Equity analysts have reacted to confirmation by the London Stock Exchange and LCH.Clearnet this week that the parties are in exclusive discussions about a possible transaction, saying a deal makes good strategic sense.
LCH.Clearnet board chose the LSEs bid over an alternative bid from Markit. LSE said that work is focused and ongoing, with a view to moving towards an agreement, though at this stage there can be no certainty that any transaction will result.
Analysts said the merger would boost the LSEs post trading business and enable it to diversify its revenue stream. In a research note out yesterday, Barclays Capitals equity research team said an acquisition makes good strategic sense with the LSE able to develop Swapclear and link up with the Italian clearing house Cassa di Compensazione e Garanzia (CC&G) and Millennium.
Credit Suisses small and mid cap equity research team on Wednesday noted that post trade revenues for the LSE represented 151 million or 22% of group revenues for the year ending March 11 2011. If we take the 356m (305m) of revenues for LCH.Clearnet and combine with the post trade revenues for the LSE this would result in pro-forma revenues generating around 47% of revenues from post trade services, so clearly the deal would provide revenue diversification.
The move towards greater OTC derivatives clearing is potentially also attractive, c10% of clearing revenues for LCH were derived from OTC derivatives. The deal should also give the LSE more control over the clearing function which may be important for future product development and it is possible that management may wish to integrate LCH.Clearnet closer with its own technology business MillenniumIT.
LSE tried earlier this year to buy the Toronto Stock Exchange going as far as agreeing on a 4.2bn merger with the exchange before the Maple Group, a consortium of Canadian financial institutions came along with an aggressive counterbid.
LSE is yet to confirm details of price for LCH.Clearnet or stake to be acquired. According to the London-based Financial Times newspaper, that price is up to 21 per share for a 51% stake, valuing the clearer at about 1bn. The deal still requires approval from LCH.Clearnet’s shareholders, which include the largest dealer banks, NYSE Euronext and the London Metal Exchange.
Credit Suisse said based on 21 per share the deal would look relatively expensive on historical PE (c50x) given LCH.Clearnet last year only made a profit after tax of 19m, but there could be scope for potential cost cutting, although success in extracting synergies in previous exchange deals has always been mixed. We estimate, based on an implied valuation of 1bn, if the LSE could take out 20% of the costs of LCH.Clearnet the PE multiple would fall to c18x and 30% cost reduction would take it to c13x, said a Credit Suisse research note.
Credit Suisse added that it remains to be seen whether LSE would be comfortable with gearing up by what is believes could be as much as c2.5x for the acquisition. In terms of the financial position of the LSE, at the 31 March 11 net debt stood at 245m although operational net debt was higher at 370m due to cash set aside for regulatory, clearing and commercial purposes. The net debt/EBITDA stood at 1x and the company indicated that it remains well within its bank covenants. At the 31 March 11 the Group had undrawn facilities of 0.5bn. If we assume 0.4bn of debt facility is used this would increase the net debt/EBITDA to c2.5x although we believe that the LSE may have reduced its net debt position since the 31 March 11. Credit Suisse added that potentially other sources may need to be considered to fund the deal, which would probably require shareholder approval.
In London trading on Wednesday, LSE shares declined 0.3% to 8.40 ($13.13). In its pre-close trading statement the exchange said yesterday its second quarter treasury income had contributed to a good 1H result. This contributed as much as a 38m boost year on year to 1H total income. LSE said it is confident of reporting good 1H results.
In other trading news the CBOE Stock Exchange (CBSX) has agreed to acquire the National Stock Exchange (NSX), an all-electronic stock exchange. CBSX will operate NSX as a separate exchange but with consolidated data systems and business operations.
(JDC)