London Stock Exchange plc (LSE LN) / Deutsche Boerse AG (DB1 GY): Companies confirmed that they are in detailed discussions about a potential merger of equals. The transaction would be structured as an all-share merger of equals under a new holding company. Under the terms of the transaction, LSE shareholders would be entitled to receive 0.4421 new shares in exchange for each LSE share and DB1 shareholders would receive one new share in exchange for each DB1 share. Based on this exchange ratio, DB1 shareholders would hold 54.4%, and LSE shareholders would hold 45.6% of the enlarged share capital of the combined group. The combined group would have a board composed of equal numbers of LSE and DB1 directors. PUSU deadline set for 5pm on 22 March.
Although there is obviously strong, strategic rationale for a renewed attempt (this is third time that LSE and DB have attempted to merge, first in May 2000 then in December 2004) to tie up Europe’s 2 largest exchanges (to extract highly meaningful cost synergies in a challenging top-line environment for exchanges), this deal is again fraught with (regulatory) execution risk.
We believe there is significant EC Phase 2 blocking risk associated with this transaction given that this deal will only be allowed if EC adopts a separate market definition for listed and OTC derivatives clearing markets: Besides tie up would control almost 40% market share of pan-European cash equities, Deutsche Boerse also owns Eurex, which is the largest listed derivatives Central Counterparty Clearing (CCP) in Europe, while LSE owns LCH.Clearnet, the largest OTC derivatives CCP. To get this deal across EC finish line, companies will need to put significant reference to EC’s 2012 precedent when it blocked the Deutsche Boerse-New York Stock Exchange by more narrowly defining the market (it looked specifically at the listed derivatives trading market and hence did not allow NYX’ Liffe to merge with Deutsche Boerse Eurex).
- Pro-forma target calculations: Assuming 10% to 20% of cost synergies (recent stock exchange M&A has resulted in cost synergies anywhere between 9% and 18%), and applying respective pre-deal NTM P/E of 18x and 17x for LSE and Deutsche Boerse (and subsequently allocating 45.6% and 54.4% for its pro-forma merger ownership), would result in LSE target pricing range of GBP 26.1- 29.4 and Deutsche Boerse deal close target pricing range of EUR 84.9-93. However given deal execution risk and long dated 12 month timetable, we would arbitrarily discount those target prices by at least 10%, achieving risk adjusted target pricing of GBP 23.5- 26.5 for LSE and EUR 76.4-83.7 for Deutsche Boerse.
- Merger arb target calculations: Applying 1 LSE = 0.4421 DB1, and using LSE and Deutsche Boerse current share pricing of GBP 26.4 and EUR 77.5, we see gross spread of about 2% (excluding dividends), which we believe is too tight given execution and timing risk.
Although both parties are obviously prone to any rival offer/interloper (Times article quotes that LSE could also attract interest from Chicago Mercantile Exchange (CME), the American derivatives market operator, or ICE, owner of the New York Stock Exchange), given the above, we would suggest very short term pair trade: Short LSE (LSE LN) vs Long Deutsche Boerse (DB1 GY).