NYSE, rival plan to merge

Erik Schatzker and Philip Boroff

Thursday, April 21, 2005 | 9:35 a.m.

The New York Stock Exchange will merge with Archipelago Holdings Inc. in a transaction that speeds the Big Board's push into electronic trading and transforms the 212-year-old institution into a public, for-profit company.

The NYSE's 1,366 members will swap their seats for 70 percent of the combined company, NYSE Group Inc., and $400 million in cash, Chief Executive John Thain said Wednesday. Shareholders of Chicago-based Archipelago, the third-largest electronic market for U.S. stocks, will own the rest.

For Thain, hired to revive the NYSE following the 2003 ouster of Richard Grasso as chairman, the merger answers two challenges in one stroke. Archipelago lets him compete better with the Nasdaq Stock Market, which has eroded the Big Board's share of trading in its own listed stocks, and soothe the members whose demands that the exchange go public intensified with the size of its market-share losses.

"The NYSE had to go in this direction," said Caldwell Securities Ltd. Chief Executive Brendan Caldwell, whose family owns one seat on the exchange and controls 12 more. "This will give the exchange a new vibrancy, new energy and new purpose. It will help rid the NYSE of all the insularity that came with being a not-for-profit."

Thain, who left a job as president of Goldman Sachs Group Inc. to run the world's biggest stock market, had said he had to do something. Under Grasso, who was forced out after engineering a $140 million retirement package, NYSE seat prices plunged from $2.3 million as recently as October 2002 to $1.5 million by March 2003.

The rout extended into Thain's tenure, with a seat selling for as little as $975,000 in January. They've since jumped to $1.62 million as of last week.

"This transaction, transforming the NYSE into a public for- profit entity, is an essential step to maintain our global competitiveness and leadership," Thain said in a statement.

The merger bridges the gap between the growing importance of electronic trading and the auction system that the NYSE has relied on since 24 brokers founded it under a buttonwood tree in 1792.

Archipelago runs a longer a trading day, 16 hours compared with 6 1/2 for the NYSE, trades derivatives such as options, lists companies that don't meet the Big Board's requirements and is more profitable.

In the first quarter, Archipelago had net income of $13.2 million on revenue of $118.7 million, a margin of 11.1 percent. Meantime, the NYSE kept 8.7 percent of its $287.6 million in revenue as profit, or $24.9 million.

Archipelago itself has been taking business from the Big Board. In March, it handled 2.7 percent of NYSE-listed stock trading.

The exchanges also compete with Inet ATS Inc., which handled 3.5 percent of NYSE stock trading 26.9 percent of Nasdaq trading in March.

The merger "is illustrative of the intense competition growing now between the various marketplaces," U.S. Securities and Exchange Commission Chairman William Donaldson, a former head of the NYSE, said after speaking at the Bond Market Association in New York. "It illustrates vividly the importance of the level playing field we've tried to put in place."

Donaldson this year yielded to Thain's concerns that a trading rule the SEC proposed would be too damaging to the NYSE. Two weeks ago, Donaldson cast the deciding vote to extend a modified version of the rule, which guarantees that all investors get the best price on electronic stock trades.

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

"Archipelago shareholders are getting a very good deal," said Caldwell, whose firm is based in Toronto and manages about $400 million. "The 30-70 split is very generous. The NYSE is worth more than that."

The transaction is subject to approval by NYSE members, Archipelago shareholders, the SEC and an antitrust review.

Goldman advised both Archipelago and the NYSE. Greenhill & Co. provided a fairness opinion to Archipelago. Lazard LLC provided one to the NYSE.

Archipelago was founded in 1996 to capitalize on a relaxation of trading rules for Nasdaq-listed stocks. Originally an electronic communications network, with no listing services, Archipelago bought with Pacific Exchange Inc. in 2000 to create an electronic stock market.

Thain said the NYSE will continue to operate its trading floor, where specialists make markets in shares of some of the biggest U.S. companies. Regulation will remain nonprofit and nonpublic, governed by a chief regulatory officer and board of independent directors.

NYSE Group will have 14 directors, 11 from the Big Board and three from Archipelago. NYSE co-Presidents Catherine Kinney and Robert Britz will be joined by Archipelago CEO Jerry Putnam.

Shares of Archipelago jumped 8 percent to $18.30 in Nasdaq Stock Market trading Wednesday. The Wall Street Journal reported before the close of regular trading that Archipelago and the NYSE would enter a transaction.

Archipelago this month opened its stock-trading network four hours earlier, at 4 a.m. New York time, putting more pressure on the NYSE to extend its own hours. The NYSE now opens at 9:30 a.m. and closes at 4 p.m.