Nasdaq to acquire electronic stock trader

Nasdaq is buying Instinet, the last major operator of an electronic trading system still standing, for $1.9 billion.

5 min read
Nasdaq, the world's largest electronic stock market, announced Friday that it would buy Instinet, the last major operator of an electronic trading system still standing, for $1.9 billion.

The deal, which Nasdaq's chief executive called the "worst-kept secret on Wall Street" comes two days after the New York Stock Exchange made its surprising announcement that it would buy Archipelago, another big electronic trading system.

The two deals will ultimately determine who controls the trading of trillions of dollars of stocks every day. The transactions illustrate how much has changed recently: the Securities and Exchange Commission has altered the rules governing markets; profits in the trading business have been pushed to virtually zero; and the vast difference in how stocks are traded, either by humans or through completely automated systems, is becoming more stark. The new reality has pushed four rivals into unlikely alliances.

The Big Board's deal is a far bolder stroke, reflecting a fundamental shift from a floor-based not-for-profit system to a public company with greater potential for electronic trading. With the acquisition of Archipelago, the New York Exchange will have the ability to trade options and derivatives as well, and it will have two different platforms to trade stocks: one for Nasdaq and Big Board stocks, and another that is a hybrid (both human floor traders and an automated system) for trading just stocks listed on the New York Exchange.

"All of the sudden, Nasdaq is not dealing with a patsy 'kick me while I'm down' kind of competitor," said Seth Merrin, the chief executive of Liquidnet, an electronic market for large orders. "Now they have the makings of a truly competitive public entity which will be fully electronic with the functionality that Nasdaq-Inet will have to offer."

Nasdaq, with its purchase of Instinet, and its electronic trading unit, Inet, becomes the technology leader, and will almost double its share of trading in Nasdaq stocks. As the New York Stock Exchange works to integrate two different cultures and technologies, Nasdaq will have an opportunity to gain volume and listings at the expense of its traditional rival.

As of the end of 2004, Nasdaq listed 3,271 companies, with a total market value of $3.7 trillion, while 2,760 companies, with a market value of $20 trillion, were listed on the New York Exchange.

Robert Greifeld, the chief executive of Nasdaq, said the deal to acquire Instinet would make Nasdaq the "dominant, leading marketplace for trading U.S. equities."

Under the deal announced Friday, Nasdaq will buy Instinet, which is 62 percent owned by Reuters, for $1.9 billion. Nasdaq will simultaneously sell Instinet's brokerage business to Silver Lake Partners, a private equity firm, for $208 million and sell Lynch, Ryan & Jones, a smaller trading service business, to Bank of New York for $174 million. Greifeld said the deal would generate cost savings of $100 million a year for two to three years and be positive for Nasdaq shareholders within a year.

Nasdaq will finance the deal with a $750 million loan from J.P. Morgan and Merrill Lynch and $205 million in debt securities backed by Hellman & Friedman and Silver Lake. The deal adds a significant amount of debt to Nasdaq's balance sheet.

"The other exchanges generally don't carry debt," said Richard Repetto, an analyst at Sandler O'Neill. Greifeld said the debt was not a concern because Nasdaq had strong cash flow and would save money in combining the two companies.

Shares of Instinet fell 51 cents, or 9 percent, to $5.19 after the announcement of the deal, which had been widely anticipated. Instinet was spun off in part by the Reuters Group in 2001. Friday, Reuters said it expected to return roughly $1 billion to its shareholders as a result of the sale of its 62 percent stake. Shares of Nasdaq surged $2.78, or 26 percent, to $13.43.

Both the Nasdaq and the Big Board transactions resulted in part from the change in SEC rules. New trading regulations require that the market posting the best price for a stock be the market that gets the trade.

Previously, quotes on small markets were ignored. Now, with two mammoth markets--the New York Exchange controls about 80 percent of the trading in Big Board stocks, while Nasdaq, with Instinet, will control about 80 percent of Nasdaq stocks--the rules allow small players that are automated to compete with the giants.

"This transaction is a recognition of the reality" of the new rules, Greifeld said.

The transformation of the market for trading stocks will be barely felt by individual investors, although big institutional investors will be able to lower their transaction costs.

"Small investors as well as institutions will be guaranteed the best prices for their trades no matter which market their orders are sent to," said the SEC chairman, William H. Donaldson. "At the same time, our rules now ensure that any market can compete with any other by offering all investors the best prices."

The merger between the New York Stock Exchange and Archipelago enables the New York Exchange to become faster and more diversified, at the same time keeping the floor specialists who work to get the best prices for buyers and sellers of stock.

"We will offer our customers choice," the chief executive of the New York Exchange, John A. Thain, said on Wednesday.

But executives of both Instinet and Nasdaq lost no time yesterday in stoking up the rivalry with the Big Board.

"Whatever they claim are the benefits of the specialists are outweighed by the detriments resulting from the specialist environment," said the chief executive of Instinet, Edward J. Nicoll, who in the past has referred to Thain as "a bureaucrat."

The combination of Instinet's Inet system with Nasdaq, Nicoll said, "would kick butt."

"It's the better technology platform and in an environment where there's commoditization of execution services, the low-cost platform wins," he said. "Even more of an advantage is the singularity of focus and the lack of conflict between the owners themselves," he said, referring to the fact that Archipelago and the New York Exchange have different trading models that will have to be integrated. "We have to see how the conflict between the floor-based model and Archipelago will work."