Data – so the now-aged maxim goes – is the new oil. If that is true then investors in the London Stock Exchange (LSE) think their company just drilled a gusher. Shares in the exchange rocketed 15 per cent on 29 July after it confirmed that it was close to swooping on Thomson Reuters’ data services arm, Refinitiv.
At first glance, there are good reasons to side with the market’s verdict. If its all-share deal receives the necessary clearances, the LSE will take control of a big player in financial data and analytics, whose various subscription-based trading platforms host daily trading volumes of $400bn (£328bn) in foreign exchange and $500bn in fixed income. In one go, it gets access to more than 40,000 institutional clients focused on investment, trading, wealth and risk management.
Initial analyst praise was also fulsome. UBS called the transaction “transformational”. How transformational might that be? “We believe the deal would be strategically sensible and transform the LSE into a truly global infrastructure player,” thinks JP Morgan.
The first response to this is to ask why the LSE should want to transform, and transform in this way. Before the deal was announced, shares in the bourse were up more than eightfold since the start of the decade, well ahead of US rivals Nasdaq (US:NDAQ) and International Continental Exchange (US:ICE), and more than double the performance of the group’s closest European peer, Euronext (Fr:ENX). Deutsche Boerse (Ger:DB1), with which the LSE had hoped to merge until a deal was nixed by EU competition authorities in 2017, has seen its shares climb by a comparatively slight 150 per cent over the same period.
That failed merger, which would have created a European exchange powerhouse, promised a path towards one possible future identity, namely scale. The other route, honed under former chief executive Xavier Rolet, has been the gradual push into data services, which goes a long way to explain the shares’ excellent run in recent years. In 2018, information services were the largest single contributor to the LSE’s top line, having grown by an average 22.5 per cent a year since 2014.
With Refinitiv, the LSE is arguably chasing both scale and data. Combined annual revenues would have come to £6bn in 2018, and the LSE thinks it can find £350m in annual cost synergies within five years. For analysts at Berenberg, the proposed deal promises to not only beef up the LSE’s strengths in over-the-counter dealing, but “reflects the way that electronification of trading has blurred the boundaries between exchanges and information service companies”.
However, there are good reasons to question the price the LSE is paying, despite the market’s effusive reaction. For one, Refinitiv was valued at just $20bn when it was carved out of Thomson Reuters last year. That deal gave 55 per cent control to a consortium led by private equity firm Blackstone, while saddling Refinitiv with around $13bn in debt. As such, the LSE is about to absorb some $12.2bn of private equity loans, which JP Morgan estimates will give the combined group pro-forma net borrowings equivalent to 4.2 times adjusted cash profits.
Last year’s buyout deal also obscures profitability. In the 12 months to December 2018, Refinitiv’s operating income before depreciation and amortisation came to $1.64bn, although this does not adjust for $469m of costs, and was reached in a period of what looks like extreme transition: in just 15 months, Refinitiv’s new owners claim to have cut costs by $350m.
Then there is dilution. The sellers’ combined equity stake in Refinitiv has been valued at $15bn, which will translate into a 37 per cent holding in the combined group. In return, the Blackstone consortium and Thomson Reuters will receive less than 30 per cent of the total voting rights, while agreeing to some unspecified lock-up provisions. Regardless, shareholders could be braced for some stock overhang, should the private equity group choose to liquidate some of its profits.
