Magic touch to NYSE merger

NEW YORK - When New York Stock Exchange chief executive John Thain arranged the takeover of Archipelago Holdings, a nine-year-old electronic exchange, by the 212-year-old Big Board, he pulled "a rabbit out of his hat".

That's the view of William Harts, who worked for the NYSE's chief rival, the Nasdaq Stock Market.

In one stroke, the NYSE will be able to extend its operating hours, provide clients with options trading and access to Nasdaq-listed stocks, and cut about US$200 million ($275 million) of expenses.

For the NYSE, the transaction is a "a giant step toward eliminating their massive infrastructure costs by adopting Archipelago's technology", said Harts, the Nasdaq's former head of strategy.

The acquisition, announced late on Thursday (NZT), may help to revive the NYSE, which has been hit by a declining share of trading in the US$14 trillion United States equity market in the past five years.

The exchange turned to Thain, 49, a former Goldman Sachs president, 16 months ago when it faced a regulatory investigation of traders, the ouster of former chief executive Richard Grasso and as investors increasingly went outside the exchange to trade NYSE-listed stocks.

By combining with Chicago-based Archipelago, Thain will seek to take orders away from its chief rival, the electronic Nasdaq.

Buying Archipelago will reduce the NYSE's dependence on setting stock prices by auctions conducted on the floor of its headquarters at the corner of Wall St and Broad St in downtown Manhattan.

The NYSE's market share in trading of its listed companies fell to 79 per cent last month from 85 per cent four years ago, and trading volumes on the Big Board are little changed during the past three years.

The NYSE's floor-based market-makers reported their first annual loss last year since the exchange began tracking their earnings in 1988. The Big Board itself had its lowest annual profit since 1991.

Thain said he had little choice but to diversify the Big Board's business beyond trading stocks.

"The growth and profit of the NYSE will be constrained as long as we are limited to one product."

The transaction transforms the NYSE, founded in 1792 when 24 people met at a buttonwood tree on Wall St, into a public company from one owned by its 1366 members.

NYSE members will swap their seats for 70 per cent of the combined company, NYSE Group, and US$400 million in cash.

Shareholders of Archipelago, the third-largest electronic market for US stocks, will own the rest.

The deal values the NYSE at about US$2.1 billion, based on market value of US$884 million for Archipelago. Members will get about US$1.51 million in stock for each seat, plus almost US$300,000 in cash, for a total of US$1.8 million.

"Archipelago shareholders are getting a very good deal," said one analyst. "The 30-70 split is very generous. The NYSE is worth more than that."

Archipelago has a trading day of 16 hours, compared with 6 1/2 for the NYSE. It also trades derivatives such as options and lists companies that do not meet Big Board requirements. It handles about a quarter of Nasdaq trading and itself has been taking business from the Big Board. In the first quarter, it handled 2.5 per cent of NYSE-listed stock trading.

A focus on trading stocks was enough for Thain's predecessor, Grasso, who ran the NYSE for eight years. Investor interest in equities took off as the Standard & Poor's 500 Index rose at an unprecedented 26 per cent annual rate in the five years ended in 1999.

During Grasso's reign, the Big Board's market-making firms, known as specialists, generated US$2.9 billion of profits.

As sharemarkets tumbled starting in 2000, the NYSE lost business to rivals such as Nasdaq and Archipelago. Grasso was forced out in September 2003 amid a furore over his US$140 million salary for that year.

The bear market led brokers and traders to flee the business, and annual lease rates for NYSE membership plunged as low as US$53,000 on February 24 from US$360,000 in September 2001. NYSE seat prices have slipped to US$1.6 million from a peak of US$2.6 million in August 1999.

Archipelago was co-founded in 1996 by chief executive Gerald (Jerry) Putnam, 46, to capitalise on a relaxation of trading rules for Nasdaq-listed stocks. Originally an electronic communications network, with no listing services, it became a facility of the Pacific Exchange in 2001. It bought Pacific outright this year for US$50.7 million.

Goldman, which led Archipelago's initial public offering last year, now owns 15.5 per cent of Archipelago and all of Spear Leeds Kellogg Specialists, the second-largest NYSE market-maker. Goldman advised both Archipelago and the NYSE on the deal. Members own the exchange. Two-thirds are absentee owners who lease their seats to traders for more than US$50,000 a year.

Under the proposed plan, shareholders will have no trading rights. Anyone who wants to trade on the floor will have to rent rights directly from the NYSE itself.

The transaction still needs approval from the NYSE members, Archipelago shareholders, the US Securities and Exchange Commission and the Justice Department.

It is expected to close by the first quarter of next year.

The new entity plans to cut costs by reducing staff and consolidating operations, but Thain said there were no plans to scrap the Wall St trading floor.

- BLOOMBERG