TW - Nasdaq: Time To Trade Again

2023-03-05 09:00:07 ET

Summary

• Nasdaq has been a steady and boring value creator.
• Macro headwinds have limited earnings growth in 2022, but growth was reported nonetheless.
• Valuations look reasonable again as leverage is under control, making me a buyer on dips here.

Towards the end of 2020 Nasdaq ( NDAQ ) announced an interesting acquisition, one which moved it into the crime fighting business as well, a deal which made quite some sense to me.

A $2.75 billion deal purchase of Verafin made that Nasdaq added financial crime-fight abilities to its line-up of products and services, soon to be integrated with its own technology offerings.

A Recap

The $2.75 billion deal for Verafin, which was only founded in 2003, came at quite an expense. While Nasdaq obtained quite some capabilities with the deal, the purchase came at quite a hefty price tag as Verafin was set to add $140 million in sales in 2021, revealing that a 20 times forward sales multiple was paid.

The deal would increase leverage ratios to 3.9 times as the revenue contribution added about 5% to Nasdaq's sales which trended around $2.8 billion at the time. Nasdaq itself generated two-thirds of revenues from corporate platforms, investment intelligence and market technology, complemented by non-trading revenues which relate to management services and market service transaction revenues.

Nasdaq was a very profitable business with EBITDA margins trending around 50% of sales as the nature of the activities makes that the D&A component was quite modest. Earnings power of $6 per share supported a $125 per share valuation, translating to a $21 billion equity valuation with 167 million shares outstanding. Net debt would jump to $5.7 billion following the dealmaking efforts as the resulting enterprise valuation of nearly $27 billion worked down to about 9 times sales.

While the deal looked a bit expensive, Nasdaq's valuation at 21 times earnings looked reasonable given the consistent growth and the valuation of predictable information and exchange providers at the time.

Moving Forward

As of today, shares of Nasdaq trade hands at $56, but this is after a three-for-one stock split which took place late last summer, which results in a pre-split price of around $170 per share. This marks still a healthy 35% return since 2020, as shares are down from a high of $70 per share late in 2021 and actually as recent as December of last year. Hence, it was clear that the reasonable valuation play late in 2020 has played out, at least to some extent.

Early in 2021, Nasdaq actually announced a small divestment, selling its US fixed income business to Tradeweb Markets ( TW ) in a deal set to translate into net proceeds of $700 million while just $23 million in annual revenues would leave the door.

Early in 2022, the company posted its 2021 results and they were quite good. Full-year revenues rose 18% to $3.42 billion as GAAP earnings rose to $7.05 per share, with adjusted earnings coming in half a dollar per share higher. Net debt came in at $5.4 billion, with leverage ratios down to less than 3 times with EBITDA posted at $1.9 billion.

The company saw moderated growth in the first quarter of 2022 and in the spring the company hiked the quarterly dividend by 11% to $2.40 per share, on an annual basis. Second quarter sales rose 6%, as this was quite good amidst currency headwinds and the lower trading activity levels on the namesake exchange, with third quarter sales growing by a similar percentage.

Revenue growth slowed down to 2%, as full-year revenues were up 5%, $3.58 billion. Margins fell a bit, notably the result of the fact that the company recorded a small gain on the sale of a business last year. Reported earnings per share fell nine cents to $2.26 per share, although adjusted earnings per share rose fourteen cents to $2.66 per share (equal to $8 per-share on a pre-split basis).

With shares now trading at $56, the multiple still comes in at 21 times earnings. Net debt fell a bit further to $4.9 billion as EBITDA approaches the $2 billion mark, reducing leverage ratios to just below 2.5 times again despite some initial buybacks performed in 2022.

And Now?

Truth is that I am gradually warming up to Nasdaq again here. The company has maintained the 21 times earnings multiple, although it has seen some multiple expansion in the meantime, while leverage ratios have fallen from about 4 times to about 2.5 times.

This in itself looks interesting, but growth has slowed down because of market conditions, volumes and a stronger dollar, while higher interest rates look more compelling to a similar near 5% earnings yield today as they did late in 2020 when interest rates were much lower. That said, I see that valuations have come down a bit again, and I am generally impressed by the boring yet secular growth displayed by Nasdaq, which makes me a happy buyer if shares fall to the lower fifties here.

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