April 22 (Bloomberg) -- Nasdaq Stock Market Inc. agreed to buy Instinet Group Inc. for $1.88 billion in cash, combining the two largest electronic markets for U.S. equities to form a stronger competitor to the expanding New York Stock Exchange.
Nasdaq will sell Instinet's brokerage arm to Silver Lake Partners, a private-equity firm, for $207.5 million, New York- based Nasdaq said today. It will also sell Instinet's Lynch, Jones & Ryan subsidiary to Bank of New York Co. for $174 million. Reuters Group Plc owns 62 percent of Instinet.
The stakes for Nasdaq, already high as it gradually lost business to newer electronic markets such as Instinet, escalated two days ago when the NYSE said it was taking over Archipelago Holdings Inc. Instead of putting NYSE Chief Executive Officer John Thain on the defensive, Nasdaq CEO Robert Greifeld was upstaged. The NYSE is the world's largest equity market, with total capitalization of about $13.7 trillion. Nasdaq's capitalization was $3.7 trillion at year-end.
``They're trying to buy market share,'' said Jamie Selway, who was Nasdaq's associate research director in the late 1990s and now runs White Cap Trading, a New York brokerage for institutional investors. ``They have to do it. Survival.''
Shares of Nasdaq, which plans to keep Instinet's electronic-trading unit, INET ECN, surged $2.78, or 26 percent, to $13.43, the biggest gain since the company went public in July 2002. Shares of Instinet fell 51 cents, or 9 percent, to $5.19 after investors had speculated it would fetch a higher price.
Reuters Shareholders
Chicago-based Archipelago, the third-largest electronic market for U.S. stocks, had a 23.5 percent share of trading in Nasdaq-listed stocks in the first quarter. Instinet has had about 25 percent. Both electronic exchanges and electronic trading systems known as ECNs can trade Nasdaq stocks.
``The notion of the New York Stock Exchange having 25 percent of (Nasdaq's) share must scare them to death,'' Selway said.
Archipelago shares fell 20 cents to $29.76, after surging 60 percent yesterday. Greifeld said Nasdaq is ``maniacal'' about pursuing its business plan, which includes increasing market share in trading of Nasdaq and NYSE-listed shares. With the INET combination, he said Nasdaq's share of trading of its own listed shares will be about 80 percent -- equal to the NYSE's dominance of Big Board stocks.
Reuters said it expects to receive about $1 billion in cash after tax and transaction fees, and expects to return ``an amount equivalent'' to that to shareholders.
Wachtell, Lipton, Rosen & Katz was Instinet's counsel. The New York law firm also advised Archipelago in the NYSE transaction. Calls to partners Martin Lipton, Daniel Neff and David Carp at Wachtell Lipton weren't returned. Skadden, Arps, Slate, Meagher & Flom represented Nasdaq.
SunGard
Greifeld came to Nasdaq in May 2003 from SunGard Data Systems Inc., a software maker that focuses on financial services and sold its Brut LLC ECN to Nasdaq for $190 million a year later. Last month, Silver Lake led seven buyout firms in agreeing to acquire SunGard for $10.4 billion.
In January 2005, Archipelago agreed to buy PCX Holdings Inc., which owns the Pacific Exchange, for $50.7 million, to move into options trading. In 2002, Archipelago merged with the RediBook ECN.
Reuters put Instinet on the block five months ago, saying the business wasn't central to its strategy. Reuters has been cutting costs and focusing on its main information and news unit as part of a ``Fast Forward'' program started by CEO Tom Glocer.
Instinet reported net income of $53.7 million for 2004, after $809 million of losses the previous two years. At the end of last year it had $902 million of cash.
`Commodity'
Bloomberg LP, the owner of Bloomberg News, competes with Reuters in providing news, information, and trading systems to the financial services industry. Bloomberg Tradebook competes with Instinet and Archipelago in the business of matching stock trade orders.
Selway, who worked at Archipelago after Nasdaq, describes matching shares as a ``commodity business.'' Electronic markets pay brokers 0.2 cent a share to post limit orders, and charge brokers 0.3 cent a share for orders executed.
In other words, a market will pay 20 cents for someone to post an order to, say, sell 100 shares of a stock, and charge someone else 30 cents to buy them. In all, the market earns just 10 cents from the transaction.
``I don't see much impact on investors,'' said James Angel, associate finance professor at Georgetown University and a former Nasdaq visiting economist. ``With competition from Archipelago, and the ever-present threat of entry from other electronic platforms, I don't think prices will go up much.''
`Better Fit'
The sale of Instinet makes Reuters a ``less complex company to understand,'' Lorna Tilbian, an analyst at Numis Securities in London, said in an interview on April 15. She expects Reuters to use the proceeds of the sale to buy back shares rather than increase its dividend.
``Instinet is a better fit for Nasdaq than it is for Reuters,'' Tilbian said. ``Nasdaq is a trading platform, Reuters is an information company.''
Instinet was founded in 1969, two years before the National Association of Securities Dealers created the Nasdaq electronic market. Instinet was a wholly owned subsidiary of Reuters from May 1987 until its initial public offering in May 2001. In 2002, Instinet purchased Island ECN for $568 million.
