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In the stocks

16 March 2016 By George Hay

Investors only buy half of the logic of splicing together London Stock Exchange and Deutsche Boerse. The two European exchanges announced on March 16 that their proposed merger would create 450 million euros in annual cost synergies, in three years time. The market has factored this in, but little more.

Since Feb. 23, when the deal was announced, LSE shares have risen 14 percent from their three-month average of 25.30 pounds. Deutsche Boerse’s are up 4 percent from 57.74, the sterling value of its undisturbed share price average at the current exchange rate. Collectively, that’s a premium of 1.7 billion pounds.

The newly revealed cost synergies are worth about the same. Turn them from euro into sterling, tax them at 25 percent, and then discount them back at an assumed 8 percent cost of capital to reflect that they don’t appear for three years. Stripping out a 600 million euro charge to achieve the savings implies an uplift of 1.6 billion pounds.

If that was all the merger offered, it would be wide open to a rival approach from U.S. rival Intercontinental Exchange, which is already sniffing around. But LSE and Deutsche are confident they can generate revenue synergies too – from incentivising higher volumes through their LCH.Clearnet and Eurex clearing houses. The theory is that “cross-margining” kicks in, and clients can put up less collateral if they deal with a combined exchange than they would today.

Imagine the two exchanges could produce the equivalent of 11 percent of LSE’s revenue – an average of the last 10 years of exchange mergers, according to Credit Suisse. Apply that to the 1.6 billion pound top line analysts expect for LSE in 2017, then tax, capitalise and discount it, and there could be a hidden 1.1 billion pounds of value.

One worry might be that regulators or competition authorities may intervene. Another is that customers could claw those gains back for themselves. The fact is that investors don’t seem to buy this half of the story. In order for the deal to go smoothly, they probably need to.



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