The industry needs to keep acquiring to achieve strategic growth
Thursday 27 Sep 2018 Author: Daniel Coatsworth

Many individuals are incredibly passionate about investing and spend a considerable amount of time chatting about stocks or investing skills with like-minded individuals. Despite this dedication, I’m amazed how little I hear London Stock Exchange (LSE) being discussed, given it is the system behind the UK stock market and the brains behind the FTSE stock market indices commonly used to benchmark performance.

Investing in London Stock Exchange’s shares have been a very profitable trade; over the last 10 years its share price has increased by 515%. The shares earlier this month hit a new all-time high.

If you’re a fan of momentum investing, this stock looks hugely attractive given the share price remains in a firm upward trend. The big drawback is how Brexit may impact the business.

The company said in August a no-deal or hard Brexit could adversely affect the group’s business, results of operations, financial condition and cash flows. It has contingency plans in case Britain leaves the EU next March without a transitional deal.

While that risk is hanging over the business, it doesn’t seem to be troubling investors given how the share price keeps rising. One possible explanation is that the exchange industry is ripe for another round of takeovers and mergers – and London Stock Exchange could be involved.

This industry has very high barriers to entry because existing exchanges have three important attributes. Firstly, they benefit from a network effect (the more people using them, the more valuable their proposition becomes, particularly in the field of liquidity and indices).

They also have intellectual property rights and post-trade efficiencies which act as barriers to rivals.

Because of these reasons, stock exchanges around the world may find it hard to grow into new areas without M&A, argues Berenberg analyst Chris Turner.

More acquisitions look inevitable, particularly as two players have already shown the benefits of buying other companies to strengthen their proposition – being ICE which has bought several trading businesses and London Stock Exchange which is very strong in information services thanks to buying index providers Citi Fixed Income Indices, Frank Russell and FTSE.

So what could happen next? CME buying London Stock Exchange looks plausible, says Turner at Berenberg – more so than a bid for the UK group by ICE where the potential rewards don’t look high enough to compensate for the risks involved.

On the flipside, the analyst says there are many reasons why London Stock Exchange may want to acquire Europe’s largest custodian, Euroclear.

London Stock Exchange’s new boss David Schwimmer comes from an M&A background and may have the necessary skills to find solutions to challenges such as ICE owning 10% of Euroclear plus excessively complicated corporate governance arrangements at the hypothetical target.

Turner reckons buying Euroclear could boost London Stock Exchange’s earnings per share by 30%. That’s an incredibly attractive proposition and surely one that is sitting front of mind for Schwimmer who has yet to communicate his strategy for the business since becoming CEO in August. Make sure you watch this space closely. (DC)

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