Nasdaq converts look attractive for outright, convert arb and equity investors, says Barclays Capital

By Rebecca Melvin

New York, Feb. 23 - Barclays Capital convertibles research deems Nasdaq Stock Market, Inc.'s 2.5% convertibles due 2013, which priced last February, attractive for outright, convertible arbitrage and equity investors given the underlying stock's current valuation, good credit metrics and a high 71.9 bond floor with a risk premium of 5.4%, making the convertibles defensive on the downside.

"We find the converts very attractive and different investors can use them to express a view on NDAQ," Barclays analysts Manoj Shivdasani, Venu Krishna and William Gioielli said in a research note Monday.

For outright and equity holders, the convertibles have an attractive risk/reward and valuation and the outlook on the financial exchange subsector is positive.

For arbitrage investors on a light hedge, the convertibles are recommended even with the possibility of mark-to-market volatility over a longer-time horizon.

OTM call option

The 9.2% total yield is attractive, and investors also own a long-dated, four-and-a-half year out-of-the-money call option on Nasdaq, the analysts wrote.

In addition, those who don't want the Nasdaq delta exposure can sell high implied volatility OTM calls.

"Hypothetically, if one sells 18.1386, 4.5 year calls struck at $55.13 using a spot of $20.3 and a reasonable vol assumption of 45%, one could collect a total premium of $47.9 or 4.8 points. That would effectively increase the yield on the convert to 10.9%. Credit investors may also choose to hedge using OTM puts," the Barclays analysts wrote.

The Nasdaq 2.5% convertibles are currently indicated at 75.75 versus $20.30. Using assumptions of Libor plus 750 basis points and 40% volatility, they have a theoretical value of 77.5, according to the analysts.

The current yield is 3.3%, and the yield to maturity is 9.2%.

Exchanges defensive

A 53% decline in Nasdaq's stock since this time last year was driven by investor concerns about potential volume headwinds in light of macroeconomic challenges, industry delevering, declining market indexes and hedge fund redemptions among others, Barclays said.

The exchanges are a relatively defensive subsector for investors within financials because they do not face credit condition-driven challenges such as asset write-downs and they can self-fund their growth.

At current levels, Nasdaq stock represents an attractive entry point ahead of fourth-quarter earnings. With less than 40% of its sales being driven by trading revenue, Barclays views the company as the most defensive exchange operator in an environment that puts volume growth rates in question.

In addition, merger synergies should drive the majority of the company's 2009 expected earnings growth.

Barclays has an overweight rating on the stock with a $35 price target.

Credit metrics

As for its credit fundamentals, Nasdaq has three pieces of debt outstanding totaling $2.56 billion. The majority of the debt, or $1.96 billion, is senior secured debt issued in connection with the acquisition that Nasdaq completed in 2008.

Nadaq and OMX combined businesses in early 2008 and now operate the Nasdaq Stock Market, the Nasdaq OMX PHLX, the Nasdaq Options Market, the Nordic Exchange and the Nasdaq OMX Europe.

The $475 million 2.5% convertibles were issued on Feb. 21, 2008 to refinance OMX debt.

The credit metrics are good, Barclays judges, with the convertible credit trading wide and a profitable business model that is self-funding from operations and with no debt maturing until 2013.

The delta of 38% affords reasonable upside equity participation and a high rho of 2.55, vega of 0.29 and attractive gamma of 0.44%.

Nasdaq is a New York-based provider of securities listing, trading and information products and services.

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