The London Stock Exchange (LSE) is the largest equity market in Europe and is not only at the heart of the city, with its great 300-year financial history, but of international financial markets. The Exchange is very technologically advanced and lists around 3,000 companies, including 350 companies from 50 countries, most of whom enjoy high liquidity, with around £4 trillion worth of shares traded annually. The LSE was listed on its own market in 2001.
In addition to the great importance of the LSE, what makes the recent bid to buy it so exciting are the big players involved, the fact that we are here dealing with international capital markets and the strategies involved in their development, national regulatory considerations and market power issues.
The website of the LSE states that it is "committed to removing cost and regulatory barriers of capital markets worldwide". One cannot say that what happened on December 13, 2004, came as a complete surprise to people who follow these matters but it was unexpected all the same, albeit generally in line with the stated objective.
On Monday, December 13, 2004, at 7 a.m., the LSE announced that it had received a proposal from Deutsche Borse AG for the Borse to bid for the LSE at 530p per share. On the previous Friday, December 10, the LSE shares had closed at 430p. The Deutsche Borse's proposed bid price, therefore, was around £1 higher than the closing price; such roundness is not unusual since the practicalities, including the voluminous documentation required, usually necessitate some "simplified" decision making. The Borse gave other, more intricate calculations, for arriving at the proposed bid price that it did.
On the Monday, the LSE shares opened at 513p and closed at 540p and turnover amounted to 53 million shares. It is not unusual for the price of a security facing a bid to exceed the bid price since the market would be expecting an improved bid or, even better, a bidding war.
The 7 a.m. statement by the LSE contained its firm opinion that the Deutsche Borse proposal undervalued the LSE and the "substantial synergies" which would result from a combination of the LSE with some other "major exchange group". The LSE reported that its board had been "advised that there can be no assurance that any transaction could be successfully implemented" and so had rejected the proposal but, nevertheless, had agreed to hold discussions with the Borse to ascertain whether an improved proposal could be made, one that could be implemented.
The LSE has 253 million shares in issue and the 530p bid therefore valued the Exchange at £1.3 billion. The market price prior to the bid, as stated, was 430p, valuing the Exchange at £1.1 billion but only give-away or naïve sellers let pre-bid market prices be too persuasive in their calculations even though, as someone recently noted in a letter to the Financial Times, the market was saying the price was 430p per share and the market is supposed to be the best valuer and the LSE is the champion of the market! Some analysts are reported to have given valuations clustered around 350p (£0.9 billion) but as a starting value, it is difficult to argue with the open market price.
As always, of course, the main questions in valuation focus, as they must, on strategy, which means future development, and which in turn means future cash flow. Immediately a bid is proposed, therefore, both the strategy and the management which will carry out this strategy come into sharp focus. That is what usually moves share price so dramatically. It is like election time.
One week after the Deutsche Borse bid, on Monday, December 20, this time at 8.08 a.m., the LSE announced that it had received "an approach" from Euronext N.V. but that the approach was at an early stage and did not therefore require a response. The LSE reported ongoing discussions with both the Borse and Euronext.
Euronext is the operator of the Dutch, Belgian, French and Portuguese stock markets and of Liffe, the London-based derivatives exchange.
Interesting discussions and views were expressed in the financial media as to the organisational and corporate governance models which would be adopted if a bid succeeded, the location of the LSE, the regulator, and whether and how the other companies listed on the LSE would be affected. Euronext seems to be more sensitive to such concerns and said that it would itself seek a dual primary listing in London and Paris. It pledged that the LSE would continue to be a Recognised Investment Exchange "regulated solely by the FSA" and "provide a solid long-term commitment that LSE would remain a UK RIE." Both Deutsche Borse and Euronext said they want to see lower costs for dealing in securities but users were far from persuaded since consolidation brings with it monopoly powers not only lower costs via economies of scale.
Euronext, like the LSE, organises transactions but does not own clearing and settlement operations. Deutsche Borse provides clearing and settlement services through subsidiary companies. If the Borse took over, it was feared that the vertical integration which may ensue would raise trading costs.
On Sunday, March 6, 2005, Deutsche Borse announced that it was withdrawing its proposed pre-conditional offer. The LSE share price, which had closed at 539p on Friday, dropped to 497p.
Pressure was brought to bear on Deutsche Borse's management by various shareholders, including Merrill Lynch and Fidelity, who did not agree with the Borse management's plans and opinion that buying the LSE would increase shareholder value. Rather, the Borse shareholders preferred that any "extra" cash be distributed to them.
As is normal in such cases, the Borse retained the right to re-enter a bid if some other party bid for the LSE.
Euronext resumed talks. It had reported that it believed that it will generate cost and revenue synergies of £141 million while the Deutsche Borse estimated annual synergies at £69 million. Again, the question of synergy value has to be put in the context that it is being calculated by an exchange which wants to buy another.
Deutsche Borse and Euronext have the best information as to what synergies each respectively is likely to gain but the higher the estimated synergies the higher the bid price the market, and the LSE, would expect. So, in such cases, sobriety is the better part of prudence.
Some say that if Euronext makes a bid it is likely to be below the Borse's 530p but others say that Euronext might pay up to 700p, valuing the LSE at £1.8 billion, in view of the higher expected synergies and fit. The LSE was reported in an unsourced report in the FT to be unfavourable to a bid below 590p to 600p per share. This last is a "believable" figure which would justify the LSE's refusal of the Deutsche Borse bid, give the LSE a "mid-range" value of £1.5 billion, and drive a hard bargain versus Euronext's reported (possibly underestimated) synergy gains.
It was mooted that the LSE might also pursue joint-venture talks with the New York Stock Exchange or the Chicago Mercantile Exchange. Talks with Euronext are still going on but at the time of writing, March 17, the shares of LSE closed at 470p and Euronext has not yet proposed a bid.
pva@onvol.net
Paul V. Azzopardi is managing director of Azzopardi Investment Management Limited (www.azzopardi.com) which is licensed by the MFSA to provide investment services, including stockbroking. The company is involved in acting as sponsoring and corporate stockbroker for various listed companies. Mr Azzopardi or related parties, including the company, and their clients, are likely to have an interest in securities mentioned.
This article is only meant to provide information, which the writer believes to be accurate at the time of writing, and is not intended to give investment advice and its contents should not be construed as such. The value of securities, and the currencies in which they are denominated, may go down as well as up.
Readers are requested to seek professional financial advice tailored to their own personal circumstances.