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Morningstar | Nasdaq's Nontrading Businesses Offset Weakness in Market Services

Narrow-moat Nasdaq’s second quarter wasn’t particularly impressive. However, it was aligned with our expectation that market services revenue would decline and mostly be offset by growth in Nasdaq’s highly profitable nontrading businesses. For the quarter, Nasdaq generated net revenue of $623 million, representing growth of only 1.6%. This was driven by anticipated declines in market services revenue, which contracted 4.2%, offset by 8% organic growth in Nasdaq’s nontrading businesses. Cash equity trading revenue declined 7% as European cash equities saw lower volume. If Nasdaq has been flexing pricing in market data (which it has been accused of doing), it isn’t noticeable in its numbers. Market data revenue has barely changed over the past year. After making some minor adjustments to our model to reflect these results, we increased our fair value estimate to $83 per share from $78. The increase is mostly the result of an increase in the time value of money and a few near-term changes to our model. We still regard the company as modestly overvalued.

One thing that we found interesting is the significant decline in Nasdaq’s fixed-income, commodities, and currencies trading segment. This isn’t a significant contributor to overall sales and shouldn't give investors too much worry, but FICC revenue declined 24% from the previous year. Management attributed this to lower market share. Nasdaq’s main competitor in FICC is BrokerTec, which was acquired by CME Group as part of the NEX deal. This would seem to suggest that CME Group has wasted no time in accelerating NEX’s revenue, and the deal looks to be value-creative for CME.

Nasdaq’s own acquisitions appear to be doing well. Though the company doesn’t specifically break out eVestment’s revenue, management did say it continues to generate double-digit organic growth. We suspect this is mostly attributable to pricing. Quandl and Cinnober, both acquired within the last year, contributed to $11 million in revenue this quarter. We regard the Quandl acquisition as a fairly good investment over the long run even if it's a near-term drag on performance. In general, it takes years to build a valuable data set as value is often determined by the amount of history a data set has. Usually, at the beginning of a data set’s life, it’s not known whether the data will ever be able to be monetized. For example, S&P will collect commodities pricing data for years to build a database and hope there’ll eventually be a liquid market reliant on its pricing data. If there is, S&P is in prime position to be recognized as the standard for that data set. Given that Quandl was only formed in 2011 and its data already is being monetized, we think this bodes well for the long-term profitability of its data.