London Stock Exchange’s mid-life crisis

As this magazine has chronicled, companies are increasingly finding alternative ways of raising money – via venture capital funds, private equity investors or even direct-to-consumer crowdfunding initiatives. The result is that the number of listed companies raising money via a stock market listing has declined steadily in a surprisingly short space of time. According to Statista, in little over half a decade the number of companies listed on the LSE, including the junior market, has fallen from 2,429, to 2,010 as of July, with the recent surge in fintech-led IPOs something of an upward blip in an otherwise downward curve.

Against such a backdrop, it is therefore no surprise that LSE’s management felt it had to do something big and eye-catching to reposition the business. However, what did come as a shock was the size and extent of the bet that management has laid on its takeover of Refinitiv, the business and markets information bit of Thomson Reuters that, through its Eikon system, provides the trading terminals found in brokerages and banks the world over. The $27bn (£19.5bn) price tag for Refinitiv was eye-catching enough, as were the reportedly $1.1bn of fees the LSE paid to its advisers, but the deal also highlights the premium that information commands. Data terminals and subscriptions are an essential cost for any financial services company or news provider and the proportion of the LSE’s revenues that are derived from information services has risen steadily since 2008 and already made up 42 per cent of sales prior to the deal (see table). It is estimated that this will rise to 75 per cent once Refinitiv is fully integrated.

The LSE isn’t the only exchange to cotton on to the value of the information its members generate and consume. Both the Nasdaq and NYSE exchanges have steadily increased prices for data over the past few years, with the effect that lawsuits have been lodged with the US securities industry regulator by some of their members alleging market abuse. There is no suggestion that the LSE has a similarly confrontational relationship with its data customers.

A question of write-downs

The concern is the size of the Refinitiv deal and the huge amount of intangible assets it has deposited on the balance sheet. More than £32bn-worth of intangibles – at the last reported interim results – explicitly link any problems that could emerge from within Refinitiv with the possibility of write-downs if even the lowest performance benchmarks are missed. Intangible and goodwill write-downs are often dismissed as irrelevant non-cash items (bosses are forever keen to point to “underlying performance” if the reported earnings are affected by them), but they do represent a tangible measure of failure, if not an immediate cash cost. Under IFRS accounting standards, companies have no option but to impair goodwill if this is found to be necessary; the International Accounting Standards Board recently rejected any return to annual amortisation as an option for goodwill accounting.

Which is why the ghost of Vodafone’s botched takeover of Mannesman at the height of the telecoms boom – the £28bn goodwill write-down it recorded in 2006 is still the biggest on record – hovers Banquo-like over any large deal.  

One early warning sign of impending write-downs is if the return on assets (ROA) ratio starts to dip. It is an indicator that acquisitions are not delivering the expected revenues. The LSE currently has a consistent ROA of 0.06 per cent on a trailing 12-month basis, the low number reflecting the small relative size of its net income compared with its now large asset base. It will take two or three sets of results before directly comparable figures are generated and the ROA moves to reflect the additional Refinitiv revenues.

Is Refinitiv any good?

Whether one big deal was the only real option, or whether a smaller tranche of bolt-on acquisitions would have been a better move is a moot point. Yet plenty of research suggests that companies making large acquisitions in one year will see their share price underperform their peers significantly the following year as integration costs and operational issues sap management time and energy.

Current evidence suggests the integration of Refinitiv isn’t delivering the profit savings that might have been expected. The disclosure in March of a potential £1bn price tag (£850m of capital spending and £150m operating expenses) to achieve annual cost savings of £125m sent the LSE’s share price down by its biggest percentage fall in 20 years. That price tag can, in part, be put down to years of underinvestment in Refinitiv’s products during its ownership by Thomson Reuters, which never really gelled as a merger. Refinitiv is also highly decentralised compared with the LSE’s command-and-control structure.

This leaves unanswered questions over the quality of Refinitiv and its core products. If it weren’t for the fact that almost everyone is working at home, the regular groans of “Eikon’s down again” would be almost audible in the streets of the City of London, after a series of major outages over the summer tested customers’ patience. That operational point aside, the question over whether Refinitiv is a stable asset is of much greater importance. The market for terminals is competitive, with Bloomberg, FactSet and S&P Global all vying for those corporate subscriptions. It is also, recent research suggests, largely lacking in growth. According to Exane BNP Paribas, the main data providers experienced between 0 and 3 per cent growth in 2020, suggesting that Refinitiv needs to deliver a solid year in 2021 to buck the prevailing trend. Then there is the rise of 'alternative data' feeds developed for smartphones to consider. Alternative data is an interesting area. Most likely, however, it would be dominated by the big tech companies if they chose to invest heavily in the concept.

Quite possibly a takeover premium will place a floor under the LSE’s share price in the short term and, whatever the issues with Refinitiv, the exchange has little trouble making money. But the LSE is discovering that running a service is much harder than simply enabling the technology for other peoples’ trades – becoming a provider and generator of data, rather than a simple utility, is a big organisational change.  

The main concern is that a deal of the size and complexity of Refinitiv, being carried through by a management with no track record of delivering anything as big and complex, introduces a risk factor to a business that has always acted as if risk happened to other people. Meanwhile, evidence of write-downs will quickly put a cap on the share price – which is what the market has already done – and keep it trading in a defined range. Getting out of that range will be a challenge even if Refinitiv's Eikon screens perform as well as they possibly can.