June 24 (Bloomberg) -- In the bidding war for TMX Group Inc., London Stock Exchange Group Plc may need to make an offer it can’t afford for a deal it can’t afford to lose.
The London-based bourse, which announced in February its all-stock offer for the owner of the Toronto Stock Exchange, raised its bid valued at C$44.93 a share this week by agreeing to pay TMX owners a special dividend of C$4 a share. Within hours, it was topped by a C$50 proposal from a group of Canadian banks and pension funds vying to keep TMX in local hands, a two-dollar increase from their original unsolicited offer in May.
For the LSE to top Maple Group Acquisition Corp.’s offer by one Canadian loonie and compensate its own shareholders, it may need to spend a total of about a billion U.S. dollars on cash payouts, according to data compiled by Bloomberg. While Maple can defray the costs of its hostile bid among 13 members, LSE risks taking on more debt and drawing down TMX’s cash balance to gain a market venue that’s one of the least valuable versus earnings. Without TMX, the bourse that traces its roots back to the coffee houses of 17th century London may now become a target, according to First New York Securities LLC.
“LSE is in a very vulnerable position,” said Andrew Ross, partner and global equity trader at First New York, a New York-based proprietary trading firm that bets on stocks, commodities, currencies and derivatives. “They lack the financial capacity to outbid the Maple group. It will be very difficult for them to remain independent if they were to lose the Canadian deal.”
Victoria Brough, a spokeswoman for LSE, Carolyn Quick of TMX and Maple’s Peter Block declined to comment.
Maple, made up of firms from Toronto-Dominion Bank to Manulife Financial Corp., said in a statement on June 22 that it would offer C$3.8 billion ($3.9 billion), or C$50 a share, for TMX, up from C$48 previously.
The group agreed to raise the cash portion of its hostile bid to as much as 80 percent from 70 percent, and offered to negotiate a reverse breakup fee if the takeover doesn’t win regulatory approval. The non-cash portion is Maple shares.
Earlier in the day, LSE and TMX agreed to pay special dividends of about C$660 million in an attempt to thwart Maple’s previous bid. TMX shareholders would receive a cash dividend of C$4 a share from the combined company once the takeover is completed, while LSE shareholders would get 84.1 pence ($1.35) a share, the exchanges said.
The LSE all-stock offer is currently valued at C$44.93 a share, according to data compiled by Bloomberg. If the cash dividend is included, it’s valued at C$48.93.
TMX rose 2.4 percent to C$45.30 yesterday in Toronto, while LSE dropped 0.1 percent to 956.5 pence in London.
The prospective buyers sweetened their offers a week before shareholders of Canada’s main bourse vote on the LSE proposal.
While LSE and TMX have already committed to spending about $670 million in cash payouts, Maple’s counteroffer means that the London bourse would now have to boost its special dividend for TMX holders by C$2.07 share to trump Maple by one Canadian dollar, according to data compiled by Bloomberg.
If LSE shareholders also get an increase in proportion to TMX holders, the cost of the additional dividends to all owners of the combined entity would reach almost $350 million.
“If the bid continues to go up, it just wouldn’t make sense for LSE,” said Sang Lee, managing partner at research firm Aite Group LLC in Boston. “They’ve probably gone as high as they can. At the end of the day, financially speaking, Maple Group is much better positioned than LSE could ever be.”
LSE and TMX intend to finance the C$4 dividend to TMX holders, as well as the 84.1 pence-a-share payout for LSE owners, with a combination of cash held by both companies and debt, LSE said in a statement dated June 22.
Together, they had cash reserves of about $818 million at the end of March, data compiled by Bloomberg show.
That may not be enough for LSE, with an equity value of $4.15 billion, to fend off a group whose three biggest companies have a combined market capitalization of $166 billion, according to Keith Moore, an event-driven strategist at MKM Partners LP in Stamford, Connecticut.
LSE is “getting close to paying a price that may make it difficult to pay off at least in the short run,” he said. “As the price escalates, financially, it’ll be more difficult to have it translate into the combined company’s operations.”
Still, LSE is likely to raise the offer, possibly by C$2 a share, because they want to control the fate of their own exchange, according to Moore.
“The real problem I see for LSE is if they can’t close on this deal, they become a target themselves,” he said.
LSE’s original bid for TMX announced Feb. 9 was part of more than $30 billion in takeover offers for exchanges in less than six months, as bourses seek to cut costs and generate more revenue from trading in stocks, options and futures.
LSE may now miss out on the wave of consolidation that began in October, when Singapore Exchange Ltd. bid A$8.35 billion ($8.3 billion) for ASX Ltd. to create the world’s fifth-biggest bourse. The deal was blocked by Australia’s government in April.
Deutsche Boerse AG of Frankfurt and New York-based NYSE Euronext agreed in February to combine to create the world’s largest exchange, while New York-based Nasdaq OMX Group Inc. and IntercontinentalExchange Inc. of Atlanta followed in April with an unsolicited offer for NYSE Euronext. They dropped the bid last month after U.S. regulators threatened to block the deal.
“It’s a consolidating industry,” said Roy Behren, a manager at the $5 billion Merger Fund for Westchester Capital Management Inc. in Valhalla, New York. “There are a limited number of quality players, and the TMX Group is one of them.”
Institutional Shareholder Services, which advises pension and mutual funds on proposals in shareholder meetings, recommended LSE’s bid yesterday.
“The strategic rationale for the merger appears to be sound,” ISS said in an e-mailed report. “The merger should allow TMX Group to achieve the cost synergies associated with combination of technology platforms, leverage the combined company’s depth of liquidity to gain new issuer listings, and improve the company’s global competitive position.”
TMX trades at 15.2 times earnings, 55 percent less than what the average exchange commands, data compiled by Bloomberg show. LSE is valued at 17 times profit.
LSE earned 23 cents for every dollar of revenue in the past 12 months, versus an average of 37 cents for exchanges worldwide. Analysts estimate LSE will increase per-share earnings by just 3 percent next year, while TMX may boost profit by 5 percent, data compiled by Bloomberg show.
Earnings at NYSE Euronext and Deutsche Boerse will climb 16 percent and 12 percent, respectively, the projections show.
TMX needs to make its offer more attractive for shareholders if it wants to compete with Maple, said Sachin Shah, a special situations and merger arbitrage strategist at Capstone Global Markets LLC in New York.
“TMX shareholders are not excited at the end of the day to own LSE shares,” he said.
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