EUR 850.00 For Business Accounts Only

Morningstar | Nasdaq Increasingly a Data Company and Less an Exchange

After taking a fresh look at Nasdaq, we are increasing our fair value estimate to $78 per share from $76 per share while maintaining our narrow moat rating. Our fair value estimate translates into a 2019 price/earnings of 18.1. Currently, the stock trades at a nearly 20% premium to our fair value estimate. Given this, we would wait for a pullback before investing. Like its exchange peers, we believe Nasdaq should increasingly be viewed as a vendor of proprietary data. Though Nasdaq's exchange operations still account for the bulk of revenue and operating income, we believe investors should be paying more attention to the company's information services segment, which is the faster-growing higher-margin business. For Nasdaq, selling data is a fundamentally better business with higher barriers to entry and greater switching costs. While historically, this data was given to customers for free in order to encourage trading, it is here where Nasdaq has recently achieved a significant portion of its growth.

In 2017, Adena Friedman became CEO of Nasdaq and quickly got to work conducting a strategic review of the company's businesses. Through this process, the company pivoted toward data and technology and away from the company's exchange business. While the exchange business will always be important given the company's data and technology businesses are reliant upon it, we believe it's a smart decision to divert investment toward expanding and developing new products that are derived from Nasdaq's exchange operations.

However, one of our bigger concerns is that Nasdaq, in an effort to expand its reach within data, will overpay to acquire additional data sets. In September 2017, Nasdaq announced it would purchase eVestment for $705 million, which at the time was 8.7 times trailing 12-month revenue. We suspect Nasdaq will have to significantly accelerate eVestment's revenue growth in order to justify this purchase price. While one acquisition that fails to live up to expectations would not meaningfully have an impact on our fair value estimate, we believe the bigger risk is that additional acquisitions made at significant premiums could hurt Nasdaq's returns.

While Nasdaq's data business accounts for only 24% of sales, the information services segment accounts for nearly 42% of consolidated operating income. This demonstrates the exceptional margins that exchanges can achieve within data offerings. In 2017, information services achieved operating margins of greater than 70%. It should be noted that information services isn't just a vendor of exchange data, but also licenses benchmarks to investors, which are frequently used to construct exchange traded funds.

Within information services, our only worry is that regulators could become sympathetic to asset management firm complaints that they are paying too much for data. In recent years, hedge funds and investment companies ranging from Citadel to Vanguard have criticized the rising cost of data. However, given fund companies are promoting index funds with cheaper and cheaper expense ratios, we haven't seen much evidence yet, that these costs are being passed through to the individual investor. The only impact we see is that asset managers have seen less margin benefit from increasing scale than in past market cycles. We will only become concerned once these costs are noticeably being passed through to the individual investor, or if it is apparent high data costs are having a negative impact on market structure. Given this, we think Nasdaq has the ability to increase prices on exchange data, but will have to strike a delicate balance between increasing prices and not attracting regulatory scrutiny.