It sure sucks to be Nasdaq OMX Group (NDAQ) these days.
Hard of the heels of Nasdaq’s three-hour outage last week comes news Monday that soon the Nasdaq exchange will go from being the second-biggest stock exchange to No. 3.
Privately held rivals BATS Global Markets and Direct Edge just announced a merger that will leave the combined company chasing only NYSE Euronext (NYX) as the top place to trade stocks, as measured by volume.
Nasdaq OMX stock declined slightly on the news, but remains up over 20% year-to-date in 2013.
Given this Nasdaq OMX news, it’s no wonder NYX, parent of the 220-year-old New York Stock Exchange, agreed to be swallowed up by yet another young, all-electronic upstart — IntercontinentalExchange (ICE) — last year.
The stock-exchange business has been an increasingly bad one for some time. Not only are trading volumes at their lowest levels in more than a decade, but running an exchange for stocks is hardly the most profitable financial product you can offer customers.
The move to decimalization from fractional price quotes has been killing margins for a decade. More recently, revenue has taken a beating from ultra-low interest rates and a decline in listings due to the drop in initial public offerings.
Besides, a far more lucrative service is running an exchange for buyers and sellers to swap derivatives contracts. Futures and options are where it’s at, especially for commodities from oil to gold to wheat.
That helps explain how CME Group (CME) — a futures and options powerhouse formed by the merger of the Chicago Mercantile Exchange and Chicago Board of Trade — came to be the largest publicly traded exchange company, with a market cap of $24 billion. (Nasdaq OMX, by way of comparison, has a market value of just $5.2 billion.)
It also goes a long way toward explaining how the venerable and vulnerable NYSE could rush into the arms of 12-year-old ICE, a global player in derivatives.
The BATS and Direct Edge merger comes from pressure the old guard knows only too well: The industry is saturated competition. NYSE and Nasdaq are household names and the only exchanges that also list securities — but they’re hardly the only place to trade. Indeed, there are currently 16 securities exchanges registered with the Securities Exchange Commission.
All of which makes further consolidation in the industry inevitable. The deal between ICE and NYX is expected to close in the fall. Once the BATS and Direct Edge merger goes through, the new entity will command nearly 21% of the share vs. Nasdaq’s share of 18%. (NYSE has 23%.)
So don’t be surprised if Nasdaq starts looking to put together its own deal soon enough. It famously dropped out of the bidding to buy NYSE a couple of years ago. It’s been looking to gain scale in the global marketplace for a long time.
Whether Nasdaq OMX is the buyer or seller remains to be seen. What’s not in question is that the exchange business is going see more surprising tie-ups in the not-too-distant future.
As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.