Tuesday, April 26, 2005

The Big Board Gets Plugged In

In a move which some referred to as “brilliant”, Archipelago Holdings, Inc. and the New York Stock Exchange announced a merger agreement last Wednesday (April 20, 2005). The merger will allow the NYSE to follow suit with many of its peers, such as the Chicago Mercantile Exchange and Nasdaq, which have also recently gone public. In addition, it will provide the 212-year old “Big Board” the ability to grow in the 21st Century by adding the ability to compete in the electronic transaction arena.

Over the past several years, the NYSE has faced fierce competition from electronic exchange companies such as Archipelago, who offer institutional traders a quick inexpensive way to handle transactions. “As we look to the future and to the challenge of competing globally in a high speed electronically connected world, it is clear that we must do more” commented NYSE CEO John Thain. Under the proposed terms of the deal, the current members of the Big Board will receive 70% ownership in the new company, expected to be called NYSE Group, and the remaining 30% would be allocated among Archipelago shareholders. Thain would remain as CEO of the new venture and Archipelago CEO, Jerry Putnam would become co-president and COO.

How did this deal come to be? It was due in no small part to the enterprising vision of Putnam who approached the NYSE about the deal in January of 2005. The deal obviously helps the smaller Archipelago gain exposure to a vastly broader market. To date, Archipelago has only captured 2% of the trade in NYSE-listed stocks. However, the upstart, Chicago based company clearly did not need this merger to stay solvent. The company raised $58 million in its IPO and had approximately $175 million in cash at the time of the announced merger agreement. Perhaps it is the goliath NYSE that will benefit most from this partnership as it solves two key issues for the staid, old institution: how to handle the decision of whether or not to go public and also how to deal with the ongoing debate of its role as a business and a regulator. It is expected that as a part of the deal, the NYSE’s regulatory arm will become a separate non-profit entity.

When the news of the proposed merger hit the street, there was a general feeling that this was a highly synergistic move for both companies. This move allows both companies to enter markets that they were previously unable to capture. Analysts cited that with this move, the NYSE was able to not only gain a foothold in electronic trading, but it also opens the door for them to pass regulatory approval toward becoming a public, for-profit company. Michael Henry, a partner of Accenture’s capital markets practice added that “by issuing stock, the Big Board would become better positioned to buy smaller rivals or other companies to expand its footprint….It’s a good complimentary mix.” Another possible benefit proposed is that this will allow the company to expand overseas through acquisitions.

Some of the concerns analysts have expressed are the difficult task of combining the two cultures and the inherent possibility of conflict at the top ranks of the new company, as well as what this means for large and small investors. An additional concern is whether the NYSE the prestige of a Big Board listing will be diluted as smaller companies become listed on the storied exchange.

Overall, we feel that while there will be challenges to this, or any major merger, the overall synergy created is more than worth the risk. The proposed deal will provide the NYSE with a tremendous economy of scope. It combines their massive volume of stock listings with the high tech know-how and adaptability of Archipelago. The 212-year old company, steeped in tradition, has historically been very slow to adopt change. This move will force them into the 21st Century. They now have the ability to tap into markets that were left un-served by their traditional business model.

One aspect that deserves additional mention is the difficulty of combining these two vastly different corporate cultures, as mentioned in the Business Week article (An Electronic Trader’s Big Score). If there was ever a company which personified “old fashioned” thinking, it would be the New York Stock Exchange. In sharp contrast, Archipelago is the epitome of the digital age; fast paced, aggressive and apparently very adaptable. Thain and Putnam must set the tone for the rest of the company by working together harmoniously.

With this merger and the pending deal between Nasdaq and Instinet, the US markets are taking the next step toward fully automated markets, as in Europe. The tradition of the open outcry system will create resistance to the deal initially, but the momentum of these deals and the reduced transaction costs will hurl the markets toward complete automation within the next 5 years. By 2010, one can envision that the current NYSE trading floor will become a museum, with tours given by ex-traders.

By Jeff Fechalos and Paul Mountain

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