LSE - a bride to be?

The London Stock Exchange remains an attractive partner for a host of reasons but has so far rejected all offers. But how long it can remain independent is becoming an increasingly urgent question, says Richard Willsher

Over the last couple of years the London Stock Exchange (LSE) has received approaches or formal offers from Germany’s Deutsche Borse, the pan European exchange Euronext, Australian investment bank Macquarie and, currently, from NASDAQ, the US electronic exchange. The LSE’s 48-page December 2006 document, Reject Nasdaq’s Offer – Maximise Your Value in a World of Opportunity, points out, ‘our share price has more than tripled in the last two-and-a-half years’. The document also notes that, since NASDAQ made a pre-conditional proposal on 10 March 2006 at a price of 950p per share, it has had to raise its bid to 1,243p in November – that is an increase of 31%. Moreover, when the market closed for trading on 29 December the price was 1,310p.

So far the LSE seems to have been true to its mission to provide its shareholders with best value. NASDAQ meanwhile had until 27 January to table a revised bid and, as we go to press, it is saying that it won’t do so. The LSE’s board had refused to meet NASDAQ’s people. Each side was posturing, talking up its own position while describing the other’s in deprecatory terms.

Setting aside the nip and tuck of the chase, let’s take a look at some of the arguments on either side. There is no doubt that LSE is on a roll. During 2006 £27.9bn in new listings were brought to its markets – ‘more than any other listed exchange in the world’, it says. Trading on its SETS platform increased hugely in 2006. It describes itself as the ‘world’s largest pool of international equity capital’, and there is ample evidence that overseas businesses, particularly those from the emerging markets Russia, India and China, among others, prefer to list in London. One driver for this preference is to avoid the heavy post Sarbanes-Oxley regulatory burden now governing the US markets. AIM – London’s more lightly regulated market for small, fast-growing companies – has also benefited from this in the last year or so.

All this is true, however such buoyancy is to be expected at a time of economic prosperity and confidence. The FTSE100 index is now substantially above the 6,000 mark and 2006 was generally an excellent year for the City of London’s capital markets. But many are saying that we are at or near the top of the cycle. Tell-tale signs are emerging. Commercial property investors have started to sell out on both sides of the Atlantic. Commentators and regulators are warning of dangers in the private equity/ highly leveraged sectors. Some of the banks have reported higher levels of corporate bankruptcy. The mergers and acquisition boom, supported by massive amounts of available cheap debt, is looking overheated and an upward trend in interest rates may, in due course, make the cost of debt service dangerously high for some big borrowers.

Against this background, NASDAQ’s view that its offer is already fully priced at present has a ring of truth about it. The LSE says that NASDAQ’s offer does not fully represent the standalone value of its business, which NASDAQ denies. But both sides have said that in the current environment of stock exchange consolidation, particularly in Europe, a combination of some sort is desirable. Analysts from Gartner, the Tower Group and the rating agencies Moody’s and Standard & Poor’s, have been saying this for some time. Economies of scale are needed to drive scale benefits and lower dealing costs. In support of its ‘final cash offer’ of 20 November, NASDAQ said that the deal would produce ‘the leading global cross-border equity market platform’. This would benefit shareholders and those using the platform. It suggested that ensuring strong but not prohibitive regulation would be a feature of the deal if it were to be consummated. But NASDAQ has some problems of its own to deal with. A new rival, the Kansas City-based BATS platform has announced new dealing tariffs which are considerably cheaper than NASDAQ’s, and BATS has lower operating costs. In addition a group of seven major brokerage houses, including Goldman Sachs and Citigroup, has said that they will launch their own equity trading system. At the same time the cost of takeover of the LSE would be expensive, as it would have to borrow heavily to pay for the 71.25% of LSE’s stock that it does not already own. The prospect of this has already caused Moody’s to place its rating on watch for a potential downgrade.

Push comes to shove?

But since the LSE issued its rejection document, and NASDAQ explained its reasons for the bid, a big new factor has come into play. NASDAQ’s CEO, Robert Greifeld, may well have been referring to this when he said in a statement: ‘The Board of LSE is ignoring the elephant in the room at its peril. Regulatory changes, increased consolidation and customer group competition are likely to bring significant downward pressure on LSE’s revenue model going forward.’ In the days before the Christmas break shareholders of Euronext agreed by an overwhelming majority to approve its US$14bn combination with the New York Stock Exchange. The market capitalisation of the shares listed on these markets will amount to US$25.8 trillion, four times that of the total for companies listed on the LSE’s markets.

Unless the LSE has some pretty powerful and, as yet, hidden cards up its sleeve it is difficult to see how it can hold out over talks with NASDAQ. While it is true that both the LSE/NASDAQ combination, and that of Euronext/NYSE, present some potentially huge and costly systemic technical issues, if the scale arguments and those of the globalisation of world stock markets are valid, then the LSE looks in danger of missing out on a very big opportunity to compete. Of course, who is to say that LSE could not itself join Euronext/NYSE? No one is yet suggesting this as a possibility however, and for sure this would pose some big questions over NASDAQ’s future strategic options, not to mention major competition issues.

The next few weeks are likely to be critical in the global game of stock market consolidation. How it will shake out is an open question, but doing nothing is looking increasingly less likely as one of the options open to the London Stock Exchange.

Richard Willsher is a financial and business writer with a background in investment banking.