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Why Nasdaq is leaning toward even-smaller companies these days.
Alix Stuart, CFO Magazine
January 1, 2003
From building a flashy headquarters in Manhattan to trying to extend its reach across Canada, Europe, and Japan, Nasdaq has spent the past few years trying to position itself as a worthy competitor to the New York Stock Exchange for blue-chip stocks. This year, though, with an ambitious plan to polish up the OTC Bulletin Board (OTCBB), it may instead go head-to-head with the Pink Sheets.
In a sign of just how badly stock prices have been beaten down, Nasdaq is preparing to make the OTCBB a more-respectable home for companies that no longer meet the financial criteria of its major markets. Pending approval from the Securities and Exchange Commission, as early as midyear Nasdaq is expected to launch the Bulletin Board Exchange (BBX) — a new exchange that will require listing standards for member firms, offer more-seamless trading technology, and ultimately replace the OTCBB.
The move is a reversal of policy of sorts. Until now, Nasdaq, which provides the technology for the OTCBB's brokers, has kept its brand a safe distance from it. The reason: with no financial-listing standards and fitful volumes, the OTCBB has been a market of questionable repute — a last resort for firms too small, or too weak, to meet Nasdaq or NYSE standards.
But given the continued migration of blue chips to the NYSE and little hope for another dot-com boom, Nasdaq sees a future in the alternative exchange. "The BBX will appeal to small, well-run companies that care about their shareholders," Nasdaq told CFO in a written statement. "These are companies that are willing and able to meet corporate-governance requirements similar to those of the Nasdaq or Nasdaq SmallCap market, but that cannot meet the financial requirements of those markets." Seen in a different light, "it's a combination of cleaning up the bulletin board and providing a softer landing for companies that fall off the Nasdaq National Market," says James Angel, a professor of finance at Georgetown University.
The plan to take over the OTCBB has been in the works for more than two years, as part of Nasdaq's scheme to split off from the NASD and go public. But it's taken on added importance as the bear market has pummeled Nasdaq's finances.
Since 2000, the number of firms listed on Nasdaq has dropped by more than 20 percent. With another 10 percent facing delisting as share prices remain below $1, and barely a trickle of initial public offerings to replace them, the attrition is expected to seriously affect the $857.2 million Nasdaq's revenues going forward. "Plummeting fees from the new millennium's bear market will depress this contribution over a protracted period," wrote Jefferies & Co. analyst Charlotte Chamberlain in a recent research note.
Consequently, the immediate benefits for Nasdaq are clear. For one, it will be able to recoup some fees from firms that it has forced to delist and collect new ones from the OTCBB companies that all currently trade for free. Plus, there's the promise of additional transaction fees if the technology and brand-name upgrade push up trading volume. That's a big "if," though, since experts estimate as many as half the 3,700 companies now on the OTCBB won't be able to meet the new criteria — and few expect those struggling on the bigger boards to flock to it. "I think it will be a case of having to go there rather than choosing to go there," says Scott Bleazard, co-founder of North Las Vegas-based Management Consulting Services, an investor-relations firm.
Ultimately, however, Nasdaq's hope may be to stem an even more embarrassing trend: the annual migration of some of its brightest stars to the NYSE. Last year about 40 firms, including Banknorth, Emulex, and BearingPoint (formerly KPMG Consulting), made the switch, in part for the prestige and global exposure they believe the NYSE provides. With any success, the BBX could potentially "create a farm system of companies that when they get bigger will go onto Nasdaq," says Prof. Daniel G. Weaver of Baruch College.
For companies that do begin listing on the BBX, the benefits are mixed. They will still be exempt from most financial standards, such as the net-asset and share-price minimums that have pushed some 600 companies off Nasdaq in the past two years. But under the new regime, firms would have to pay annual listing fees of $4,000 to $10,000 and meet corporate-governance standards similar to those proposed for other national markets — which may include retaining an independent director with financial expertise. That could put compliance costs anywhere from $50,000 to $200,000, according to Bleazard.
Companies already trading on the OTCBB that have undertaken governance reforms have the most to gain. "We expect it to have more benefits than negatives because we're already doing the negatives," says Anthony Albanese, CEO of Michigan Heritage Bancorp Inc. While the BBX rules will add about $10,000 in costs, Albanese is optimistic about the extra credibility the exchange could afford. "We expect to see better analyst coverage and, hopefully, a higher stock price," he says.
But other executives are unconvinced the upgrade will have the desired effects on institutional investors. "It's a much tougher sell for Nasdaq to raise the credibility of the over-the-counter market than to take something that already has credibility, like the Nasdaq SmallCap, and make adjustments," says Tim Bixby, president and CFO of $8 million LivePerson Inc., a New York-based provider of online sales, marketing, and customer-service solutions. With LivePerson's stock price trailing under the $1-per-share price minimum for more than a year (the stock is now around 75 cents), the company moved to the SmallCap in May 2002, a move that Bixby says has had little impact on its investor base. However, he believes that dropping down to the OTC market — even an upgraded version — "would absolutely have an impact for some of our funds — they just can't own those stocks."
The biggest losers, though, will be those companies unable or unwilling to meet the higher listing fees or requirements. They will be relegated to the Pink Sheets, a market with no SEC reporting requirements, and about Nasdaq's only competition for the penny stocks once the OTCBB disappears. Such a downgrade, though, will also reduce their access to capital, says Brad W. Smith, an OTCBB Advisory Board member and president of WBS&A, a capital-markets advisory firm. And for that reason, he is lobbying Congress to preserve the OTCBB as is. A BBX-only regime, he says, is "evidence that Nasdaq intends to take only the companies that are most profitable to it from the OTCBB and leave behind the regulatory cost" of policing weaker entities.
Truth & Consequences
At this juncture, Nasdaq is clearly looking for a win. After writing off $15.2 million to shut down its Nasdaq Japan exchange last summer, struggling to gain momentum with its two-year-old unprofitable Nasdaq Europe, and having its IPO stymied, growth prospects are dim.
Will the BBX help bolster those prospects? In terms of making up lost revenues, the answer is likely no. "We expect the BBX to be profitable, but to contribute only a small percentage of Nasdaq's total revenue," says the company. But creating a halfway house for its weaker stocks may ultimately make the main market a more hospitable place for healthy companies.
Alix Nyberg is a staff writer at CFO.