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Morningstar | Nasdaq's 3Q Overshadowed by Regulatory Concerns

Narrow-moat Nasdaq’s performance during the third quarter was overshadowed by ongoing regulatory issues. For the quarter, the company generated net revenue of $606 million, modestly lower than last year’s third-quarter revenue. However, on an organic basis, excluding divestitures, organic revenue grew by 5% from the previous year. Information services and market technology were the biggest contributor to sales growth, up 5% and 13%, respectively. On a GAAP basis, market services revenue increased only 1% from the previous year, but given the volatility that began just after quarter-end, we’d expect a significant rebound in the fourth quarter. However, these results are obscured by the SEC’s ruling that the New York Stock Exchange and Nasdaq had not provided sufficient evidence that depth-of-book data is constrained by competition. We think Nasdaq will find it challenging to realize greater pricing on equity data going forward. We now forecast growth in information services to decelerate to levels comparable to overall economic growth. Given this, we plan to lower our fair value estimate to $74 per share from $78.

However, we’ll caution that it is conceivable the SEC could limit pricing on exchange data even further, leading to additional decreases in our fair value estimate. We’ll know more after this week’s SEC roundtable, where exchanges and their customers meet with regulators to debate these issues during seven panel discussions. If anything, the Oct. 24 earnings release demonstrates the immense complexity of the issue and how inefficient the regulatory framework is. According to management, 400 rule filings approved by the SEC are being challenged individually by Sifma and Bloomberg. Of the 400, 130 relate to Nasdaq. This would be a very long process to make rulings on all of these appeals. We wonder if the SEC is encouraging exchanges along with their customers to meet and come to some compromise.

Finally, with all the noise related to the SEC, it is important to note that on Sept. 10, Nasdaq's Nordic clearinghouse experienced a default event after a private trader bet that spreads on Nordic and German power prices would narrow. Instead, according to Nasdaq, "the defaulted portfolio's spread was 17 times larger than the normal observed daily spread changes." The trader’s losses exceeded its collateral, requiring Nasdaq to use its default fund. This resulted in an $8 million charge to this quarter's earnings. We don’t have any reason to believe this event will repeat. However, as interest rates rise, we would expect additional volatility.

Ronan Ryan, president of IEX Group, is scheduled to present at the Management Behind the Moat conference held at Morningstar's Chicago office on Nov. 7-8, 2018. If you are interested in attending the conference, please reach out to your sales representative for registration information.