it considers serious acquisition targets. Yet with a P/E ratio topping 50, it's still pretty well priced up in nosebleed territory. Certainly, the stock has been a tremendous performer since its inclusion in the Motley Fool Rule Breakers portfolio -- rocketing up nearly 300% in the two years since being picked. Past stock price growth doesn't predict the future, however. Over time, a company's business results determine what its stock is truly worth.
While NYSE Euronext has had a tremendous life as a public company, the future doesn't look nearly as bright. With expensive industry consolidation, a maturing market, and pricy shares, there seems to be a lot more risk than potential reward involved in owning this company's shares right now. There's no penalty in sitting on the sidelines, and that's where my cash will remain.
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At the time of publication, Fool contributor Chuck Saletta did not own shares of any company mentioned in this article. NYSE Euronext is a Motley Fool Rule Breakers pick. The Fool has a disclosure policy.
