London Stock Exchange Group PLC (LSE) and Deutsche Boerse AG (DB1) have confirmed rumours that they are again discussing a merger.
This "merger of equals" would create the dominant European exchange group. But would does the deal have a chance of succeeding? Details are still scare but some points immediately jump out to us.
Would This Breach Anti-Trust Rules?
First are anti-trust concerns. Recently these were cited as by the European Commission when it blocked the attempted merger between Deutsche Boerse and the NYSE Euronext, which was blocked by the European Commission.
This raises the all-important question of whether this deal even has a chance of getting approved: we believe it does.
The European Commission blocked the previous deal primarily on concerns of a monopoly in European exchange-traded derivatives, but the current deal has different dynamics, as LSE deals primarily in the over-the-counter space.
In its previous ruling, the commission said that over-the-counter and exchange-traded derivatives do not compete with each other because of the different natures of these contracts. This makes the current deal much more interesting, as the two main franchises of SwapClear and Eurex would then not be labelled as being in direct competition, potentially avoiding anti-trust concerns.
In addition LSE is also not a main player when it comes to trading the international central securities depository, so the potential for anti-trust issues with Deutsche Boerse's Clearstream are extremely low.
For the deal to go ahead, adjustments may be needed to completely satisfy regulators, but we think the risk of a complete regulatory blockage is less than for the Deutsche Boerse-NYSE merger. We are currently maintaining our narrow moat ratings for both Deutsche Boerse and LSE and our current fair value estimates of £29 for LSE and €85 for Deutsche Boerse.
Competition Rules
Another argument previously used by the European Commission involved the importance of potential competition, where even the threat of competition helps keep the current dominant players in line. Here it gets a little more interesting, as LSE is currently in the process of launching CurveGlobal, which is its attempt at competing in the exchange-traded derivatives space.
It could be argued that, even if CurveGlobal isn't established yet and even if it struggles to gain market share, the mere threat of competition is necessary.
However, we would point out that in the event Deutsche Boerse and LSE merge, Intercontinental Exchange would still be a primary competitor in the space, and Nasdaq is also attempting to break into interest-rate exchange-traded derivatives, so competition would still remain. This leads us to believe that this deal will not get an automatic no from regulators.
Shareholder Benefit
Finally, if the deal does happen, is it beneficial for shareholders? While details are scarce, in a broad sense we believe this deal would be beneficial for both firms.
The exchange industry is one with inherent operating leverage, therefore increased scale tends to increase cost efficiency. There is also the potential for cross-margining benefits, as LSE and Deutsche Boerse would have an even larger derivatives risk pool under their control. This could increase margining efficiency and reduce the capital requirements placed on their customers.
New Opportunities?
Overall there appear to be a lot of complementary aspects to this deal. It is also interesting to note the changing dynamic between the companies. In the past, LSE was much smaller and was fighting off takeover bids, but it is now a dominant force among the European exchanges and has seen some of the highest growth in the space. Meanwhile, Deutsche Boerse has not been the same growth story and is searching for new opportunities. Therefore, we think this deal makes strategic sense for both parties. However, there is still uncertainty as to the exact details of the deal, which means we cannot be sure it will get the required regulatory approval.
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