NASDAQ OMX Earnings Preview: Derivatives, Equity Trading Volumes Decline
NASDAQ OMX Group (NASDAQ:NDAQ) is scheduled to announce its second quarter results on July 24. The company’s Q1 revenues grew by over 20% year-on-year (y-o-y) to $900 million primarily due to a rise in trading activity in the U.S. and growth in NASDAQ’s technology and corporate division from acquisitions. Corporate services offered by NASDAQ OMX include the investor relations (IR), multimedia solutions (MM) and public relations (PR) divisions of Reuters, which the company acquired in late 2013. Management mentioned that excluding acquisitions, the company still saw a 9% y-o-y organic increase in revenues as well. [1]
Over the last few years, the company’s EBITDA margins have consistently fallen from 80% in 2008 to just under 73% last year. The company’s non-GAAP operating margin in Q1 was similar to Q4 2014, but was 3 percentage points lower than the prior year quarter. The dip in margins is mainly attributable to a decline in the high-margin cash trading business in recent years. The slight decline in equity trading volumes in the June quarter could ensure that the trend continues.
Our $30 price estimate for NASDAQ OMX’s stock is about 15% lower than the current market price.
See our full analysis for NASDAQ OMX
Dismal Trading Volumes in Europe and the U.S.
Derivatives trading revenues generated by NASDAQ OMX’s European platform have remained flat in 2014 year-to-date, compared to the year ago period. On the other hand, trading volumes of options and futures in Europe have declined successively for every month in 2014 thus far, over the corresponding 2013 period. In five of the six months (through June), the decline in trading volumes has been by double-digit percentages. The total decline in the number of contracts traded is down by almost 15% y-o-y to 44 million contracts. A similar trend was observed for competing exchange operators such as CME Group (NASDAQ:CME) and Deutsche Boerse Group. [2] [3] If the decline in derivatives trading continues in Europe at the same rate through 2014, it could translate to a $30-35 million decline in revenues for the full year.
NASDAQ OMX posted encouraging figures for equity trading volumes in the U.S. at the start of the year. There was an 11% annual increase in the revenues generated by the U.S. equity trading business during the first quarter as trading volumes rose by 25% y-o-y in the first three months of 2014. The growth in trading volumes slowed down in April but still maintained 4% y-o-y growth to nearly 29 billion shares traded during the month. However, trading volumes fell on a year-on-year basis during the months of May (6% decline to 24.4 billion shares) and June (13% decline to 23.6 billion shares). [4] We expect NASDAQ’s cash equity trading volumes to stay flat over last year with a flattish forecast for full-year revenues. Looking ahead, the trading activity could gradually pick up in the long term.
This decline can be partially attributed to the skepticism in the market following the scrutiny surrounding the “payment for order flow” trading practice by the Justice Department, the Commodity Futures Trading Commission and the SEC. [5] The practice involves brokerages selling orders to third parties who trade with the customers of brokerage firms, making a profit as a result. We currently forecast NASDAQ’s U.S. equity trading volumes in 2014 to be about flat relative to 2013 volume levels.
Non-Trading Businesses Likely to Sustain Growth
As a result of weakness in trading business, much of the growth in revenues and profits is expected from other revenue streams. Last year, NASDAQ acquired the PR, multimedia and corporate solutions division of Thomson Reuters for over $350 million and the e-Speed trading platform for about $1.2 billion. These acquisitions led to significant revenue growth in the corporate services (+137%) and brokerage services (+141%) divisions, respectively. That growth was largely responsible for offsetting the 13% decline in NASDAQ’s cash equity trading business in the U.S. All other businesses remained nearly flat for the full year. Going forward, the increasing revenue contribution from market data, market technology and other corporate services could compress margins as these businesses have lower margins than the trading business. Market Data, Brokerage and Indexing Services and Market Technology businesses have witnessed growth in the last few years. Brokerage services revenues surged by 140% in 2013 mainly due to the eSpeed acquisition. Excluding eSpeed, organic growth was also strong at 20%. Going forward, we expect organic growth in this division to continue due to the increasing demand for market services.
NASDAQ’s market data revenue stream has grown at a CAGR of almost 6% since 2010. However, we have a conservative long term estimate of about 4% annual growth in the division owing to somewhat stagnant demand for market data in European markets. The company’s listing business performed well in the previous quarter, with a 5% increase in net listing revenues. The company listed 73 new companies on its platform, compared to 34 in the year-ago quarter. The company also announced an IPO win rate of 64%, which is a strong positive for the company as it is up from 52% in 2013. However, it is interesting to note that NASDAQ’s listing business grew by just 2% y-o-y in the U.S, whereas the growth rate in Europe was over 15%. This could signal continuing skepticism among investors and companies in the U.S. towards NASDAQ, as well as the threat posed by IntercontinentalExchange Group’s (NYSE:ICE) NYSE, especially in the case of technology companies. Going forward, it is likely that the U.S. listings business takes some time to pick up, but we expect the European listings business to continue to grow at a rate similar to Q1 (see NASDAQ’s Tech Glitches Could Negatively Impact Its U.S. Listings Business).
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Notes:- NASDAQ OMX Q1 2014 Earnings Call Transcript, Seeking Alpha, April 2014 [↩]
- CME Group Monthly Volumes, CME Investor Relations, July 2014 [↩]
- Deutsche Boerse Monthly Volumes, Deutsche Boerse Investor Relations, July 2014 [↩]
- NASDAQ OMX Monthly Volumes, NASDAQ OMX Investor Relations, July 2014 [↩]
- Fallout From High-Frequency Trading Hits Brokerages, Wall Street Journal, April 2014 [↩]