Deals

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.

The market thinks Brexit has killed the planned merger of the London Stock Exchange and Deutsche Boerse. The companies may need to do something clever to prove investors wrong.

The LSE is trading at a big discount to the deal terms despite both exchanges firmly recommitting to their union hours after last week's referendum shock. Its shares closed on June 27 where they would have been had they simply tracked the stock market from the day before the merger idea became public.

Round Trip
LSE shares are close to their level before merger talks with Deutsche Boerse
Source: Bloomberg

Both sets of shareholders should still want to back the deal when it comes up for investor approval next month. The cost savings that would accrue from the tie-up are probably still achievable regardless of Britain's status in Europe. The logic of gaining scale still applies, and Brexit is not about to destroy the U.K.'s large and liquid stock market.

Recent market moves have not invalidated the terms of the deal either. LSE shareholders are to get 46 percent of the enlarged company, reflecting the relative values of the two exchanges over the three months up to Feb. 22 just before the deal leaked. On spot prices today, LSE would have been entitled to receive only 43 percent of the combined group, implying Deutsche Boerse shareholders are paying a 6 percent premium. But that would be an odd reason for the German company's investors to block the deal given the volatility of recent days. Who knows how things would look at the point of completion, scheduled for early 2017.

Exchanging the Pain
Shares in LSE and Deutsche Boerse have fared worse than others in the Brexit rout
Source: Bloomberg

The bigger risk comes from regulators. The question is whether Germany demands that the exchanges drop the idea of having a U.K. holding company -- even though a London-based structure would be a big attraction for global investors in the stock. The head of German financial watchdog Bafin said on Tuesday it was hard to imagine the eurozone's most important exchange venue being "steered" from outside the EU, Reuters reported. 

If that's how the the deal gets killed, could the tie-up be reconstructed to assuage the concern? Not easily. Suppose LSE and Deutsche Boerse got comfortable with shifting the governance entirely to Germany. Given Deutsche Boerse is already providing the merger's CEO, the deal then becomes a takeover rather than a merger. LSE shareholders would demand that Deutsche Boerse pays a full control premium and expect their board to conduct an auction. Deutsche Boerse would balk, and come into play itself. Neither management team would want that. Nor, perhaps, would German politicians. For his part, Carsten Kengeter, the CEO-designate, has spent most of his recent career in London.

A solution demands a nuanced workaround locating the merger in two countries at once, but with a tilt towards one. There are precedents of sorts. Think of Unilever, Royal Dutch Shell, BHP Billiton, Rio Tinto, Glencore and Relx (the former Reed Elsevier). But at the same time, the shares need to qualify for both the Dax and the FTSE-100, with a board structure that suits the rules of both. British and German companies are very different in that regard.

Plus any pivot to Germany cannot be so great as to require a control premium. All in all, a tough circle to square.

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:
James Boxell at jboxell@bloomberg.net