NYFIX is a brokerage technology services provider. The company sells software, hardware, execution, clearing, and connectivity to facilitate trading. It has 4 primary business lines:

 

Transaction Services:

 

2005 Revenue Growth: 79%

2005 % of Revenue:  27%

 

Includes NYFIX Millennium and routing orders to exchanges and ECN’s for execution. The growth of Millennium volume accelerated in the first half of this year with volumes up approximately 100% (however, it appears pricing concessions were made to build this liquidity). Millennium is a “dark pool” of liquidity similar to POSIT, Pipeline, and Liquidnet (which raised private equity last year at a $1.8B valuation and recently announced their 2Q06 average daily trading volume was 46 million shares). These systems allow traders to enter orders for execution without exposing the order to the entire market. For example, if a trader wants to buy 100k shares of a stock, this order could be sent to Millennium and it would reside in this system awaiting a match. If no match in made, no other traders have been alerted to this buying interest, thus market impact is minimized. If a match is found, then the execution occurs at the mid-point of the bid/ask spread. These “conditional orders” also interact with “pass-through” orders which pass through the system, instantaneously checking in Millennium on their way to another execution destination such as an ECN or Exchange. Approximately 85% of executions are conditional vs. conditional while 15% are conditional vs. pass through. On average, Millennium is executing just over 20 million shares a day while routing out another 15 million shares a day for executions elsewhere. The current size of Millennium today is approximately the same size as POSIT two years ago and since that time, POSIT has grown to be a huge success. Millennium receives order flow either directly from traders or through other systems such as Channel ITG and Morgan Stanley that “sweep” Millennium seeking liquidity.

 

Millennium was initially positioned as a destination for Listed order flow almost exclusively. Going forward, the company will be making a push to include OTC order flow as well. This greatly expands the market potential and could result in another 25-50% growth spurt in the next 12-months.

 

Volumes can be tracked at http://www.nyfix.com/sellside-solutions/nyfix-millennium/historical-trade-data

 

FIX Network:

 

2005 Revenue Growth: 40%

2005 % of Revenue:  41%

 

The network and FIX connections that connect buyside clients to brokerage firms and exchanges. This also includes the acquired Javelin Technologies, the market leader in FIX engines (software that translates FIX messaging into orders).  The NYFIX network is an open network meaning any order management system, broker, etc can connect to the network as opposed to the Macgregor network which only clients using the Macgregor OMS can connect to their network. Key competitors are Macgregor and TNS.

 

OMS:

 

2005 Revenue Growth: 2%

2005 % of Revenue:  23%

 

 

Order Management System for sell-side brokerage firms. This helps brokers manage their orders received by clients as well as monitor the filling of orders at exchanges and ECN’s and allocate the trades to each client. Key competitors are GL Trade and Royal Blue. OMS is the segment that would be most likely to be sold separately, however, management believes OMS is a key product used to cross sell other products.

 

 

2005 Revenue Growth: -8%

2005 % of Revenue:  9%

 

Electronic trading solutions for the global derivative market, including order management workstations and exchange connections. NYFIX is clearly not succeeding in this segment. Derivative trading has grown exponentially in the last several years and NYFIX has not participated. We would expect the company to either fix it or sell this segment in the coming years.

 

 

A key item to note is that NYFIX’s main business lines should all benefit from the increased electronification of equity trading. These businesses are very attractive to investors right now both from an investor and acquirer perspective. However, the shares have been justifiably punished due to poor management (which has recently been changed) and de-listing of the shares due to delayed accounting re-statements.

 

 

 

                  ^{3 foreign listing}            

 

 

ITG paid 3.8x forward revenue to acquire Macgregor, an OMS vendor, in July 2005

 

 

NYFIX’s accounting problems started when the SEC reviewed a 2003 registration statement and determined the company needed to re-state its 1999 to 2002 financials to consolidate the company’s initial investment in its Millennium subsidiary. That re-statement was completed in 2004. By late 2004, NYFIX was notified of a second inquiry into its stock option grants. The SEC found the company had issued options below the market price and these options needed to be expensed through the income statement. Its easy to see now that the investigation turned to focus on the backdating of options. So of the 100+ companies currently being investigated for option backdating, NYFIX was one of the first.  When the company missed several re-filing deadlines, NYFIX was de-listed from the NASDAQ in September 2005. The back dating of stock options has turned into a massive project that has resulted in the changing of auditors, CFO, and CEO and has been costly because the company has had to hire consultants and experts to review hundreds of thousands of documents relating to option back dating. Peter Hansen, the ousted CEO is still chairman and I believe is one of the reasons the process has taken so long because he is the center of much of this review. It’s my expectation that he will soon be removed as chairman and will have no other involvement with the company other than his ownership. This should be a positive catalyst for the stock.

 

The outstanding option issue one year ago looked much worse than it does today because recently many more companies has been accused of back dating stock options. While it has caused the company to be de-listed and been a huge use of resources and time, from a valuation perspective, the impact is minimal. The stock today is at multi-year lows thus despite back dating these options are still underwater. Additionally, the company has re-set option grants that did not have full and proper documentation.

 

 

The company has twice missed self imposed deadlines to complete full filings of financial statements – once at the end of April and again at the end of June. This has been a major blow to the stock and credibility of new management. This type of delay is not unprecedented, for example Bisys (BSG) has been working of restatements for almost 4 years and Bearing point is going on 1.5 years. I believe the delay has been caused by the fact that the center of much of the investigation, Peter Hansen who founded the company, is still with the firm and just removed from CEO late last year. This has slowed progress especially because the in-depth review uncovered $2 million of questionable revenue booked in 2001 (before current management). The company did release quarterly revenue by division for the last 9 quarters indicating that the new management and the new auditors, have 100% confidence in these revenue numbers.

 

While the company did generate positive cash flow in 2005, the costs to re-state financials in 2006 has been very expensive - $3.9 million in 1Q alone. To alleviate any liquidity concerns, NYFIX raised $12 million in a private placement last month at $4.65 per share(10% above today’s price).  It was later revealed that the investor was Wellington and the placement agent received compensation in stock.

 

It’s important to note that the company is primarily financed through permanent equity. The only debt outstanding is $7.5 million of convertible due December, 2009 (at significantly higher prices). Thus there should not be any liquidity concerns for some time to come assuming the restatement costs begin to decline.

 

 

NYFIX recently announced a partnership with Goldman, Citigroup, and Morgan Stanley to use the NYFIX network to deliver Indications of Interest (IOI’s). This is likely a $10 million annual revenue opportunity. While not a huge dollar amount, it is a good example of how NYFIX can leverage its existing assets into more revenue opportunities at little incremental costs.  NYFIX’s network, self-clearing, execution, and OMS systems can be levered into many more areas.

 

 

The new CEO is Bob Gasser, formerly head of NYFIX’s execution division and prior to that head of trading at JP Morgan. He brings professional management vs the former CEO that was the founder and more of an entrepreneur and salesman than a manager. For example, Bob has streamlined the company into the 4 reporting divisions that they have today and each division has P&L and budgeting responsibility. This seems very basic, but it was not done in the past and is just one example of basic steps that are being taken that could lead to much better profit margins going forward.

 

Gasser also brings some key relationships. For example, the new head of Fidelity’s trading desk worked with Gasser at JP Morgan. NYFIX obviously will not reveal client names, however, we believe key relationships such as this have been a contributor to Millennium volume increases in 1H06.

 

Two new key board members have been added recently to increase credibility as well. Lon Gorman is a member of the Audit and Compensation Committee and was previously a member of the executive committee for Charles Schwab. Richard Roberts served as a Commissioner of the SEC and joined NYFIX’s board earlier this year. 

 

 

1)      Peter Hanson removed from board. Not only will this help perception, but I believe it will help management streamline their time and increase focus rather than dealing with past issues.

2)       Complete re-audit. The full filing of financial statements will allow investors to better value the company and alleviate any fears that there is “another shoe to drop”

3)      Re-file financial statement with SEC with all notes and disclosures

4)      Re-list as a public company

 

 

The downside to NYFIX stock should be limited because it would make a very attractive acquisition candidate. Given the company’s recurring revenue base, high incremental margins, and strong growth prospects, there is a strong appetite for NYFIX and other firms in brokerage technology. Just last month, Bank of New York merged their brokerage technology segment with Eze Castle supported by an investment from GTCR and its expected the company will be IPO’d in the coming years.

 

At least one industry magazine reported the GL Trade was interested in acquiring NYFIX earlier this year and I believe there is some validity to this rumor. However, I would not want to see NYFIX sell at such depressed prices and management and investors would have no way to gauge a fair price for the firm given financials have not been filed. The company should be able to get the stock to $10 on its own merits and then re-consider any opportunities to be acquired.