NYSE Upped to Neutral

On Jan 18, we upgraded our recommendation on NYSE Euronext Inc. (NYX - Analyst Report) to Neutral based on its proposed $8.2 billion merger with IntercontinentalExchange Inc. (ICE - Analyst Report). This shall further boost efficiencies, though higher debt raises the concerns of the rating agencies. Hence, this stock has gained a Zacks Rank #3 (Hold), indicating no clear directional pressure in the near term.

Why the Upgrade?

NYSE reported third-quarter 2012 operating earnings per share of 44 cents, up 3 cents from the Zacks Consensus Estimate. However, results plunged 38% from 71 cents recorded in the year-ago quarter. Net revenues stood at $559 million, sliding 20.6% from $704 million in the prior-year quarter. It also fell short of the Zacks Consensus Estimate of $570 million. Over the past 4 quarters, NYSE has delivered an average surprise of 1.82%.

Following the release of the third quarter results, the Zacks Consensus Estimate for 2012 has edged down 1.1% to $1.80 per share. Moreover, the Zacks Consensus Estimate for 2013 declined (down 1.8% to $2.26 per share) at a slower pace.

Although NYSE’s financial results reflect the industry-wide low trading scenario, it continues to maintain a leading position by developing a market model in response to the emerging trends and technological advancements in the trading environment.

Most significantly, the proposed merger with IntercontinentalExchange is expected to generate more than 15% of earnings accretion within the first year of completion, while boosting the operating and competitive leverage of the merged entity. Additionally, management projects run-rate expenses synergies of about $450 million, which will be reaped in the second year of the merger startup.

Following the merger, IntercontinentalExchange will also initiate annual dividends of about $300 million, which is the current dividend payout of NYSE, scheduled to culminate by the first half of 2013.

However, wariness prevails over the combined debt of the merged entity, which is projected to be about $4.7 billion, as IntercontinentalExchange plans to use all of its $1.0 billion cash and raise another $1.8 billion from its revolving credit facility to buyout NYSE.

Although the business profile of the merger appears strong and NYSE is making efforts to reduce its debt obligations through refinancing and other activities, we believe these actions would take quite a long time given the company’s capital and other extraordinary cost requirements in the upcoming quarters.

Other Stocks to Consider

Apart from NYSE, other stocks in the stock exchange industry that are expected to rebound with economic improvement include CME Group Inc. (CME - Analyst Report), NASDAQ OMX Group Inc. (NDAQ - Analyst Report) and IntercontinentalExchange. All these companies carry a Zacks Rank #3 (Hold).