After announcing earnings Tuesday morning, NYSE Euronext (NYX) received a 10% haircut. Although earnings came in strong (2007 saw earnings increase 214% over the previous year), investors were obviously concerned about expenses associated with the Euronext merger. Management re-affirmed guidance for synergistic cost savings of $250 million, but at the same time, rolled out a time table that pushes those savings back three quarters from when originally expected. It didn’t help at all that the overall market was down 3% the same day as very few buyers of any kind were found on the street.

Despite difficulties in fixed income and equity markets alike, fundamental growth for exchange operations has grown tremendously over the last 18 months. As evidenced by its 214% gain in net income, trading exchanges are profitable businesses as technology continues to allow more and more trades to be handled through technology that gets less expensive every day. In fact, one of the largest projected cost savings for NYX is the consolidation from 10 data centers to just four over the next year. This cuts down on capital equipment, maintenance, and personnel expenses that would have been necessary to keep all 10 centers open. While the company will need to continue to spend to keep technology on the cutting edge to serve expanding needs of customers, the consolidated data centers can employ the latest available networking equipment and stay competitive within their field.

In addition to the cost saving issue, there has been some concern as to the ability of the US portion of the company (formerly NYSE) and the European counterpart (Euronext) to effectively merge. As board members sit on opposite sides of the Atlantic and executives jockey for position and control, there is definitely a danger of disrupting the businesses that both firms have built so meticulously. While NYSE has ample experience in consolidating acquisitions, this merger of equals requires a different approach and will test managements adaptive qualities. At this point it appears the integration is progressing well, but investors should keep a close eye on mixed signals that could come from management which may indicate rifts between different leaders. If this begins to appear, it would harm the credibility and strength of the company and make further acquisitions more difficult.

Speaking of further acquisitions, NYX has proven its ability to grow through consolidating smaller exchanges into its family. This is a major trend sweeping the globe as the top tier competitors look to leverage the infrastructure they have built. The danger, however, is that in this search for partners to increase the growth prospects, companies such as NYX, CME or even ICE could end up paying more than a fair valuation for targets simply to achieve goals of revenue growth. Each additional purchase made by NYX should be scrutinized by investors to determine if the deal actually adds value to shareholders or simply makes them larger. Again, management has skill in this area; but as targets are becoming scarcer and the large exchanges are likely chasing the same name, discipline must be used to determine the price at which NYX should simply walk away from a prospective deal.

All of these concerns aside, I believe that NYX has gotten knocked down to a very attractive level. Earnings are growing and the stock multiple does not seem to properly account for the strength of management’s track record. While I am not currently buying the stock due to its declining pattern, I am keeping it on my fundamental watch list and will likely own it at some time this year when the stock begins to show relative strength. The business they operate is extremely profitable. The brand commands respect. And finally, the future continues to be bright as more and more of the worlds population become involved in the financial markets.

NYX Notes

FD: Author has no position in NYX

Additional Reading

IntercontenentalExchange – Attractive Value

FC Stone – Commodity Consulting

CME-Nymex – The Regulatory Clouds Gather