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June 30, 2004

Sharpening Up For An IPO At ArcaEx

By Gregory Bresiger

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It's all in the family for Archipelago. The ECN turned stock exchange for

Nasdaq and listed trading has much of Wall Street watching closely as it goes public. That's because the metamorphosis of Archipelago Holdings is the result of its close connections to its customers, investment bankers, competitors and a regulator.

Many of these parties hold a stake in the company, which operates Archipelago Exchange (ArcaEx). Some have bought a stake. Others have earned it through large-scale executions. Now the stakeholders are betting that these relationships will be profitable. And that Archipelago can survive with the other two big boys of the trading industry, Instinet and Nasdaq.

Archipelago Holdings officials, who declined comment on the story because of IPO rules, hope that more than strong volume and their pure play matching engine will keep the company in the black. Some trading executives question whether this will work at a time when many players are practically giving away their services to obtain vital liquidity pools.

Fighting Competition

In an offering that Archipelago hopes will raise up to $150 million, the company is asking investors to bet on its continued growth, profits, a diversification of its trading model and that the company can fight off dog-eat-dog competition.

The random element in these battles is the Securities and Exchange Commission's proposed Reg NMS. Both Archipelago and its big rivals, the NYSE and Nasdaq, are hoping the process will result in a more favorable market structure. But they all can't be winners in this sweepstakes.

So Archipelago, which last year executed 104.3 billion Nasdaq shares as well as relatively small amounts of NYSE and Amex listed business, is about to go public. Many of the biggest trading firms, several of them with a share in the one-time ECN, will be monitoring these events. A number of them, including Goldman Sachs, CS First Boston and Merrill Lynch, will serve as investment bankers in the deal. Indeed, officials of many trading firms and investment bankers, who normally speak to Traders Magazine, declined comment because of potential conflicts of interest. Another official, Archipelago CEO Gerald Putnam, understandably can't comment. He has a 3.02 percent stake in the company.

Does Archipelago, with its Pacific Exchange/ArcaEx facility that is also a regulator, have the right formula to survive in a very competitive trading and regulatory environment?

The Archipelago IPO prospectus, which notes that the company was in the black in the first quarter after years of red ink, outlines some rocky and hopeful scenarios for this would be public company.

"Our status as a facility of PCX Equities allows us to generate revenues from two additional sources, market data fees and listing fees, which we were ineligible to earn as an ECN," according to the 328-page registration statement. Proceeds of the offering would be used for the expansion and diversification of product offerings.

Archipelago, which began in 1996 as one of the original four SEC "qualified" ECNs, was created in the wake of the order handling rules. The company expects that its greatest expansion will come at the expense of the Big Board and Nasdaq.