Tuesday, September 06, 2005

Shareholder equity for NYX shareholders will be uniform

rather interesting discussion about the impact of the percentage ownership stake has emerged in the Arca bleachers (ie., The Y! Finance message boards). For the sake of continuity and depth of concepts achievable with links, thought it'd be fun to forward the discussion here to ArcaNews. To be sure, reasonable people will disagree, but that's what makes a market. Please feel free to post your comments at the end of this post. Bottom line here is that shareholder refers to NYX shareholders and the equity each NYX share/holder has in NYX is equal.

The premise to this discussion derives from a post here at ArcaNews which states that the percentage ownership stake of NYX is trivial to AX shareholders. The fact is that one share of AX will convert to one share of NYX. This fact is stated in the S-4 filed with the SEC.
Again, here's specifically what the S-4 says:
"In the proposed merger, Archipelago stockholders will be entitled to receive one share of NYSE Group common stock for each of their shares of Archipelago common stock." (Source: 3rd paragraph on page 2 of the S-4).

Before getting into the discussion, here's a primer on some of the concepts alluded to below.

Shareholder Equity
: Appears on a firm's balance sheet as a line-item. It is calculated by taking the total assets and subtracting the total liabilities. Click here for a fairly good explanation of Shareholders' Equity and understanding a balance sheet.

Revenue: The money received by a firm as a result of its activities (generally sales activities). This number is found on an income statment. Click here for a fairly good explanation of revenue.

Net Operating Income: Also found on a firm's an income statement. Expressed as a formula, it's:
Revenue - Cost of goods sold - sales discounts - sales returns and allowances - expenses

(it's worth noting AX's net operating income growth over the last few years. Check out how AX has grown this line here!!)

Economic Value Added ("EVA"): Expressed as a formula, it's:
Net Operating Income After Taxes - (Capital x Cost of Capital). Click here to learn about EVA from the folks that coined the concept.

These are the basics. Certainly most around here understand them, but it never hurts to put some information out there.

Now, here's a re-post of the discussion from Y! Finance message boards:

A few points I need to make:

With regard to the Charles Gasperino article. THis guy does not understand the economics of the NYSE. I agree with the points you made on your website. But you need to add that the price of making the trade is only a small fraction of the overall cost to the stock trader. By far the bigger "cost" is the bid-ask spread. The smaller exchanges he cites as competitors willing to underprice the NYSE can never do it unless the NYSE raises their prices VERY substantially. Their illiquid markets will never create good price discovery and the bid ask spreads will be so wide you could drive a truck through them - the overall cost to the stock trader is then much higher even with lower trading fees on these smaller exchanges. In a sense, the NYSE is the low-cost provider.

With regard to the 30/70 split or 80/20 split being irrelevent - I disagree. Yes, the AX shareholder will receive one NYSE share for one AX share - but depending on the split, there could be a lot more NYSE shares out there and our share would represent a smaller portion of the company ie, we would own less of the company it does matter - a lot. Think about it, if the split was 99% NYSE vs 1% for AX - wwould this not matter? We could still own one share of NYSE, but it would only represent a small sliver of equity in the new company."

Thanks for your insight flash. I think we see the fraction of ownership issue differently. Take the hypothetical example of 99%/1% and the issue of how much equity in NYX an AX shareholder will have. When an AX shareholder sells a share of NYX, they will receive in return for the share the entire price of a share of NYX. They won't receive 1% of the value of a share.

Take it to the balance sheet where shareholder equity resides. Once AX becomes NYX they'll use the same balance sheet. The balance sheet will not break out shareholder equity for one-time AX shareholders and shareholder equity for NYSE seat holders. There will be one line for shareholder equity and that value will be uniform across the board for all shareholders of AX.
Think of this way:
One apple pie = NYX
if you cut the pie into 30 pieces or you cut it into 70 pieces, in the end you still have one pie. That pie has all the same ingredients contained in each slide. And the end product of all the ingredients is the entire pie.

if NYSE seats/AX shares = NYX, each piece contains the same ingredients, and each piece tastes like apple pie. The taste is not diluted due to small slices/big slices. All the ingredients are blended.

Same here: each item on the balance sheet, statement of cash flows, and income statement is analagous to each ingredient in an apple pie. That apple pie is NYX, the public company with one uniform share value at any given

Reasonable people will disagree. Here I think we just agree to disagree. The split isn't going to change. Thain, his board, and filings have essentially branded the fact that it's 70/30 - period, end of discussion. This chatter is just fun fodder while we wait for the deal to materialize and ArcaEx to spring into action.

Thanks again for yer insight!"

"I totally agree that if the intention is to buy NYSE shares AFTER the merger then it makes no difference what the split turns out to be...but if you are an owner of AX now it could mean a much thinner slice of pie.

Thanks for keeping the site going. Are you really 90 years old? "


"I have to disagree with your analogy...

While shareholder equity will be the same for NYSE seat holders and AX shareholders post-merger, shareholder equity for AX shareholders could very well diminish prior to the merger. How ? The NYSE shareholders have not had any shares allocated so far. That means the new company will have to generate new shares of stock for every seatholder on the NYSE.

Let's say you have 300 share of AX. Regardless of the merger you'll still have 300 shares, and 300 votes for proxy. But Mr. Seatholder had 700 created for him as a result of the settlement. Has your influence diminished for proxy-related issues ? Yes, assuming you don't buy more shares ahead of time. Will your price/share diminish ? It has to. If all shares are priced equally, the value of a share has to decrease, assuming a constant market cap value. Adding more shares will lead to a dilution in price.

Going back to your analogy, you said,
"One apple pie = NYX
If you cut the pie into 30 pieces or you cut it into 70 pieces, in the end you still have one pie. That pie has all the same ingredients contained in each slide. And the end product of all the ingredients is the entire pie."

True, but how many apples are you putting into the pie in the first place ? Are you counting, say, only the 30 you're contributing, or have you neglected to recognize that someone else wants to add 70 more to the pie ? It may taste really good as a whole, but your initial contribution has just been minimized.

Values for current AX shareholders can only be justified if trader sentiment believes in the long-term viability and growth of the company, and is also reflected by an increase in the company's market cap. Otherwise, the stock may seem overpriced.

I'll keep an eye on further developments. AX is an interesting story, both in the short and long term.

All this talk about apple pie is making me hungry. I'll have some peach cobbler for dessert tonight. "

"Thanks for your analysis -- like a said, this is a fun excercise.

Guess we too, agree to disagree.

Here's what I mean:
You say,". . .shareholder equity for AX shareholders could very well diminish prior to the merger. . ."

I say that shareholder equity is the same for ALL NYX shareholders. There will be one balance sheet, and the numbers on this financial statement apply to one company. That compant is NYX. There won't be any footnotes stating that only a fraction of the NYX shareholders' equity belongs to people that owned a piece of AX prior to the merger.

It's inconsequential that any shareholder equity diminishes prior to the merger because prior to the merger, there will not be any NYX shares. These shares are AX after some plastic surgery. Certainly there are NYSE seats for sale, but these seats only reflect the implicit value that NYSE merging with AX creates. That's another reason seatholders, as a whole, are happy with this merger. Until the merger is complete (likely Q1 2006), AX will have its own financials. The numbers contained on these statements will not include any synergies or accretion of the NYSE bidness. That stuff happens once the deal is done and AX and NYSE are a one single unit. This unit will be NYX.

Another way of thinking of it (to steer away from desserts) is that you have a 1959 Studebaker Lark. No doubt, a pretty cool car. Thing is the engine's old, rusted, and not up to snuff with engines that are in some of today's cars. So, you put a 2005 Corvette engine in the Studebaker and clean the car up. That old '59 Lark's value intrinsicly improves due to a brand new, efficient and powerful engine. Here the Studebaker is the NYSE and the 'vette is AX (please forgive some of these metaphors!).

If all owners of the '59 Lark were told they they'll get new engines that are compatable with their antique car and would give their old buggies new life, these owners would rejoice and be happy to pay a bit of a premium for the engine. That's cuz the new engine represents new life for their historic wheels.

So, I stand behind my original statement that to AX shareholders the split of ownership is trivial.


Blogger hundredyearstorm said...

I have posted here before an been deleted, but let me try again. The ownership split matters, bottom line. There literally is no argument on this.

AX has 48M shares outstanding. If AX shareholders are entitled to 30% of the combined company, than post deal, NYX will have 160M shares outstanding or 48/.3. Now suppose that NYX is worth 5B. This means that each share of AX is worth 5B / 160M = $31.25.

Next, assume the ownership split is changed such that AX shareholders are entitled to only 20% of NYX. Post deal there would be 48M/.2 = 240M shares. That means an AX share is worth $20.83.

So unless you live in a world where a 33% reduction in value is economically neutral to you (and if this is the case, I have a bunch of business propositions to discuss with you), the ownership split matters.

5:22 PM  
Anonymous Anonymous said...

hundredyear -
let me just take your thesis apart piece-by piece:

"AX has 48M shares outstanding. . ."
1) FACT:
AX has 47,256,000 share outstanding (source:

1) "If AX shareholders are entitled to 30% of the combined company, than post deal, NYX will have 160M shares outstanding or 48/.3."
1) I say:
What in the world do you mean? Specifically, "NYX will have 160M shares or 48/.3"

Your fuzzy math is conceptually ass-backwards. Why would AX retain 30% of their shares? (read: the 47 million they have outstanding) They're not merging with themselves.

With math one determines a percentage of a number by MULTIPLYING the factor (i.e., 30 percent) with the base (i.e. $47M) -- NOT DIVIDING IT.

Just so you know, ~47M x .3 = ~14M. but these numbers have nothing at all to do with anything.

Do yourself a favor and read the S-4. Facts are layed out there.

One more thing to point out. The market will determine how much NYX is worth -- nothing or nobody else.

This is part of the magic of the stock market, for better or for worse. There's no "Becket Guide" to equities. No grading system for uniformity. Just what the market thinks at any given moment. Look at the late '90s?

On a day in 1999, the market thought Qualcomm was worth $500/share. On another day, the market thought Priceline was worth $180/share.

Thanks for your interest though. Good luck!

9:52 PM  
Blogger hundredyearstorm said...

Trust me, I've read the S-4. And trust me, I know how to do math. So let me show you why you're wrong.

1) You're clearly anal retentive to correct me for saying AX has 48M shares out when in fact they have 47.3M shares, but so be it. I stand corrected.

2) If you read the S-4, you'll notice that the number of NYX shares outstanding on the cover is 158,306,662. Hmmm, where did that number come from? I wonder what 158,306,662 * .3 equals? How bout 47,491,998. Amazing.

The opposite of multiplication is division. So if instead you do the math the way I did, you would divide the number of AX shares by the percent ownership they will have in NYX. That is 47,256,00 / .3 = 157,520,000. Close enough, though probably not for your math. Understand?

To your final point that the market will determine the value - no kidding! I used 5B as an example. Here, let's do the math assuming NYX is worth 1B. The illustration looks like this:

1B * 30% / 47.3M shares = $6.34/shr

1B * 20% / 47.3M shares = $4.23/shr

(6.34-4.23) / 6.34 = 33% decline in price, just as before.

Trust me, the percent ownership split matters.

4:59 PM  
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5:45 AM  

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