As Kansas City, Mo.-based Bats Global Markets Inc. revs up for the launch of a new primary stock-listing platform later this year, the exchange is making a pretty bold call at an unlikely time in the history of U.S. stock listings. The number of publicly listed companies has fallen for more than a decade -- down 42% since the peak of 1997, according to New York-based management consultant Grant Thornton LLP. In contrast, listings in other major markets have shot higher, with China, where IPOs have soared almost 200% since 1997, leading the pack.
It's still unclear what will stop the downward slide in U.S. IPOs, including the opportunity to list more cheaply on new, competitive exchanges such as Bats, which stands for Better Alternative Trading System. Bats was launched just six years ago as an electronic communications network by David Cummings, owner of Tradebot Systems Inc., and became a regulated exchange in 2007.
As the NYSE Euronext and Nasdaq OMX Group Inc. struggle for growth in a mature U.S., Bats has become a thorn in their sides. Bats' plan to list in the primary market is an audacious move, considering that few have attempted, much less succeeded at, effectively competing against the two big incumbents. The move seems to be timed to take advantage of the disruptions the NYSE and Nasdaq have experienced.
"We believe there is a need for an alternative listing venue in today's market, which has only been heightened in recent weeks as legacy exchanges weigh different merger-and-acquisition strategies," said Joe Ratterman, president and chief executive of Bats, on May 16 when it announced its plans. The announcement came the same day regulators shot down Nasdaq's plans to buy the NYSE.
Can Bats succeed? After all, NYSE Euronext appears eager to marry itself off to Deutsche Börse AG in a bid to amp up growth. That's left Nasdaq, spurned in its NYSE overture, foraging for fresh growth ideas.
What's clear is that the U.S. listings market is struggling for growth, something NYSE chief executive Duncan Niederauer underscored yet again at an investor conference in early June in Germany with Deutsche Börse. "Our first-quarter [earnings] show the importance of diversification. You will [see] we continue to be less and less reliant on our traditional business -- cash trading and listings and trading business and specifically, the U.S. listings business," he said.
In recent years, the U.S. listings business has been burdened by expensive compliance requirements under Sarbanes-Oxley and Securities and Exchange Commission pricing rules aimed at opening up competition but that effectively hampered pricing power at the big exchanges. It may cost $100,000 to $500,000, respectively, to list on the Nasdaq or the NYSE, but from there listed companies are looking at an annual minimum compliance cost of at least $1 million. Broker-dealers have become more reluctant to make markets in stocks that aren't extremely liquid, which has hurt thousands of smaller companies. Many brokers won't risk the time and cost of generating market research and flogging a stock if high-frequency traders can step in front of their trade for fractions of a penny. At that level, it becomes difficult to recoup the cost and time put into a sales effort.
"The question you need to ask as a CFO or issuer is how the market is going to support your stock price. Is it going to be a zombie stock, will anyone market you?" asks David Weild, former vice chairman of Nasdaq and now a capital markets adviser at Grant Thornton.
What, then, would possess Bats to jump into this market just as the NYSE appears to be boarding a plane for Germany and a larger share of the derivatives business? After all, others have tried to launch primary listings for smaller companies in the past, only to see those efforts fail. "We've seen this playbook before when the NYSE tried to launch Arca [for smaller-cap listings] and didn't gain any traction," says Bruce Aust, head of U.S. listings at Nasdaq. However, he concedes that Bats is "competitive" and that "we don't take any competitors lightly." Others agree the going will be tough.
"It's going to be an uphill battle to succeed for Bats," says Sang Lee, managing director of Aite Group LLC, a Boston-based independent research and advisory firm. "We've seen tons of innovation over the past 10 years from a transaction perspective, whereas on the listing side we haven't. At the end of the day, we can safely argue that we've had fairly stable competition within the listing markets."
That, of course, is where Bats sees its advantage: It relishes attacking what it views as competitive complacency. Some market observers believe that if anyone can take on the NYSE and Nasdaq in the primary listings market, Bats can.
Certainly, a look at its track record suggests that it's been smart, lean and hungry enough to do a fair amount of damage. Since launching in 2005, Bats has become the third-largest stock exchange in U.S. equities trading, as measured by daily volume, after the NYSE and Nasdaq.
It has pirated a 10.8% share in the secondary U.S. equities market and 6.2% in Europe, a number likely to grow due to its pending acquisition of Chi-X Europe Ltd., Europe's largest alternative trading system. It has a 3.5% share of the U.S. equity options market and is planning to launch an IPO worth $100 million of its own shares on its own platform later this year.
With this kind of rapid-fire success, some say Bats is best positioned to revive the U.S. listings business.
It has already shown that it's adept at seizing on models that work. In the secondary market, Bats copied Nasdaq and the NYSE by offering deep pools of liquidity in the stock market. The big difference: Bats did so at dramatically lower prices. The exchange essentially pays the same or slightly less than the big exchanges to brokers for adding trading volume to its exchange, while it undercuts Nasdaq's fees for removing that volume (that is, sending an order at a price that is immediately executable).
"They've done a great job building a robust exchange with a lot less technology investment than any other competitor," says Larry Tabb, chairman of Tabb Group LLC in New York. "They have the ability to operate -- they're going to be a survivor. They flourish in this kind of very competitive marketplace." A key advantage is their cost and efficiency. With just 114 employees globally (as of March 31), Bats' total staff compensation is just 3.7% of total revenue, a figure that resembles a dust mote from the vantage point of its bigger competitors.
In contrast, Nasdaq has 2,216 employees with compensation taking up 13% of revenue. Bats' super-low operating costs mean it can thrive with much smaller market share than the NYSE or Nasdaq, which like sharks must always be on the move. "Bats is much more likely to make a living on the small-company listings business than Nasdaq because it has low fixed costs," says a senior analyst. "It wouldn't take much market share for them to succeed."
Whether that ends up helping the broader U.S. listings business is another question.
A look at the IPO landscape for smaller-cap companies looks pretty grim. In 1993, 300 U.S. IPOs raising less than $25 million came to market. Fast-forward to 2007, just before the financial crisis, and that number had slumped to roughly 30, according to Grant Thornton. Since then, it's barely budged. It's unclear what kind of volume Bats will be able to generate and what kind of companies will list -- and how aggressively it will go after this slice of the market.
Whatever it does, it will do so at a relatively attractive cost to its rivals. It plans to charge an annual flat fee of $35,000 after an initial fee of $100,000. In contrast, Nasdaq charges an initial fee of up to $225,000, with the annual fee climbing as high as $99,500, depending on the size of the float, while NYSE Euronext charges an initial fee of up to $250,000 and an annual fee of roughly $500,000. "While not necessarily cheaper for all issuers at all other markets, [the fees] are roughly equivalent or less than issuers would pay at other exchanges," Bats said in a statement.
Although it hasn't specified the size or type of listings it plans to target, many assume Bats will aim to carve out a niche for smaller-cap companies that have struggled to raise capital in public markets. That could put the exchange in direct competition with Nasdaq's own pending listings platform for venture capital firms -- BX Venture Market. On May 11, just days before Bats' own announcement, Nasdaq said it had finally won regulatory approval to launch BX, aimed at over-the-counter firms and VC-backed companies that can't meet the minimum $15 million market cap required for Nasdaq's other three listing platforms. That's the first time regulators have given their blessing to a smaller-cap listing venue since the early 1990s, when the American Stock Exchange launched a similar initiative only to see it fail, in part because of accusations of lax listing standards.
Some remain skeptical about how much liquidity BX will generate, seeing it more as a way for Nasdaq to retain companies that no longer meet listing qualifications. Grant Thornton's Weild says he doubts the platform will go far in boosting U.S. IPO volume, in part because companies raising less than $15 million in capital may not make enough to cover associated costs. He says most companies that bring IPOs tend to gun for the $15 million range.
"If you're a tiny company that wants to demonstrate that it has met a higher standard, then list on BX -- but the costs may outweigh the proceeds of a little IPO, in which case you do a bigger IPO and list on Nasdaq," he says. "The real opportunity here is for companies that are being delisted from Nasdaq but already meet all these requirements -- SOX and Dodd-Frank compliant, etc.," to stay in the Nasdaq family, he says. If anything, "there's a risk BX Venture does a disservice because people think help is finally on the way. There's a cavalry coming, but nobody's sitting on the horses."
Nasdaq, for its part, takes a sunnier view of its growth prospects. "I've been with Nasdaq since 2008, and I'm very encouraged if you look at what's coming. The number of companies in our pipeline has never been greater. We have a record number of applications on file. We're back to the days before the financial crisis," says Aust, referring to the exchange's primary listings.
While Aust won't say how many deals are in the pipeline, Nasdaq has done 42 IPOs year to date, compared with 89 for all of last year, just 33 in 2009 and 24 in 2008. Still, business can't compare to 2007, when it saw 154 IPOs.
Bats, which declined to comment because it's in a quiet period for its own IPO, is certainly well aware of growth constraints -- even if it manages to make a dent in the U.S. IPO market. Analysts expect Bats to continue innovating in new markets, with the next stop potentially in European derivatives.
Mark Hemsley, CEO of Bats Trading (Europe), is a former Euronext Liffe executive who has extensive derivatives market knowledge. "One potential big opportunity from all the consolidation is European derivatives," a banking analyst says. 'The London Stock Exchange has already said it doesn't like that the NYSE and Deutsche Börse are going to create one goliath business. I think Bats and Chi-X will go after that business."
With the exchange world awash in major global mergers and competition looking increasingly formidable, Bats is demonstrating an admirable dose of entrepreneurial pluck. The big exchanges such as the NYSE and the Deutsche Börse would be wise not to dismiss this Kansas City upstart.