What Nasdaq sees in Instinet
by Donna Block in Washington
Updated 09:25 PM EST, Apr-19-2005
Is bigger better? The Nasdaq Stock Market Inc. seems to think so. The world's largest electronic trading venue, along with a consortium of private-equity firms led by Silver Lake Partners LLC and current investor Hellman & Friedman LLC, is on the brink of buying Instinet, the institutional brokerage and electronic trading network controlled by Reuters Group plc.
The sale price is expected to come in at between $1.8 and $2.2 billion. Analysts expect an announcement with actual terms any day now.
"This is really good for Nasdaq," said Jodi Burns, a senior analyst with financial consulting firm Celent Communications LLC. "It's good because it keeps Instinet out of competitor Archipelago [Holdings Inc.]'s hands, Nasdaq doubles its market share and it brings on board more robust and faster technology."
Nasdaq is thought to be interested primarily in Instinet's electronic communications network, Inet, rather than its institutional-brokerage business. Negative tax implications prevented Reuters from splitting the two.
While Nasdaq would have full control of both Inet and the broker-dealer division, sources say Nasdaq will sell off the brokerage side to avoid competing against its own customers. The obvious buyer, they say, is Silver Lake.
"PE firms are making some really big deals happen," said Octavio Marenzi, president and chief executive officer of Celent. "Typically, they go into transactions like this with a view towards selling down the road."
But even with private equity firms shouldering a large portion of the burden, there is concern over how Nasdaq would absorb the costs. "I'm worried that Nasdaq will destroy its balance sheet in an attempt to keep this valuable asset out of the hands of a competitor," Burns said.
With little cash and lots of debt, Nasdaq was seen as the dark-horse contender for this long-expected acquisition, behind Archipelago and the Chicago Mercantile Exchange Inc. But the inclusion of private equity money has changed the balance of power. "A deal of this magnitude could not have been done without significant backing from other sources," said Eric Fitzsimmons, senior analyst at research firm SNL Financial in Charlottesville, Va.
A Nasdaq-Instinet combination also positions the new entity to take on the New York Stock Exchange. The Big Board, which controls about 80% of the trading in NYSE-listed stocks, is developing its own electronic trading system.
The electronic marketplaces are now jostling for position in an effort to steal some of that market share, and new rules the Securities and Exchange Commission has promulgated could help them do just that.
"The NYSE is under attack by [electronic communications networks] who are trying to take over the listed space, pushing the exchange out of its own business," Marenzi said. "If they [Nasdaq] pull this off, it's a great deal. And with the help of the PE firms, they've positioned themselves well."
The new SEC rules, known as Reg NMS, for Regulation National Market System, favor electronic trading by requiring that all trades be executed at the venue displaying the best price. Electronic markets allow traders to access that price and execute trades more quickly.
"It forces the NYSE to compete on a level playing ground and increases competition by making all markets mutually accessible," said Bethany Sherman, a spokeswoman for Nasdaq.
The combination of Nasdaq and Instinet will also give Nasdaq the lion's share of the highly competitive electronic trading landscape. Where once there were three fierce competitors, now there are two.
However, Burns added, many traders may be uncomfortable with Nasdaq's dominance and may defer trades to smaller venues and regional exchanges. "It remains to be seen if market-share gains arrived from this deal are long-lived," she said.
Nasdaq is a for-profit company with private ownership interests. According to the latest proxy statement it filed with the SEC, former parent and regulator the National Association of Security Dealers, or NASD, owns 33.5% of the company, and Hellman & Friedman has 15.7%. In 2000, Nasdaq applied to the SEC for exchange designation, but approval has been slow in coming.
Brokerages have attracted buyout shops in the past. In 1996, for instance, Boston's Thomas H. Lee Partners LP bought Freedom Securities Corp., the parent of both Sutro & Co. and Tucker Anthony Inc.. Lee later sold the business to RBC Financial Group. In 2004, Lee led a leveraged recapitalization of Refco Group Ltd., a commodities broker, valued at about $2.3 billion.
In another large deal, a consortium including Silver Lake and Boston's Bain Capital LLC and TA Associates Inc. invested several hundred million dollars in Datek Online Holdings Corp., an online broker, and in an online exchange owned by Datek called The Island ECN Inc. In 2002 the investors sold Datek to another broker, Ameritrade Holding Corp. Separately that year, they swapped their interest in The Island for a minority stake in Instinet Group Inc.
— David Carey in New York contributed to this report |
