LSE Equity Evaporates as TMX Deal Shows Scant Profit: Real M&A

May 24, 2011, 10:35 AM EDT By Nandini Sukumar and Rita Nazareth

May 24 (Bloomberg) -- No company’s stock is worth less as currency for takeovers than London Stock Exchange Group Plc, according to traders who profit from mergers and acquisitions.

The value of the bourse’s offer to buy TMX Group Inc. with equity fell 4.9 percent below the price of the Toronto stock exchange operator’s shares yesterday, according to data compiled by Bloomberg. The gap is the widest of any all-stock deal over $1 billion, indicating to arbitragers that LSE’s equity alone won’t be enough to fend off a higher bid from a group of Canadian banks and funds trying to keep TMX in local hands.

While TMX’s directors last week rejected the unsolicited cash-and-stock offer by Maple Group Acquisition Corp. in favor of LSE’s $3.1 billion all-share proposal, owners of the Toronto bourse stand to get equity in a company that’s 39 percent less profitable than the average market venue by selling to LSE, the data show. Without the deal, Europe’s oldest independent bourse risks being left out of the industry’s biggest round of consolidation. In the past decade, exchanges from Hong Kong to Singapore and Sao Paulo have eclipsed LSE by market value.

“There are two ways to look at this: Is TMX currently trading at a premium or is LSE trading at a discount?” said Frederic Ponzo, managing partner at London-based GreySpark Partners, which advises financial institutions. “The problem for LSE is the same for the last 10 years now. They are big, but not big enough. They are still in a difficult position.”

Long-Term Value

Carolyn Quick, a spokeswoman for TMX, didn’t immediately respond to voicemails left at her office or an e-mail requesting comment yesterday as Canadian financial markets were closed for a national holiday. A voicemail message left on her mobile phone seeking comment also went unanswered.

“The LSE-TMX merger is just that -- two strong, successful businesses with complementary assets and brands combining to create a leading international exchange group,” David Lester, LSE’s director of information services, said in an e-mailed response. “Anyone can deliver cash on day one through saddling a business with debt, but few deals can offer the long-term value for shareholders that LSE-TMX will create.”

Based on the terms of LSE’s takeover, each TMX shareholder will get 2.9963 LSE shares for every share they own in Canada’s largest exchange, according to data compiled by Bloomberg.

That valued the deal at about C$42.06 a share yesterday, about two Canadian dollars below TMX’s closing price last week.

Today, TMX declined 1.1 percent to C$43.58 as of 10 a.m. in Toronto. LSE rose 1.4 percent to 901 pence in London.

Maple Bid

LSE faces competition from Maple, a group of four Canadian banks and five pension funds that’s trying to block the largest foreign takeover of a financial services company in Canada.

While TMX Chief Executive Officer Thomas Kloet, 53, said in a telephone interview May 20 that the combination will create a bourse “whereby our shareholders continue to share in the growth of the company,” the C$3.6 billion ($3.7 billion) proposal from Maple this month values the Toronto exchange at a premium to LSE’s bid and will be paid mainly in cash.

“It’s pretty clear the domestic bid in Canada is real and it’s likely superior financially,” said Andrew Ross, partner and global equity trader at First New York Securities LLC, a New York-based proprietary trading firm that bets on stocks, commodities and derivatives. “I don’t think that shareholders at LSE would look very favorably upon LSE really aggressively attempting to outbid this Canadian group.”

LSE’s deal for TMX in February was part of more than $30 billion in takeover offers for exchanges in less than six months, as bourses try to cut costs and generate more revenue from trading in stocks, options and futures.

Exchange Acquisitions

The deals began in October, when Singapore Exchange Ltd. bid A$8.35 billion ($8.3 billion) for ASX Ltd. of Sydney. LSE followed with its own offer for TMX on Feb. 9.

Less than a week later, Frankfurt-based Deutsche Boerse AG announced its takeover of New York-based NYSE Euronext, which Nasdaq OMX Group Inc. of New York and IntercontinentalExchange Inc. of Atlanta countered in April.

Singapore Exchange’s acquisition of ASX was rejected by Australia’s government last month, while Nasdaq OMX and ICE dropped their bid for the New York Stock Exchange this month after U.S. regulators threatened to block the deal.

“They either need to salvage the TMX deal or find another deal quickly,” said Dirk Hoffmann-Becking, a London-based exchange analyst at Sanford C. Bernstein & Co. “Shareholders in the end look for money today.”

Xavier Rolet, LSE’s 51-year-old CEO, will cut 35 million pounds ($56 million) a year in costs as part of the deal and expand into businesses such as derivatives as competition increases.

Earnings Growth

LSE earned 23 cents for every dollar of revenue in the past 12 months, versus an average of 37 cents for exchanges worldwide, data compiled by Bloomberg show. TMX had a profit margin of 34 percent. Analysts estimate LSE will increase per- share earnings by just 3 percent next year, while TMX may boost profit by 5 percent, data compiled by Bloomberg show.

Earnings at NYSE Euronext and Deutsche Boerse, which may save as much as 550 million euros ($772 million) by combining, will climb 16 percent and 12 percent, respectively, the projections show.

A takeover of TMX would create a $7.2 billion exchange, leapfrogging Nasdaq OMX, ASX and Singapore Exchange among the world’s biggest trading venues.

Losing out would leave LSE, which traces its roots back to the coffee houses of 17th century London and has a market value of $3.9 billion, further behind.

Standalone Value

Deutsche Boerse and NYSE Euronext are creating the world’s largest exchange with a market value of $24.2 billion. Hong Kong Exchanges & Clearing Ltd., currently the biggest bourse with a market value of $23.6 billion, is six times the size of LSE, data compiled by Bloomberg show.

Sao Paulo-based BM&FBovespa SA, the operator of Latin America’s biggest securities exchange, is three times as big.

“As a standalone company LSE faces pretty aggressive competitors,” said Adam Sussman, New York-based director of research at Tabb Group LLC. “So the stock is more difficult to use as a takeover currency.”

Sachin Shah, a merger arbitrage strategist at Capstone Global Markets LLC in New York, says that LSE can boost shareholder value more by putting itself up for sale instead.

Shares of LSE jumped 6.8 percent on May 16, the biggest advance in 17 months, on speculation that Nasdaq OMX would pursue LSE after dropping its bid for NYSE Euronext. Nasdaq OMX has previously tried to acquire the London exchange three times.

Nasdaq OMX’s Frank De Maria declined to comment.

‘Not Over’

“Nobody wants to own LSE as a standalone company,” Shah said. “The market is anticipating that a deal with TMX may not occur and a standalone value is not as attractive. The consolidation with exchanges is not over.”

Instead, “the market is sensing that LSE is not going to be around” because it will become a target, he said.

Overall, there have been 9,737 deals announced globally this year, totaling $957.2 billion, a 22 percent increase from the $786.7 billion in the same period in 2010, according to data compiled by Bloomberg.

--With assistance from Whitney Kisling, Justin Doom and Sarah Rabil in New York. Editors: Michael Tsang, Daniel Hauck.

To contact the reporters on this story: Nandini Sukumar in London at nsukumar@bloomberg.net; Rita Nazareth in New York at rnazareth@bloomberg.net.

To contact the editors responsible for this story: Daniel Hauck at dhauck1@bloomberg.net; Katherine Snyder at ksnyder@bloomberg.net; Nick Baker at nbaker7@bloomberg.net.

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