Nasdaq's 2.5% convertibles attractive compared to similar convertibles, straights: Barclays Capital

By Rebecca Melvin

New York, March 18 - Nasdaq OMX Group Inc.'s 2.5% convertible notes offer investors attractive relative value as a solid intermediate-duration security when compared to other like investment-grade convertibles and straight bonds, according to Barclays Capital equity-linked strategies and convertibles research.

Investment-grade seekers should buy the Nasdaq 2.5% convertibles outright, which are at about 95.875 with a 3.8% yield, 2.4 years duration and low 10% delta.

Holders of the Nasdaq 4% straight bonds due 2015, which are yielding 4% and mature in 4.8 years, should swap into the convertibles for shorter duration, almost the same yield and an added long-dated out-of-the-money option, Barclays Capital analysts Manoj Shivdasani, Venu Krishna and Peng Cheng wrote.

Holders of investment-grade convertibles of similar profile should also swap, the analysts said, citing examples including Transocean Inc.'s 1.5% series C convertibles, which are putable in 2.7 years and yielding 3.08%; ProLogis' 1.875% convertibles, which are putable in 2.8 years and yielding 4.07%; and ProLogis' 2.625% convertibles, which are putable in 3.2 years and yielding 4.55%.

The swap will pick up yield and improve the credit profile, the analysts said.

It should be noted that Barclays Capital credit analysts recently downgraded ProLogis to "underweight" on the company's weak credit metrics relative to other BBB- rated real-estate investment trusts, primarily due to the substantial proportion of underperforming assets on the company's balance sheet.

Nasdaq's equity outlook is positive, with stable growth revenue streams and solid credit and free cash flow margin, and there's a potential buyback, the analysts said.

Barclays Capital's equity analyst, Roger Freeman, has a 1-Overweight/2-Neutral rating on the stock with a price target of $27.00, a 33% potential upside to the current price of $20.51 (Nasdaq: NDAQ), based on 13 times estimated 2010 earnings of $2.05.

Nasdaq stock currently trades at about 10 times forward earnings, versus 12.8 times for NYSE Euronext, 16.5 times for the S&P 500 Financials index and 15 times for the S&P 500 index, the analysts said.

The Nasdaq multiples should expand given the company's solid operating performance and stabilizing market condition, the analysts wrote.

In 2009, on revenues of $1.45 billion, the company generated free cash flow of $322 million. The estimated free cash flow for 2010 is $479 million on revenues of $1.55 billion.

Barclays Capital's equity analyst believes that the company will use free cash flow for debt and/or equity repurchases. The company has already bought back $47 million of the convertible issue, with $428 million currently outstanding. Its original size was $475 million.

Moody's Investors Service's November upgrade of Nasdaq to investment grade on strong credit fundamentals is also viewed as positive. Moody's cited diversified revenue, improved profitability and reduced leverage as reasons for its upgrade.

Capitalizing on the opportunity, Nasdaq issued $400 million of five-year notes at 4% and $600 million of 10-year notes at 5.55% with the existing convertibles to refinance prior debt.

On Thursday, the 2.5% convertibles traded last at 96.125, according to Trace data. Barclays reported that the convertibles, prior to publishing, were trading at 95.875 versus a share price of $20.51. That worked out to a 3.8% yield to maturity and a premium of 158%.

The 3.4-year convertibles are yielding 3.8%, or 190 basis points over interpolated Treasuries, only slightly lower than the 4.8-year 4% bonds, which are yielding 4.01%, or 149 bps over interpolated Treasuries, the analysts wrote.

"The convertibles have a duration that is 1.5 years shorter, offer similar yield and a far higher spread over Ts than the straights - indicating clear relative value. Not to mention the convert holders also get a call option, albeit deep out of the money (delta ~ 10). Also the convert yield of 3.80% is 59 bps higher than the BBB+ [to] BBB- 3 - 4 year bonds in the U.S. credit index (weighted average yield to worst of 3.21%)," the Barclays analysts wrote.

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