Finance

Chris Hughes is a Bloomberg Gadfly columnist covering deals. He previously worked for Reuters Breakingviews, as well as the Financial Times and the Independent newspaper.

IHS's agreement to merge with rival data provider Markit looks like a leap of faith. It's not often a deal is sold to shareholders on the basis of a small overlap.

The terms announced on Monday give Markit shareholders 43 percent of the enlarged company even though they contribute only 41 percent of combined market value as of Friday's closing share prices. The implied value put on Markit's shares of $31.13 each equates to a 6 percent premium to Markit's pre-deal $29.49 price, rising to 9 percent based on its average over the last three months. 

Diverging Paths
IHS shares have underperformed since merger talks with Markit started in December
Source: Bloomberg

The pair trade on comparable earnings multiples, and the skew in the financial terms towards Markit can be viewed to offset a skew in the governance toward IHS. Jerre Stead, IHS chairman and CEO, keeps his role for a year, until Markit counterpart Lance Uggla takes over. But IHS nominates six out of the 11 board seats. With Stead in the driving seat first, and IHS bringing over twice as many staff to the tie-up, the IHS culture looks likely to dominate.

Projected annual cost savings of $125 million a year by 2019 aren't overwhelming, at about 10 percent of combined adjusted Ebitda -- mergers typically extract much more. The savings could have a present value of more than $700 million, against the pair's combined $13 billion pre-deal market capitalization. Their relatively small size reflects the lack of operational overlap, with IHS focused on energy and transportation data for corporate customers, and Markit majoring on financial information for investment and trading clients. (There it competes with Bloomberg News parent Bloomberg LP in selling information and data to the financial industry).

Shifting IHS's domicile to the U.K. in a so-called tax inversion will allow it to benefit from Britain's ever-decreasing corporate tax rate. But it doesn't look like a game changer: IHS's effective tax rate last year was 20.5 percent, against the 17 percent rate that's set to prevail in Britain. 

Merger of Equals?
IHS's culture may dominate, but Markit brings financial muscle with lower leverage
Source: Bloomberg

The bigger opportunities for shareholders seem to lie further out. The companies are promising an annual revenue boost of $100 million within three years. The idea is to cross-sell each sides' services. If the combined company manages to realize these benefits, they could be worth a huge sum on their near-20 times forward earnings multiples. 

The question is, will they be able to realize those gains? These are two very different businesses, products and customers, so at the very least executives face the challenge of demonstrating that they can cross sell. 

The same goes for the increased financial muscle. Markit has less debt than IHS so the pair's leverage will be 3 times Ebitda against IHS's 3.7 times. Management is already talking about buybacks and further acquisitions. But buybacks have to be done at the right price, and acquisitions have to make sense. 

The rise in the companies' share prices after today's open has already accounted for the cost savings, plus a bit more. Shareholders would be forgiven for waiting to price in the deal's other touted benefits.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Chris Hughes in London at chughes89@bloomberg.net

To contact the editor responsible for this story:
Jennifer Ryan at jryan13@bloomberg.net