When most people hear the name “Nasdaq,” they think of the world’s premier venue for buying and selling tech stocks. The Nasdaq exchange is where the cool kids of Silicon Valley and other points West––from Jeff Bezos to Steve Jobs to Mark Zuckerberg to Elon Musk––first offered their shares to all and sundry, and its fame grew as their fledgling companies mushroomed into the world’s most valuable enterprises.
The Nasdaq also earned renown as the first electronic marketplace for equities. From the beginning, it deployed only banks of quietly whirring computers, even as its competitors hosted raucous crews of traders who crowded into “open outcry pits,” shouting orders and flashing hand signals in a system that hadn’t changed much since the days of Teddy Roosevelt. Its reputation for thinking digital, starting so early, helped make Nasdaq a comfortable place for the tech titans who still keep their companies listed there and for the new founders who keep coming.
But Nasdaq, Inc., the company, didn’t get nearly as much attention or respect as the Nasdaq, the stock exchange it owns and operates. Now that it’s turning 50—its anniversary is Monday, Feb. 8—Nasdaq is finally winning recognition for the performance of its own stock, and for its success selling advanced technologies that match the high-fliers on its exchange. With $2.9 billion in revenues in 2020, and a market cap of $24.6 billion, Nasdaq is a midsize player by corporate standards. What’s generating the excitement is its potential to far exceed the modest prospects of the mature investment-exchange business, by selling technologies it uses itself to the wide world of financial services.
“When you raised the name Nasdaq with people in the investment community two years ago, they’d say, ‘Nah, it’s just a famous exchange,’” says Owen Lau, an analyst with Oppenheimer & Co. “They were surprised that just 30% of its revenues come from trading, and 70% from areas like indexes and, especially, trading technology.” Lau notes that the 75% jump in stock price in the past two years, one of the best records among established names in financial services, got a lot of Wall Street analysts and money managers to stop yawning and eyeball its daring, highly distinctive strategy.
The transformation began in the mid-2000s under CEO Bob Greifeld, but Adena Friedman, who succeeded Greifeld at the start of 2017, is accelerating the shift. Her game plan centers on moving away from reliance on the company’s exchange and listing businesses to refocus on selling cloud-based software products to banks, brokers, and even other stock markets—products designed to greatly improve the speed and capacity of their often-outdated trading platforms. “Part of our sales pitch,” Friedman tells Fortune, “is that our own exchanges are using these technologies right now, and they work.”
She’s also investing heavily in SaaS (software as a service) offerings in the booming field of fighting money laundering and fraud. Friedman is more than doubling the size of that franchise via the $2.75 billion acquisition of Verafin, the largest provider of anti–money laundering (AML) products for banks. Nasdaq expects the deal to close in the first quarter of this year.
Although the bedrock trading business is lucrative, revenues jump around and don’t show consistent growth, rising and falling with unpredictable shifts in volumes. The Nasdaq exchange had a monster year in 2020 because of the market’s extreme volatility and frenzied trading activity. But markets could turn calm and revenues slump in the next quarter, or in any quarter. What’s more, the total number of U.S. listed companies is stable, and not expected to rise rapidly, although Nasdaq has managed to modestly expand by grabbing market share.
By contrast, sales in its market technology and intelligence businesses are both strong. Tech is expected to grow at as much as 16% a year over the next half-decade. Plus, those revenues are highly predictable. Banks and exchanges generally sign up for SaaS platforms on long-term contracts, and almost always renew. Plus, personnel and maintenance costs are low because customers simply download and update products as apps from the cloud.
Friedman’s drive has made Nasdaq the largest provider of market technology in the world. Once the Verafin deal closes in 2021, its revenues in that sector will be running at around $500 million. While that may sound like a low number for a market leader, this is an arena dominated by small players that lack Nasdaq’s imprimatur—and the company is adding to organic growth by buying lots of them.
Friedman says it’s a good sign that Nasdaq still holds a tiny portion of the sales in crime prevention and trading technology. The reason: The total market, she reckons, now amounts to $26 billion, and it’s growing rapidly, giving Nasdaq a big opportunity to both grab business from small competitors and ride a fast-moving train. Says Sandy Frucher, Nasdaq’s former vice chairman, “We’ve evolved from markets that go up and down, that you have very little control over, to new sectors that will both grow overall earnings but a lot faster, and a lot more smoothly.”
The flagship sails on
Friedman’s pivot to technology is playing out even as the Nasdaq’s flagship exchange continues to thrive. It’s locked in a battle of giants with the New York Stock Exchange, and in some skirmishes, Nasdaq is winning.
The overall market cap of Nasdaq-listed companies still trails the NYSE, home to so many big industrial and financial names, $32 trillion to $22 trillion. But Nasdaq is now home to the six most valuable companies in the world: Apple, Microsoft, Amazon, Google parent Alphabet, Tesla, and Facebook. Its Nasdaq Stock Market captured 15.6% of total trading volumes in 2020, the largest share for any single exchange. Nasdaq’s six options exchanges did over one-third of transactions in that category last year, which made them tops in the U.S. for the 11th straight year.
Nasdaq remains the top magnet for new listings and IPOs. It’s come a long way from its roots as a venue that mostly attracted small companies. Last year, it won two-thirds of the new listings in the U.S. Those included a multi-decade high of 316 IPOs in the U.S. that raised an also industry-leading $78 billion, among them the initial offerings of Warner Music, Royalty Pharma, and Airbnb. In Scandinavian and Baltic states—where Nasdaq-owned national exchanges, believe it or not, dominate trading—it garnered an additional 45 IPOs. Nasdaq also lured AstraZeneca, American Electric Power, and 18 other transfers from the Big Board.
In rewarding investors, Nasdaq resembles some of the hot tech performers listed on its exchange. Over the past 10 years, its stock (ticker: NDAQ) has delivered total annualized returns of 20.2%. That beats the S&P 500 by 6.5 points, and just about matches the Nasdaq 100 at 20.6%. Nasdaq actually tied Google over that period, and ran close to Salesforce.com (21.4%). During Friedman’s four years at the helm, Nasdaq has done even better, by notching annualized returns of over 22% as of Feb. 4.
Friedman has become a crusader for making corporate boards, now dominated by white males, far more diverse. In December, she proposed a rule that would require Nasdaq-listed companies to have at least two minority directors, including one woman, within four years. If an exchange member chose not to comply, it would have to provide a public explanation.
The initiative––now before the SEC––was controversial. It prompted the Wall Street Journal editorial board to claim that Nasdaq was favoring quotas over allowing boards to add the best people. “It’s a big part of our mandate,” Friedman tells Fortune. “We realized through studies that when companies have at least one diverse board member, they do better. We’ve seen progress with women, but much less with minorities.” She adds that Nasdaq wants to provide uniform tables showing the representation of women and minorities for all Nasdaq-listed companies. “It’s a market solution, not a government mandate or hard mandate, since companies can be excluded if they explain why. Now that ESG is such a concern, we feel it’s important to provide investors with all the information on diversity they’re seeking.”
During Nasdaq’s half-century, a wave of consolidation has remade the exchange business, as dozens of national and regional marketplaces sold themselves to larger players, leaving a small group of behemoths that own multiple venues. The NYSE Euronext bought the American Stock Exchange in 2008, then five years later fell to Intercontinental Exchange. That company now operates a global portfolio that trades everything from oil to bonds to Bitcoin futures, and even originates home loans. Formerly stand-alone exchanges in Europe, including markets in Brussels, Paris, and Amsterdam, are all part of Euronext, which ICE spun off after the NYSE deal.
After the dotcom bust, a new path
Given its weakness in its early days, it’s remarkable that Nasdaq didn’t get devoured, instead emerging as one of the few big survivors that did the hoovering. It managed this feat by pursuing an approach far different from that of its current rivals.
Founded in 1971 during the Nixon administration, Nasdaq started as the for-profit trading arm of the nonprofit National Association of Securities Dealers (NASD). It was owned by a group of member-brokers who for the first time moved from yelling bids and offers on exchange floors to sharing quotes on computer screens. While the disruptive technology rippled around the world, Nasdaq in the early years got most of its listings from small companies. They chose the Nasdaq because the NYSE would only take candidates that were booking profits, while the Nasdaq accepted growth companies still posting losses.
Nasdaq separated from the NASD in 1999 as a private enterprise owned by the brokers. By then, it had hosted the IPOs of subsequently famous companies like Apple, Amazon, and Microsoft, and its brand had become synonymous with high-flying tech stocks. But, as Friedman puts it, “we weren’t reenergized as an independent company.”
By 2002, Nasdaq was still a single exchange, without ancillary technology businesses. “Nasdaq was a boutique,” recalls Frucher. “We sold one product in one place. We were selling equity trading and building a book of listed companies. When I did pitches for companies to list, I’d say, ‘Would you rather stand in the footsteps of Andrew Mellon and Andrew Carnegie or Steve Jobs?’ We had a new, cutting-edge approach.”
Still, as a company, Nasdaq was wobbling on a single leg. And by that point, it was fighting for its life. It suffered from a lax, unaggressive culture, and new electronic communication networks (ECNs), led by Instinet and Archipelago, were posing stiff competition, challenging its dominance in digital trading. To make matters worse, the dotcom bust shrank Nasdaq’s roster of listed companies by 1,000—or over a quarter—from 2000 to 2002.
The company’s rise began with the arrival of tough-talking CEO Bob Greifeld in early 2003. Greifeld helped Nasdaq survive by purchasing ECNs such as Brut and Inet. But his ambitions went far beyond equity trading. He wanted to both go global and diversify—especially into taking the advanced technology that Nasdaq was buying and developing for powering its own exchange and supplying it to banks, brokers, and other stock markets.
Greifeld’s chief lieutenant was Friedman, who’d joined as an intern in 1993. Friedman served as Greifeld’s point person in securing two megadeals, both of which closed in 2008, that transformed Nasdaq. The first was the purchase of the Philadelphia Stock Exchange, one of America’s largest houses for trading options. Overnight, the merger made Nasdaq a major force in a big new market. “That became a big profit center,” says Frucher. The second was the largest acquisition in Nasdaq’s history, its $3.7 billion purchase of OMX, a union for the stock exchanges of Sweden, Denmark, Finland, and Iceland, as well as those of Latvia, Lithuania, and Estonia.
Then, as now, OMX handled around 80% of the equities and options trading across Europe’s northeastern tier. Says Frucher, who was heading the Philadelphia exchange: “Adena had been running the index and options business, and Bob elevated her to chief strategist. I’d hear from her from the strange and interesting locations. One day she’d call from the Baltics, and another time she’d stop in mid-sentence to give coaching instructions at her son’s soccer game.”
OMX had a second business that would prove crucial to Nasdaq’s future. One of its divisions, heavily funded by the Swedish government, sold trading technology around the globe to such clients as exchanges in Hong Kong and Singapore. The two transactions remade Nasdaq, previously a single U.S. equities exchange under siege, into a global force that now owned multiple venues, ran major options operations both at home and in Europe, and sold digital tools worldwide.
A veteran returns
Friedman left in 2011 to spend three years as CFO of financial giant Carlyle Group. When she returned to Nasdaq in 2014, Greifeld made her COO, and in that role she oversaw the non-trading businesses, including a product suite that no other exchange in the world was offering in big way: market technology. “The mission was maximizing our potential as a data and tech provider, a shift that started with Bob,” she says. “I was charged with seeing where the puck is moving, where clients are looking for new solutions. It helped that our needs were the industry’s needs.”
In her new role, Friedman recalled Nasdaq’s experience moving its own trading platforms to the cloud. “We were the first to do anything in the cloud,” she says. “In 2006, we started housing data on Amazon servers. It was unbelievable how much data we could store, and how much easier it was to use.” She says that migrating 20 Nasdaq exchanges to the cloud provided invaluable experience in advising clients that pondered taking the same plunge. The trend, she says, is now unstoppable: “All the new markets now want to move to the cloud.”
Nasdaq’s business now stands on four legs. The biggest is market services, the core trading and clearing businesses on those 20 exchanges, led by the tech-loaded U.S. exchange. In 2020, that business delivered $1.1 billion in net revenue, 38% of the company’s $2.9 billion total. That was a 21% gain over 2019, driven by huge trading volumes as markets swung wildly while hopes for a recovery from the pandemic waxed and waned. Market services are highly profitable, yielding operating margins of over 60%. The problem is that revenue is highly erratic. Sales in the division fell slightly in both 2016 and 2017, then jumped 8% in 2018, fell again in 2019, then went on a moonshot last year. (Put another way: Despite last year’s big jump, growth averaged just over 5% over the past four years.)
The second big business is corporate platforms, an area that last year accounted for 18% of sales. It has two parts: an arm that provides technology and advisory services to improve companies’ investor relations and corporate governance. The second group is tasked with keeping and growing listings. Platforms had an unusually strong 2020, growing revenue by 14%. The main driver was a big jump in new listed companies, aided by an oversize share of last year’s oversize surge in IPOs. But while platforms is also a high-margin sector, boasting operating margins of 35% to 40%, it’s not a go-go franchise, in part because so many tech companies have been staying private for much longer periods. Since 2016, sales have progressed only 17% in total.
With services generating only modest growth, featuring lots of dips and spikes, and platforms waxing steadily but slowly, Friedman is banking on a different pair of power levers to put sales on a trajectory that’s both faster and more consistent.
The larger of the pair is investment intelligence, which in turn comprises three branches: market data, indexes, and analytics. This division brings in around 30% of revenues. Nasdaq, like other trading venues, sells the pricing data from its exchanges both to trading houses and public websites such as CNBC and Yahoo Finance that display Nasdaq quotes everywhere from trading terminals to iPhones. “Wall Street traders buy the data,” says Lau, the Oppenheimer analyst. “If you don’t have the order book for stocks with instantaneous price information, you can’t trade. Traders want to see the trends in buying, selling, and at what prices.”
Nasdaq also licenses its Nasdaq 100 indexes for both stocks and futures to asset managers, who use them as the basis of their index funds and ETFs. This franchise had a fantastic 2020, lifting revenues by $122 million or 46%. Index fees rise with the assets in the funds linked to Nasdaq products. Last year, those fees got a lift from both rising stock prices and a multiplication of new futures and other products that proved big hits.
Analytics, though now small, also promises a strong future. It supplies data on the specialties and performance of 74,000 investment vehicles, selling the information to pension funds, family offices, and other managers looking for the safest and most profitable places to put their clients’ savings. For example, Nasdaq analysis will show the funds who’s tops in everything from ESG to farmland investing. Its researchers also provide intelligence on fundamental market trends such as car registrations or where people are shopping for groceries in different regions.
Friedman has big ambitions for analytics and indexes. She predicts the two businesses will almost triple sales from a combined less than $400 million last year to $1.1 billion in 2025.
A big tech offensive
Above all, Friedman is counting on a tech offensive to kick Nasdaq to a higher gear. The market technology franchise, the fourth leg of the company, is getting the biggest investments and logging most of the acquisitions. When Friedman took charge four years ago, the exchanges accounted for 90% of Nasdaq’s capital expenditures; today, Nasdaq is marshaling around 50% of that cash to build a tech and intelligence powerhouse. “Now, we’re matching where we’re spending our dollars with our growth opportunities,” says Friedman.
Market technology comprises two businesses, both deploying SaaS. The first is software for such platforms as price-matching engines used not just by exchanges, but banks, broker-dealers, and regulators. In the past, the product, Nasdaq Financial Framework, provided customized solutions for clients, meaning a Nasdaq team would go on-site to a bank, say, and install the system in its mainframes.
That process required lots of manpower, and the platform wasn’t nearly as flexible or powerful as the SaaS product. With SaaS, customers can download the software directly from the cloud, and Nasdaq provides automatic upgrades as part of its long-term contracts. (Those contracts also lock in automatic price increases.) It’s the broker-dealers and banks, as opposed to the exchanges, that are fueling most of the growth. Their trading technology is frequently outmoded, and they increasingly find that using a contractor to overhaul their IT is a lot cheaper than doing it internally.
The second big push comes in fighting financial crime. “Having the best technology in preventing AML and fraud is now just as important as having the best technology in operating trading on an exchange,” says Friedman. Nasdaq has long had a presence in market surveillance. Its software is a tool for compliance departments to catch the bad guys. Brokerages use the software to detect if a trader is front-running customers, or building big, authorized positions in a stock, endangering the firm’s capital.
Banks have to file reports with regulators when they see suspicious activity, such as big cash deposits or huge money transfers from one of their accounts in New York to, say, an account at a broker in the Caribbean. “It’s not humanly possible for banks to have their personnel examine even a small fraction of those reports,” says Lau. The Nasdaq software flags the transactions that need to be investigated, and filters out the ones that it deems legitimate. That winnowing process allows compliance departments to focus their time and energy only on the ones that flash red for illegal.
Friedman is expanding the crime-fighting suite to encompass fraud. At $2.75 billion, the Verafin acquisition is the second biggest in Nasdaq history to OMX. Verafin has a big customer base of around 2,000 mostly small and medium-size banks. Its revenues of about $140 million in 2020 are growing at 30% a year.
Though it’s the biggest in the business, Verafin still holds a tiny share of the $12.5 billion market. Its main competition isn’t other software providers, all of which have far fewer customers, but banks that in the past were attempting to build their own AML products in-house. Once again, the trend now favors outsourcing, and Verafin is reaping the benefits. Since Nasdaq already counts many big banks, brokers, and exchanges as clients for its market surveillance software, it’s planning to both bring the Verafin product to those markets, and offer customers of all sizes a package encompassing both fraud protection and AML.
The market tech business does pose risks, however. On the company’s fourth-quarter conference call on Jan. 27, Friedman discussed a sharp slowdown in spending on such tech that occurred last year. She noted that “customers were focused on meeting current trading needs” in turbulent markets. She added that customers turned cautious because of the uncertainty caused by the COVID-19 crisis. On the other hand, she disclosed that “we’re now starting to see more engagement.” For Friedman, the strategy is basic: Crime prevention won’t be a choice going forward, but something banks, brokers, and exchanges must invest in to survive and thrive.
Anti-fraud technology is a business that the company’s leaders would scarcely have imagined being in when Friedman joined as an intern back in 1993. Then, Nasdaq suffered from complacency. “Complacency is the killer of great companies,” she says. In Friedman’s view, the only way to grow, and slay that enemy, is to stay nimble and diverse––as she likes to say, to see “where the puck is going.” She’s taken her shot based on embracing innovation, and it’s likely headed for a goal.