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Nasdaq Inc.(NASDAQ: NDAQ)released third-quarter 2016 results on Oct. 26, and for those who follow the global exchange closely, similarities to the previous sequential quarter were quite evident. Short-term costs from a host of recent acquisitions again partially offset revenue gains from the purchases. Before delving into these and other details, let's first review a high-level financial summary of the last three months:
Nasdaq Inc.: The raw numbers
Data source: Nasdaq Inc. 8-K filing, Oct. 26, 2016. YOY = Year over year.
What happened with Nasdaq Inc. this quarter?
- Market services, the company's largest segment, expanded revenue by 6.5%, to $213 million, due to increased equity trading and derivatives revenue, as well as higher trade management services revenue. The company cited the inclusion of results from its June 2016 acquisition of ISE (International Securities Exchange)as the primary factor behind the growth. Operating income improved 4.6%, to $114 million.
- Technology solutions, Nasdaq's next-biggest segment, reported a leap of 27.5% in revenue, to $167 million, and a similarly impressive 57.9% advance in operating income. Key drivers included 24% organic growth in the company's market technology business, and 31% growth in revenue in its corporate solutions arm. The company noted that corporate solutions' expansion benefited primarily from the recent acquisitions of Marketwired and Boardvantage.
- Information services pushed revenue slightly higher, by 3.8%, to $137 million. Operating income improved approximately 1%, to $97 million.
- Listing services, Nasdaq's smallest business segments, also booked moderate revenue and operating income gains. It reported a 3% enhancement in revenue, to $68 million, and 6.9% growth in operating income, to $31 million.
- Nasdaq continued a streak of recent listing dominance. The exchange completed 79 new listings in Q3 2016, and was able to boast that 74% of all U.S. IPOs during the last three months were listed on Nasdaq.
- NFX, the company's energy futures trading exchange, which launched in July 2015, appears to be ramping up trading volumes. In September 2016, the exchange hit a record of open interest in contracts, at 1.2 million. Trading volume of 8.9 million contracts in the third quarter represents growth of 16% from the prior sequential quarter alone (Q2 2016).
- As in the second quarter, Nasdaq enjoyed an overall revenue benefit from its many recent acquisitions, and a commensurate drag on earnings. The company cited a $58 million positive revenue impact from acquisitions and attributed most of its $54 million expense increase to onboarding costs of its four most recently completed acquisitions. These included the purchase of Chi-X Canada (redubbed "Nasdaq CXC") in February 2016, in addition to the three purchases named above.
- However, the expense drag from Nasdaq's recent buying spree should moderate over the next several quarters. The company reported that it's achieved about $23 million of a total $60 million in annual targeted acquisition synergies as of the end of the third quarter.
What management had to say
One of Nasdaq's strategic imperatives has been the diversification of revenue, as the company seeks to supplement trading income with a number of other top-line enhancements. During the company's third-quarter earnings conference call, CEO Bob Greifeld drew a direct correlation between the company's acquisition strategy and its recent revenue transformation:
Greifeld's point that acquisitions have shifted Nasdaq's revenue structure to a composition of more than 75% non-trading income underscores an achievement -- as well as a reality. Below is a graph from Nasdaq's third-quarter 2016 investor presentation, which shows organic revenue growth trends among the company's services:
Image source: Nasdaq, Inc. Q3 2016 investor presentation.
Over the last four quarters, market services organic revenue, which encompasses equity, cash, fixed income, and commodity trading and clearing services, has declined 22 percentage points. Acquisitions such as ISE have stabilized trading revenue. But more importantly, non-trading acquisitions, bringing new and varied services in house, point to the future of Nasdaq's revenue and earnings. That's why shareholders can be somewhat tolerant of lower earnings for now, while the company absorbs its diversification purchases. The payoff, a much more balanced and predictable revenue base, should be worth the wait.
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Asit Sharma has no position in any stocks mentioned. The Motley Fool recommends Nasdaq. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.