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S&P Wary of NYSE's Liquidity

Zacks Equity Research

Last week, Standard & Poor's Ratings Services (S&P) revised its outlook on NYSE Euronext Inc. (NYX) to negative from stable, based on the company’s dismal financial performance in the second quarter of 2012. However, the rating agency has asserted the company’s credit ratings for the time being.

Accordingly, S&P affirmed NYSE’s counterparty credit rating at “A+/A-1,” senior unsecured debt at “A+” and its commercial paper at “A-1,” although the outlook now remains negative. The revised outlook elucidates on the rating agency’s creditability, since the company’s cash and operating cash flow appear under pressure and does not look impressive. NYSE has debt obligations worth $750 million in June 2013.

Moreover, the rating agency is already wary of NYSE’s current liquidity. The company’s liquid assets can hardly cover three months’ operating expenses.

NYSE has been wooing its investors with consistent dividends and share buybacks amidst the declining trend of its operating margins and operating cash flow. The company deployed $450 million on share repurchases and dividend payments in the first half of 2012, which were higher than $400 million of funds allotted for operations.

As of June 30, 2012, NYSE’s total debt stood at $2.3 billion, higher than $2.1 billion at 2011-end. At the end of the reported quarter, cash and cash equivalents, investments and other securities were $416 million, down from $432 million at the end of 2011.

As a result of higher capital expenditure and debt, NYSE’s debt-to-EBITDA ratio also deteriorated to 2.1x from 1.6x recorded at the end of 2011, which was the lowest level since the inception of this organization in April 2007.

Further, NYSE reported second-quarter 2012 operating earnings per share of 51 cents, a penny higher than the Zacks Consensus Estimate of 50 cents. However, it was quite lower than 61 cents recorded in the year-ago quarter. Consequently, operating net income plunged 20% year over year to $128 million from $160 million in the year-ago quarter.

Net revenues stood at $602 million, sliding 8.9% from $661 million in the prior-year quarter. It also came lower than the Zacks Consensus Estimate of $606 million. The deteriorating performance was primarily due to decelerated performance across board, particularly weak revenues from transaction, clearing fees and market data, which contribute about 75% to the gross revenue.

Moreover, volumes declined across all global derivatives and cash trading venues. Alongside, unfavorable currency fluctuations and lower average revenue per contract added to the woes. These downsides were partially offset by a dip in expenses, although margins continued to be weak.

However, during the second quarter of 2012, NYSE also entered into a three-year senior unsecured credit facility agreement worth $1 billion, scheduled to mature on June 15, 2015. This financing replaces NYSE's existing $1.2 billion credit facility, which it entered in 2007 and was scheduled to mature on July 31, 2012.

The new revolving bank facility is projected to be utilized for general corporate purposes. S&P believes this credit facility should be able to provide cushion to NYSE’s liquidity crunch.

Conversely, the usage of credit facility can further weigh on the borrowing costs and thereby hampering margins. Even the current rate of expense control would be of little help to the fundamental growth. Hence, the current volatile economic environment warrants a much more strict expense management in order to sustain growth and accumulate enough cash to cover at least six months of operating expenses, excluding depreciation and amortization.

Moreover, given the tough state of competition in the industry, primarily from arch-rivals such as CME Group Inc. (CME) and IntercontinentalExchange Inc. (ICE), amid the failure and termination of NYSE’s merger with Frankfurt-based Deutsche Boerse raises ample operating risks for the company. Significant fiscal and monetary policies are also required to be taken for controlling the debt- and interest-coverage metrics. 

Overall, these factors validate S&P’s cautious outlook and do not indicate any scope of upgrade for the next 1.5–2 years. On the flip side, the rating affirmation also credits the company’s strong business and risk profile along with its leading market position as well as its investments in long-term growth, which again leads to financial risk cycle that the company is already facing currently. NYSE carries a Zacks Rank #3, implying a short-term Hold rating.

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