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Introduction

Nasdaq, Inc. (NDAQ) is the company behind the NASDAQ market and as you can imagine, the elevated volatility levels in the first semester have boosted trading volumes and ultimately benefited the company as a whole. This resulted in an exceptionally strong financial performance in the first half of the year. I like exchanges as they tend to be a good vehicle to take advantage of increased volatility levels. A few weeks ago I had a closer look at Cboe Global (CBOE) and I wanted to see if Nasdaq is also still attractively priced.

Data by YCharts

Strong revenue and cash flows made H1 2020 a semester to remember

In the second quarter of the year, Nasdaq reported a total revenue of $1.4B, an increase of about 30% compared to the revenue in Q2 2019. As you can see on the image below, the market services segment was the main driver for the total revenue increase, but Nasdaq also had to deal with higher expenses. That’s why its net revenue (total revenue minus transaction-based expenses) increased by ‘just’ 12% to $699M.

Source: SEC filings

The other operating expenses increased as well, but at a much slower pace as the $384M in other operating expenses is just 5% higher than the operating expenses in Q2 last year, and this caused the operating income to increase by approximately 20%. Additionally, the net interest expenses were lower ($25M versus $28M) while Nasdaq also reported a $26M income from unconsolidated investees to end up at a pre-tax income of $316M and an after-tax income of $241M or $1.47 per share.

An excellent result and even better than the Q1 result. Looking at the financial results for the entire first semester, the net income of $444M represents $2.70/share. A decent result considering the company had to record a $25M restructuring charge in the first half of the year. Excluding this, the EPS would have come in over $2.80/share.

I’m always more interested in a company’s free cash flow performance as it’s one thing to generate a nice paper profit. I also like to see how much of the paper profit actually gets converted into dollars flowing into the treasury.

Nasdaq reported an operating cash flow of $821M but this includes change in the working capital position as well and on an adjusted basis, the operating cash flow was $585M (compared to $485M in H1 2019, so we notice a very clear increase in the first half of 2020).

Source: SEC filings

The capex was just $68M in H1 2020, resulting in a free cash flow result of approximately $517M. Divided over 164.3M shares outstanding (as of July 28), this results in a FCF/share of $3.15 in H1 2020.

What did Nasdaq spend the money on?

In the first half of the year, Nasdaq spent approximately $158M on dividend payments and the current quarterly dividend has been confirmed at 49 cents per share. Based on the current share count, this will cost Nasdaq about $160M in the second semester, so the cash outflow related to the dividend remains pretty low compared to the incoming free cash flow.

Data by YCharts

In the first six months, Nasdaq also repurchased 1.5M shares at an average price of $102, resulting in a $152M cash outflow related to these repurchases. And as you notice, the combination of dividends + share buybacks in the first half of the year represents just over 60% of the incoming free cash flow. On the one hand, it’s good to see Nasdaq is spending within its means and the current spending pace on the shareholder rewards should remain sustainable, even when the free cash flow decreases a bit in the current semester.

Source: SEC filings

The remainder of the cash (and the cash generated through the release of some of the working capital) was just added to the balance sheet and as of the end, Nasdaq had $711M in cash and a net debt of $2.75B compared to just over $3B as of the end of December 2019.

Investment thesis

It’s pretty clear Nasdaq’s first semester was excellent, but this also means the lower volatility levels in the past few months will very likely lead to a softer financial performance in H2 2020. This doesn’t make Nasdaq less appealing as the company has used some of its incoming cash flow to buy back stock and the lower net share count will help to reduce the per-share impact of the lower net income and free cash flow result.

I currently have no position in Nasdaq but if the share price dips a bit deeper compared to where it’s trading at right now, I could be interested in initiating a long position. There are also options available on Nasdaq and writing an out of the money put option could be my preferred strategy here. A P110 expiring in December of this year has an option premium of just over $2, and an average purchase price of $108 would be a very interesting entry point. And if Nasdaq trades above $110 on the expiry date, I can just keep the $2 option premium.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.