NDAQ - Nasdaq: Adenza Worries Are Not Taken Away

2023-08-14 11:01:12 ET

Summary

• Nasdaq's +$10 billion deal for Adenza caused a $3 billion decline in shares due to near-term dilution and increased debt.
• Nasdaq's Q2 earnings release confirmed the soundness of the strategic deal but highlighted the painful near-term dilution and higher leverage.
• The Adenza acquisition is expected to be accretive in year two, but the added debt and dilution make me cautious with a desired entry target in the mid-forties.

When Nasdaq ( NDAQ ) announced its +$10 billion deal for Adenza in June, market participants, including myself, were a bit cautious on the deal. While it made a lot of strategic sense, it was the near term dilution and debt built-up, which stood at the basis of a $3 billion decline in the shares at the time of the announcement. This reaction in itself was interesting enough to pick up coverage again.

While I believed that the sell-off, upon the deal announcement was fair, I was hoping to get more clues on the deal upon the second quarter earnings release. Unfortunately, that has more or less reconfirmed my initial takeaway: that of a sound strategic deal, while near term dilution would be quite painful and leverage would become higher, leaving me cautious here, as I work with a lower desired entry target.

Where Do We Stand?

Earlier this year, Nasdaq posted its 2022 results, a year in which it grew sales by a modest 5% to $3.58 billion, although that growth slowed down throughout the year. Adjusted earnings per share rose in line with the topline, advancing by fourteen cents to $2.66 per share.

Net debt was reported at $4.9 billion, for a leverage ratio around 2.5 times based on a $2 billion EBITDA number. With shares trading in the mid-fifties upon the release of those results, a 21 times multiple looked quite reasonable, given the long term growth prospects but certainly the track record of the business.

In April, Nasdaq announced flattish first quarter sales, as adjusted earnings improved by three cents to $0.69 per share. Amidst a flattish net debt load of $4.8 billion, the 495 million shares were valued at $28.7 billion at $58 per share, for a $33.5 billion enterprise valuation.

That valuation is important, as the company announced a $10.5 billion deal to acquire Adenza from private equity company Thomas Bravo in June, adding mission-critical risk management and regulatory software to the line-up. While risk management, treasury, regulatory and compliance software are desirable assets, an 18 times sales multiple looked very steep with $590 million in annual revenues.

In comparison, Nasdaq trades at just over 5 times gross sales and about 9 times net sales (after deducting rebates etc.). The company points out to 58% EBITDA margins reported by Adenza, as well as 15% growth rates, to justify the premium.

Moreover, the purchase price has fallen a bit as $5.75 billion of the deal would be paid in cash with over 85 million shares offered to fund the remainder of the transaction, meaning that Thomas Bravo will obtain a 15% share in Nasdaq post the deal. Net debt would jump to $10.5 billion, as EBITDA is only seen at $2.3 billion on a pro forma basis, for a 4.7 times leverage ratio, a bit steep to my taste.

With $340 million in EBITDA and a $10.1 billion price tag, it is hard to see how the deal will be accretive, and it is not, at least not at first. Following $80 million estimated expense synergies and $100 million in revenue synergies, accretion should arrive in year two, although not quantified by management.

In the article in which I looked at the deal, I believed that earnings might fall to about $2.50 per share upon consummation, which meant that at $51 per share, the company still traded at 20-21 times earnings, although this time with a 4.7 times leverage ratio, meaning that I lowered my desired entry target to the mid-forties, reflective of the added leverage in the meantime.

Trading Stable

Since the deal announcement about two months ago, Nasdaq has tapped the capital markets in June, offering $4.25 billion and EUR 750 million in senior notes. The dollar denominated bonds were issued at rates between 5.35% and 6.10% (with the latter being a 2063 offering) while the EUR denominated bonds were issued at 4.5%.

In July, Nasdaq announced a 4% increase in net revenues for the second quarter, with revenues reported at $925 million, as adjusted earnings per share rose by two pennies to $0.71 per share, as net debt ticked down to $4.6 billion. The 4% growth rates is better than it looks as activity levels are down a bit, so in that sense the underlying performance remains solid, but management has not been able to address the issues relating to the Adenza deal.

The company believes that Adenza will generate $300 million in unleveraged pre-tax cash flows in 2023, while the associated interest payments for the same period are seen at $325 million, clearly dilutive as there is the equity component of the deal as well. Moreover, no quick deleveraging is seen, as the combination of anticipated further hikes in the dividend and share buybacks means that a 3.3 times leverage ratio is only seen by 2026.

Still Erring Cautious

As my concerns on the deal remain intact, and have not been tackled upon the quarterly earnings release, I am still reserved at levels around the $50 mark, similar to the time when the deal was just announced.

Added debt and dilution is substantial as current financing markets make it prohibitive to see a near term positive impact, making me simply quite cautious here, as I see no reason to alter my desired entry target of the mid-forties.

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