London Stock Exchange Group (LSE:LSE) and Deutsche Börse (DB1X.N:GER) have agreed to merge and give birth to the largest European stock exchange group with a combined market capitalization of over $6tn.

Industry Overview

Not only have the financial markets been exceptionally turbulent since the last quarter of 2015 but also the exchange operators that are responsible for their smooth functioning.

The agreement between LSEG and DBAB represents a natural continuation of a wider industry consolidation that has commenced last year.

Earlier this month BM&F Bovespa, the leading market operator in South America took over its biggest local competitor Cetip SA in a $3.3bn deal. The Brazilian operator has been continuously acquiring minority stakes in stock exchange of neighbouring countries in an attempt to reinforce its position as a key player on the global stage.

NASDAQ, another major player does not fall behind and has been conducting very aggressive expansion strategy over the last months. More precisely, the company has been involved in five acquisitions – Boardvantage, Deutsche Boerse AG’s International Securities Exchange, Marketwired, Chi-X Canada and The Options Clearing Corp (20% stake).

The observed consolidation is mainly driven by the increasing competition and pressure for lower trading fees, benefits from more centralized collateral management system and cost synergies.

International stock exchanges with a global positioning such as the LSEG have also been threatened by the recent liberalization of the Chinese capital markets. The Shanghai-Hong Kong Stock Connect launched in the end of 2014 has significantly facilitated the access to shares listed on the Chinese mainland market and a new channel connecting Shenzhen and Hong Kong stock exchanges will be launched later this year.  As the local operators become more easily accessible for foreign investors, the attractiveness of international stock markets will continue declining, unless they find a way to position themselves better and add more value.

 

LSE

London Stock Exchange Group is the largest international market operator in Europe with a  listed companies market capitalization of approximately $4tn. The firm is structured in seven business units – Capital Markets, Post Trade Services CC&G and Monte Titoli, Post Trade Services LCH Clearnet, Information Services, Technology Services, Investment Management, and Others.

In addition to that, the group owns a wide range of iconic brands and products among which Borsa Italiana, MTS and Turquoise, UnaVista and FTSE.

DB

Deutsche Boerse is a German financial infrastructure and transaction service provider, headquartered in Eschborn and with a market capitalization of $2tn. The company operates in four main segments Xetra, Eurex, Clearstream (a clearing house), and Market Data+ which includes the financial news agency Market News International.

Recently, DBAG has acquired 360 Treasury Systems AG and Indexium AG.

Deal Rationale

Extensive synergies drive the deal and shape its way to success.

LSEG and DBAG provide a forecast of €450m cost synergies per annum, which they expect to be achieved three years after the merger completion. The main sources of the estimated value creation are: technology driven efficiencies, management rationalization and business segment optimization.

However, revenue synergies demonstrate to be the most relevant: exploiting their complementarity in asset classes and expertise, the two stock exchanges hope to boost their growth perspectives through enhanced product and service offering. Both LSEG and DBAG operate through a range of divisions while boasting a long standing track record of customers’ understanding. Precisely, DBAG retains solid competences in listed derivatives, technology, post trade and risk and balance sheet management (i.e. Eurex Clearing and Clearstream) and represents a peerless window to Europe’s largest economy, Germany. Instead, LSEG, which takes advantage from London’s geo-political role as a bridge between American and Asian markets, is an unsurpassed listing venue, a leader in OTC clearing and risk management (through LCH Clearnet), post-trade, technology, global indexes, primary and secondary markets. Hence, the combined company will cover multiple leading positions across different asset classes (e.g. derivatives, equities, fixed income, FX and energy products) and businesses (e.g. capital markets, post-trade, index and information services, technology).

In fact, UK TopCo will not only be a global trading platform, but also a first-class clearing franchise characterized by an aggregate margin pools of about €150bn across LCH. Clearnet and Eurex Clearing, with significant positive externalities in resilience and transparency of European financial markets. Moreover, thanks to the global index leaders FTSE Russell and STOXX, the combined company will become a first class information services provider: this is incredibly important in order to face the increasing demand for benchmarking mechanisms and index data products.

Furthermore, regulatory reporting and post-trade services provided through UnaVista and Regis-TR, will make UK TopCo especially captivating in the eyes of banks and asset managers. Indeed, such an integrated entity will boost harmonization in the European financial markets, so adapting to the pressures coming from European authorities, whose ultimate objective is the creation of a single solid market for financial services in Europe. In this regard, the ECB’s T2S (TARGET2-securities) infrastructure project plays a critical role: coming into force in 2015, it entails the adoption of a new centralized securities settlement engine in Europe or, as defined by the ECB itself, a “pan-European platform for securities settlement in central bank money”. Thanks to the joined force of Clearstream, Monte Titoli and globeSettle, the combined group will be perfectly positioned to be competitive in the newly T2S integrated environment.

Hence, the merger will not only lead a reinforcement of LSEG and DBAG’s, but also of the European capital markets as a whole. In this sense, Deutsche Börse AG and London Stock Exchange announced an “industry-defining merger”: this is how the two parties defined their agreement to tie up, which will result in the creation of the biggest stock-exchange operator in Europe and a truly international player. Indeed, the resulting entity will be characterized by broadened customer base and true global reach. This will be primarily enabled by the combination of LSEG and DBAG’s infrastructure base and distribution network and will result in an appealing platform for Asian and US players interested in investing in Europe.

Finally, in addition to attracting capital from international venues, the newly formed company will free up existing capital, extremely precious for real economy, thanks to its cross-selling potential: economies of scope derived from providing multiple services and products through the same diversified portfolio will enable UK TopCo to reduce margins and cost of capital, to the benefit of customers. This is precisely the case of the envisaged development of a margining service between both listed and OTC derivatives.

LSE DB structure of the deal

The two exchanges had already planned to merge several years ago but the deal never occurred. In 2000, when DBAG and LSEG were in talks for a merger, LSEG rejected a £808 million (£27.19 per share) take over bid from the Swedish OM Gruppen, because it would not have brought a substantial advantage in Europe for LSEG shareholders. Five years later, Deutsche Boerse offered £1.3 billion in cash to take over LSEG, but, again, the offer was turned down because it was too low, not recognizing “the inherent value in the LSE’s business”.

More recently, the potential deal was announced in February causing LSE’s shares to increase immediately by 17%, reaching £27.06. Similarly, DB’s shares jumped 7% to €81.71. After this announcement, Intercontinental Stock Exchange (ISE), NYSE’s owner, affirmed it was considering to make an offer for LSE, but as DB’s chief executive Carsten Kengeter reported, it just caused some speculations. However, the positive markets reaction after the deal announcement suggests that investors believe that this merge can add value to the two exchanges, especially in terms of synergies and cost savings.

The deal consists in an agreed merger of equals, in which DB’s shareholders will end up owning 54.4% of the new entity and they will be paid a €2.25 per share dividend. On the other hand, LSEG’s shareholders will control the remaining 45.6% and they will receive two dividends of £18.6 each.

The new combined group will be based in London, and Carsten Kengeter will be the CEO, while Donald Brydon, LSE Chairman, will be the Chairman of the board of directors.

Beyond regulatory approval, a major source of uncertainty for the deal is represented by the Brexit referendum on June 23, since an eventual exit of the UK from the Europe would probably damage both the newborn entity and other non-European exchanges headquartered in London.

LSE’s financial advisers were Barclays, Goldman Sachs, JP Morgan, Robey Warshaw, RBC Capital Markets, Société Générale and UBS. Deutsche Börse received financial advice from Perella Weinberg, HSBC, Bank of America Merrill Lynch and Deutsche Bank.

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Sources and References: FT,  WSJ, World Federation of Exchanges, LSE Group, Deutsche Börse Group

To contact the authors:

Dimitar Stoyanov                 dimitar.stoyanov@studbocconi.it

Giulia Ballabio                     giulia.ballabio@studbocconi.it

Giulio Tanzi                         giulio.tanzi@studbocconi.it