Electronic networks encroaching on NYSE's turf
Archipelago leads pack
David Berman
Financial Post
July 21, 2004
Sometimes you have to feel sorry for the lumbering New York Stock Exchange.
Although the venerable exchange is also world's largest, with total share volume of 350 billion in 2003, efficient upstarts are picking away at its dominance.
Trading volume is declining. So is the NYSE's share of trading in its listed stocks.
Threat No. 1? Chicago-based Archipelago Holdings LLC, an electronic communications network that is in the process of an initial public offering.
This week, Archipelago announced it intends to list its shares on the Pacific Exchange under the ticker symbol AX.
In its revised prospectus, the company estimated the IPO price would be US$13.25 to US$15.25 a share, with 9.2 million shares sold in the offering.
Archipelago operates the Archipelago Exchange, also known as ArcaEx, through which its customers can trade more than 8,000 different equities.
Whereas the NYSE and Nasdaq use intermediaries to link buyers and sellers, ArcaEx uses a process known as "sweeping" -- essentially searching other exchanges and ECNs to execute orders, often bypassing the major exchanges.
To date, Archipelago, which was founded in 1996, has been devastatingly effective.
"They took advantage of the improvements in telecommunications and computing power. They basically matched orders that came in from one side against orders that came in from the other side -- and that's an ECN," said Richard Bove, an analyst with Hoefer & Arnett.
The company's transaction fees -- which represent the majority of its revenues -- have grown to US$428-million in 2003 from US$172-million in 2001.
In the first six months of 2004, the company generated transaction fees of US$251-million, an increase of 30% over the first six months of 2003.
Perhaps more impressive, Archipelago handled 25.6% of the total trading volume of stocks listed on the Nasdaq exchange in the first half of 2004.
Now, however, the company is at a crucial junction as it attempts to translate this early success into long-term profitability that shareholders will applaud.
For one, it must expand its customer base. In 2003, its biggest customers were its investors. Revenue generated by its investors last year accounted for 38.4% of total sales. In 2004, the share has grown to 40.7%.
Despite the impressive growth in sales, earnings have been more elusive. Archipelago has had just one profitable year since 2000, a US$1.9-million profit in 2003.
In the first six months of this year, however, the company has produced net earnings of US$39.4-million.
However, Archipelago faces a number of well-armed competitors, including Nasdaq Stock Market Inc., Instinet Group Inc. and a reinvigourated NYSE, that could transform its offering into ho-hum territory.
For example, the NYSE is trying to reinvent itself under John Thain, the chief executive. Mr. Thain, who assumed the top job at the exchange in January, is considering a plan that will target the encroachment of Archipelago and other ECNs.
The NYSE's share of trading in its listed stocks fell to 79.3% at the end of 2003, down from 82.1% at the beginning of the year. The exchange attributed the decline to the evolving competitive landscape.
Under Mr. Thain's plan, the NYSE would staunch this decline by developing fully automated electronic-trading capabilities that would allow the exchange to compete, at least to a limited degree, with ECNs.
Meanwhile, Goldman Sachs Group -- which owns a stake in Archipelago -- and Morgan Stanley are also fighting for a larger piece of the ECN action by bolstering their ECN capabilities.
"[Existing ECNs] are being co-opted by the big firms like Goldman Sachs and Morgan Stanley -- and even companies that are not in the brokerage industry," said Mr. Bove.
"Firms like State Street and Bank of New York are putting in similar systems."
© National Post 2004 |
