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NASDAQ Downgraded to Underperform

NDAQ FB

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We have downgraded our recommendation on NASDAQ OMX Group Inc. (NDAQ - Analyst Report) to Underperform from Neutral based on reduced investors’ confidence on the stock following the technical snags during the Facebook Inc. (FB - Analyst Report) initial public offering (IPO). Weak first-quarter 2012 earnings and headwinds related to volume and pricing are the other downsides.

NASDAQ’s first-quarter 2012 operating earnings per share of 61 cents fell shy of the Zacks Consensus Estimate of 63 cents, but were in line with the prior-year quarter earnings. GAAP net income came in at $85 million or 48 cents per share, lagging behind $104 million or 57 cents per share recorded in the year-ago quarter.

NASDAQ continues to suffer from an eroding market share and weak trading volumes, which is directly affected by economic and market conditions, volatility of interest rates, inflation, changes in price levels of securities and the overall level of investor confidence.

The company’s matched market share executed in NASDAQ-listed securities declined from 46% in 2007 to 27.7% in 2011, while the combined matched market share in all U.S.-listed securities declined from 29% in 2007 to 21.2% in 2011. This steady erosion increases the operational and financial risk of the company.

Further, the technical glitches during the Facebook IPO dealt a severe blow to investors’ confidence. While the exchange has taken steps to rectify the procedure for future IPOs, it is facing lawsuits filed by disgruntled Facebook investors and the IPO is being reviewed by the Securities and Exchange Commission and the Financial Industry Regulatory Authority.

Moreover, the exchange was compelled to announce a $40 million compensation for investors who lost money. However, the move failed to pacify investors, who consider the compensation to be inadequate to cover their losses. Rival NYSE Euronext Inc. also protested against the compensation claiming that it provides unfair competitive advantage to NASDAQ.

Nevertheless, NASDAQ continues to provide leading technology for the world’s competitive and demanding capital markets.The company’s next generation technology is capable of handling over one million messages per second at an average speed of sub-250 microseconds, currently the fastest in any exchange or alternative trading system in the world.

The launch of NASDAQ’s third retail equity stock options trading platform – BX Options – is expected to attract retail investors, thereby boosting trading volume.  Further, the launch of MSCI Emerging Markets and MSCI EAFE Index Options are expected to provide competitive advantage to the exchange as they are the first and only cash-settled options based on the EEMIQ and EAFEQ indices.

NASDAQ currently carries a Zacks #3 Rank, implying a short-term ‘Hold’ rating.

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