NDAQ - Nasdaq: A Risky Acquisition

2023-07-13 08:58:43 ET

Summary

• Nasdaq is now down over 10% since it announced the $10.5 billion blockbuster acquisition of Adenza last month.
• The acquisition should expand the company's software & technology segment and substantially increase its market opportunities.
• The expensive purchase price and the highly leveraged balance sheet may weigh on the company moving forward.
• The current valuation is not particularly attractive when considering its underwhelming growth and elevated leverage.

Investment Thesis

Nasdaq Inc ( NDAQ ) is down nearly 20% since my previous coverage in February. Last month, the company announced its $10.5 billion acquisition of Adenza from Thomas Bravo, which marks its largest-ever acquisition to date. It is aiming to create a new financial technology segment to expand its total addressable market and accelerate its growth outlook.

While the combination with Adenza should be accretive in the long run, the price tag and leverage are two major concerns in the near term. The market also seems pessimistic about the deal as the company's share price has declined over 10% since the announcement of the deal.

What Does Adenza Bring To The Table?

Adenza is a company that provides risk management and regulatory software solutions to the financial services industry. The New York-based company currently serves over 60,000 users in 70 countries. It recorded an excellent revenue CAGR (compounded annual growth rate) of 15% in the past 3 years, with 80% of the revenue being recurring. This allows the company to have a best-in-class adjusted EBITDA margin of 57% in FY22.

The acquisition clearly signals Nasdaq's intention to expand its software and technology segment, as it continues to diversify its revenue stream beyond index, listings, and trading. After the acquisition closed, the company is going to combine Adenza, its marketplace technology solutions, and its anti-financial crime solutions to create a financial technology segment. The new segment is expected to account for 36% of total revenue .

The expansion into the financial risk and regulatory market should increase the company's growth opportunities. According to Nasdaq, Adenza presents a SAM (serviceable addressable market) of $10 billion growing at a solid CAGR of 8%. The market is benefiting from the rising adoption of cloud and SaaS, which continues to drive the demand for modern financial software solutions. Adenza will boost the company's SAM by 42% from $24 billion to $34 billion and is expected to lift its revenue growth by 100 basis points in the medium term.

A Hefty Price Tag

Adenza is a great company but the purchasing price and the post-acquisition balance sheet are major concerns that may weigh on the company. Nasdaq is acquiring Adenza at an EV/EBITDA ratio of 31x (or 26x including all synergies), which is extremely expensive. For instance, this represents a premium of over 100% compared to Nasdaq's EV/EBITDA ratio of 15.4x. This is also higher than other best-in-class info service companies such as S&P Global ( SPGI ), Moody's ( MCO ), and MSCI ( MSCI ), as shown in the chart below.

In order to fund the acquisition, Nasdaq will also have to take on $5.9 billion in debt. Considering the current interest rates, the debt will likely have to be issued at a pretty high rate. This alongside the existing debt of $5.6 billion will present a massive net debt of $11 billion ($11.5 billion in debt with $444 million in cash. This translates to a net debt to EBITDA ratio of 4.7x, which is very high as 2x to 2.5x is often considered the healthy standard.

Nasdaq, on leverage post-transaction:

Following the transaction, Nasdaq expects leverage1 of approximately 4.7x and investment grade ratings of BBB/Baa2 Stable. Nasdaq is committed to reducing leverage to 4.0x in 18 months and to approximately 3.3x in 36 months. Nasdaq intends to pursue its existing capital deployment plan.

Despite the substantially increased leverage, the company has no intention to change its capital allocation strategy, which is a questionable decision. With ongoing buybacks and growing dividend payouts, it will take the company 36 months to reduce its leverage back to 3.3x, as mentioned by the company. Having such elevated leverage for an elongated period can be risky, especially when considering the highly uncertain economic outlook.

Valuation

After the meaningful decline in share price, Nasdaq is now trading at an fwd P/E ratio of 18.4x, which is slightly below other major financial exchanges such as CME Group ( CME ) and Intercontinental Exchange ( ICE ), as shown in the first chart below. The current multiple represents an 11.5% discount compared to peers' average fwd P/E ratio of 20.8x. However, I do not think the company is particularly cheap. As shown in the second chart below, its revenue growth is the weakest among peers. After the acquisition, its balance sheet is also much more leveraged, which may weigh on the company moving forward.

Investor Takeaway

Nasdaq's massive acquisition of Adenza seems like a risky bet in my opinion. On one end, this can help the company expand its presence in the software space and further increase its market opportunity. On the other end, it is paying a significant premium for the purchase and will have to take on a large amount of debt to fund it. These large acquisitions also tend to take a lot of time to progress and integrate. This alongside the leveraged balance sheet presents ample uncertainties in the near term. Despite the pullback, the current valuation is not particularly attractive either. Therefore, I am reiterating my hold rating on the company.

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