Stock exchanges do not come up for sale very often; one as large and prestigious as the London Stock Exchange even less often, so there is a lot of interest around this.
Deutsche Borse’s attempt to merge with the LSE is reaching a critical stage. Deutsche Borse has until March 22 to make a formal offer.
Here’s what this is all about:
1) Forget about stock trading: The money is in the clearing business and the technology/index business. Cash equities is not a high multiple business. Even though most people think of the LSE as a listing and equity trading venue, 60 percent of the revenues are generated by the clearing business and its information and technology business.
I love the clearing business. If I only had to own one piece of the financial world, I’d own clearing. It’s boring, it flys below everyone’s radar, and it makes money. Every single day. You’re a tollkeeper. You charge both sides to make sure that the stuff you are buying and selling (like stocks) actually gets delivered.
The LSE has a 60 percent stake in LCH.Clearnet (LCH), one of the premier clearing operations in the world (the rest is owned by a consortium of banks).
If I had a choice of owning one other business in addition to clearing, I would own an indexing business. It’s the same idea as clearing. It’s boring, it flys below everyone’s radar, and it makes money. You license other people to use your indexes (or to get access to your data, like stock quotes), and they pay you money every day.
The LSE owns Russell Investments (think Russell 2000), and the FTSE Group, another large provider of stock market indices.
In other words: These are world-class assets. And they don’t come up for sale that often.
2) The synergy potential (i.e. cost savings) for the winner is significant. Reuters reports Deutsche Borse is claiming synergies greater than 300 million euros. That’s significant, but I bet they — and maybe ICE — can do even better. When LSE bought Russell, they were reportedly able to achieve 80 percent synergies.
I’ll give you another example: A few months ago, ICE spent $5.2 billion to acquire Interactive Data Holdings, which specializes in pricing corporate bonds. ICE is expanding its data business because it’s so profitable. These data and indexing businesses can easily integrate back-office functions. It wouldn’t be hard to see ICE integrating the LSE’s Russell and FTSE together with IDC, where they could likely take out even more of the typical 30 percent synergies.
And remember, if you can demonstrate greater synergy, you can put more debt into the equation.
3) Exchanges have gotten bigger, and the markets have gotten more global. LSE’s CEO, Xavier Roland, has spoken often about the need for further consolidation among exchanges. He expects we could end up with as few as a half-dozen or so big global exchanges, and a few smaller ones. Some of these bigger exchanges would have a “continental” focus (North America, Europe, Asia), rather than a national focus.
4) Money aside, the big issue is politics and whether national regulators will allow these deals to go through. The last great wave of merger attempts about five years ago failed for exactly this reason.
In 2012 the NYSE tried to buy Deutsche Borse, and the European Commission turned it down on anti-trust concerns, specifically that the combined entity would have too much concentration in the interest rate futures market.
In 2011, the LSE was going to buy the Toronto Stock Exchange. Canadian authorities turned them down because the banks didn’t want it.
And in 2011, Australia and Singapore were talking about merging. Australian regulatory authorities threw cold water on that deal as well.
So who — if anyone — will win this battle? Two things seem important:
1) The principals have to convince regulators that this is not a “takeover.” As noted above, other cross-country deals have failed because no one wants the crown jewel to be traded to another country. That’s why this deal with Deutsche Borse and LSE seems to be very carefully pitched as a “merger of equals.”
2) The principals will need to convince regulators that they are not creating an anti-competitive environment, which sunk other mergers. If there are concerns, they may have to divest assets. For example, both control important clearinghouses: LCH.Clearnet in the case of the LSE, and Eurex Clearing, the largest European clearing house, in the case of Deutsche Borse.
Who has the edge — ICE or Deutsche Borse? The talks originated with the Deutsche Borse, so it’s logical to assume that’s where the shareholder sentiment is.
It also makes some sense if you believe that regulators might be more amenable to “continental” mergers (i.e. between two countries on the same continent) than to “trans-continental” mergers, which is what the ICE-LSE deal would be.
But that may not be a universal sentiment. London banks may have good reason to be concerned that the merger with Deutsche Borse may allow Frankfurt to overtake London as the financial center of Europe.
And banks may have a very large say in the deal. The LCH.Clearnet agreement between the LSE and the banks states that banks can terminate any agreement upon a change of control. In other words, the banks appear to have some veto power over the deal, as least as it regards change of control of LCH.Clearnet.
So much of this may depend on whether British banks would prefer to have Deutsche Borse or ICE as partners.