Deutsche Boerse and the London Stock Exchange are taking a fresh run at a merger that would create a large European exchange operator potentially capable of facing down strong competition from the United States and Asia.SUZANNE PLUNKETT/Reuters
The easy explanation for the proposed merger of London Stock Exchange Group and Deutsche Boerse is Brexit – Britain's potential exit from the European Union. The more sophisticated explanation is that Xavier Rolet, the French boss of the LSE, is striking while the LSE is running hot. His exchange may never be so valuable again.
Still, the merger attempt wins the convenient-timing award. On Monday, the day before the LSE-Deutsche Boerse merger was unveiled, British Prime Minister David Cameron, fresh from striking a deal in Brussels that would give Britain more independence from the European Union while remaining inside the 28-country bloc, was urging MPs and Britons to cast a pro-EU vote in the June referendum.
If Britain were to bolt, there is no doubt that putting the LSE and Deutsche Boerse under one roof would be exceedingly difficult. As a British company divorced from the EU, the regulatory hurdles of merging with a larger EU company – Deutsche Boerse – would be horrendous.
While Brexit may have been on the minds of the LSE and Deutsche Boerse executives, it hardly could have been the driving force behind the merger attempt, all the more so since the odds are against Britain waving goodbye to the EU. Instead, the LSE seems to be motivated by it own success. Investors have rewarded the LSE for its aggressive and bold diversification plan.
The strategy gave the LSE two big advantages: It made the exchange attractive to foreign suitors and it put the shares on a long bull run that will ensure the LSE will play a big role in any merger, even if that merger is with a heftier company.
The all-share merger, if it takes place, would give LSE equity holders 45.6 per cent of the enlarged group; Deutsche Boerse equity holders would get 54.4 per cent. If the LSE had been a stock market underperformer, it would have been utterly buried in any takeover. Now it's able to boast that its deal with Deutsche Boerse is a "merger of equals," one that will give both companies equal representation on the new board.
Shares of LSE Group rose 14 per cent on Tuesday, after the merger talks were confirmed, giving the company a market value of £8-billion ($15.5-billion). While the one-year return of 5 per cent has not been spectacular, the shares have increased 218 per cent over five years. Compare this with TMX Group, owner of the Toronto Stock Exchange. It has lost 20 per cent over one year and is down 2.4 per cent since 2011, the year the LSE tried to buy TMX (TMX shareholders rejected the deal). Deutsche Boerse has had a pretty shabby run, too. Over five years, its shares are up by only 42 per cent – one fifth the pace of the LSE.
How did the LSE get it right?
Until about five years ago, the LSE was a story of missed opportunities. It was relatively small and undiversified. It had singularly failed to build (or buy) a competitive international derivatives exchange and a clearing system. It was slow and bureaucratic.
Over the years, the LSE turned down a flurry of takeover and merger offers that might have improved its competitive position while enriching shareholders. The LSE and Deutsche Boerse first announced a merger plan way back in 2000. It went nowhere. Four years later, Deutsche Boerse made another failed lunge at the LSE. It was not alone. In the past decade, Sweden's OMX Exchange, Australia's Macquarie Bank and Nasdaq Stock Market (twice) made takeover offers for the LSE – all of which fell apart for regulatory or valuation reasons.
During that era, the LSE made one decent takeover. It bought Borsa Italiana, the owner of the Milan exchange, in 2007.
Mr. Rolet, a banker who had had careers at Goldman Sachs, Lehman Brothers, Credit Suisse First Boston and Dresdner Kleinwort Benson, was recruited as the LSE's chief executive officer in 2009 and promptly went into deal-making mode. Most of the acquisitions were savvy, broadening the LSE's geographical reach and giving it more exposure to clearing, derivatives and high-margin information services. The idea was to reduce the LSE's reliance on declining, low-margin stock trading volume. The LSE currently relies on the stock markets for one-quarter of its business; at Deutsche Boerse, the figure is 50 per cent. In came the FSTE and Russell indexes, which are used as benchmarks for funds around the world, including exchange-traded funds. The clearing company LCH.Clearnet landed in the LSE's portfolio in 2013. The LSE also owns Turquoise, the pan-European trading platform. The big miss was TMX Group. In retrospect, however, it seems a small loss. The Toronto exchange is heavily weighted toward mining and energy companies, most of which are in the tank.
Mr. Rolet's deal-making flurry seems to have worked. The deal with Deutsche Boerse looks like the last piece in the diversification game, one that should make the new group a viable competitor to the global trading and financial data monsters, including CME Group, Intercontinental Exchange (owner of the New York Stock Exchange) and Hong Kong Exchanges and Clearing.
There is no guarantee the LSE-Deutsche Boerse merger will go through. Exchanges are not just businesses; they are political beasts and no big country likes to be without its own exchange. German control of the LSE might be a particularly difficult issue as Britain tortures itself over the wisdom of remaining part of a continent dominated by Germany. The benefits of merged international platforms might also be overdone. Multinational corporations usually have no trouble raising capital anywhere. What is not in doubt is the attraction of the LSE, a former laggard turned into a formidable competitor. If Deutsche Boerse's third approach fails like the previous two, the LSE will still have options, Brexit or not.
Eric Reguly