Early in March, I concluded that it was near time to trade again with regard to shares of Nasdaq, Inc. (NASDAQ:NDAQ). I called the company a rather steady and somewhat boring value creator, which has seen macro headwinds limit earnings growth in 2022, but growth was still seen nonetheless.
With valuations rapidly getting more reasonable and leverage being under control, I was starting to become a buyer on dips in the lower fifties, with shares trading hands at $56 at the time.
A Quick Base Case
Early in 2022, Nasdaq posted its annual results. Sales were up 18% to $3.42 billion, with GAAP earnings reported at $7.05 per share, but this was ahead of a three-for-one stock split. Following the stock split, earnings came in at nearly $2.40 per share, or just over $2.50 per share if we look at adjusted earnings. Net debt of $5.4 billion worked down to a leverage ratio nearly 3 times based on $1.9 billion in EBITDA.
With a stronger dollar and lower activity levels hurting the business in 2022, the company grew full year sales by a modest 5% to $3.58 billion, with growth slowing down during the year. Adjusted earnings per share rose fourteen cents to $2.66 per share, although the company managed to reduce net debt to $4.9 billion, aided by a small divestment, with leverage ratios coming in around 2.5 times based on a $2 billion EBITDA number.
Trading at around 21 times earnings, the valuation multiple looked quite stable and appealing given the stability and long-term growth prospects of the business. Leverage ratios have fallen further, and while the near-term outlook was anything but spectacular, I was warming up to the valuation and prospects for the shares at the time, concluding to enter a position if shares would fall to the $50 mark.
What Happened?
Shares fell all the way to $51 and change in March, just as I missed my entry point, and while shares recovered nicely to $58 in recent trading days, they have fallen back to $51 and change. Shares are down 11%, having fallen more than $6 per share in a single trading session on the back of a substantial deal.
But first look at the operational results. In April, Nasdaq announced flattish revenues at $1.53 billion, as net earnings improved by four cents to $0.61 per share, with adjusted earnings up three cents to $0.69 per share. Net debt was stable around $4.8 billion, as the 495 million shares valued equity at $28.7 billion at $58 per share, for a $33.5 billion enterprise valuation.
The big news arrived on June 12, when Nasdaq announced that it has reached a $10.5 billion deal to acquire Adenza from private equity firm Thomas Bravo. With the deal, Nasdaq will acquire a successful provider of mission-critical risk management and regulatory software.
Adenza itself is the product of Calypso and AxiomSL, adding capabilities and activities like end-to-end treasury, risk and collateral management workflows, as well as regulatory and compliance software. With an expected $590 million revenue contribution this year, a near 18 times sales multiple looks very steep. After all, Nasdaq itself trades just over 5 times sales here.
The company defends the rationale by pointing out to 58% EBITDA margins, for an 30 times multiple on that front, as well as 15% revenue growth rates. The effective purchase price has fallen a bit, as Nasdaq will pay $5.75 billion in cash and issue 85.6 million shares, effectively lowering the purchase price to $10.1 billion at these lower share price levels. Following the deal, Thomas Bravo will own nearly 15% of the business, as net debt will essentially more than double to about $10.5 billion. With pro forma EBITDA seen around $2.3 billion, the company expects to operate with a 4.7 times leverage ratio.
Given the mere $340 million EBITDA contribution and a $10.1 billion price tag, it will be hard for the deal to be accretive. In fact, earnings per share accretion is only seen in year two, driven by an expected $80 million in expenses synergies and $100 million in revenue synergies (over time). The press release and deal presentation seem to suggest that some dilution will be seen in year one, but fails to confirm or quantify this.
What Now?
The reality is that shares have fallen quite a bit in response to the deal. In reality, the near-term earnings power of $2.66 per share (as reported in 2022) will likely see a limited impact. Adjusted earnings of $2.66 per share times 495 million works down to a $1.33 billion earnings number by the current operations.
The $340 million EBITDA number will be reduced by an estimated interest expense of about $287 million based on $5.75 billion cash payments and a 5% cost of debt (based on own estimates). With the incremental earnings contribution pre depreciation expense coming in at $53 million, this suggests that earnings might fall to $2.37 per share based on the new share count, marking quite some dilution. That however is likely in part outdone by continued growth ahead of closing, perhaps some cheaper financing rates and the quick realization of some synergies.
However, the near-term earnings picture will likely be limited to levels around $2.50 per share, marking some dilution. With shares down to $51 again, the resulting 20-21 times multiple is intact, but a 2.5 times leveraged balance sheet will see leverage increase to 4.7 times again, making me a bit cautious here. After all, the deal looks expensive, and while it makes sense, it has partially been priced in now.
While I like the long-term nature of the deal, which makes Nasdaq less reliant on market activity levels, the reality is that the deal looks very rich, so I understand the near-term selloff on the back of the deal announcement. Given this background, I am extremely cautious here, and I am lowering my desired entry target for Nasdaq, Inc. to the mid-forties, reflective of the added leverage in the meantime.
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