Majestic Research

Financial Times

Nasdaq Exits, But Curtain Has Yet to Fall on LSE

By Norma Cohen in London and Ben White in New York
Published: March 30, 2006

Nasdaq’s abrupt withdrawal of its tentative offer for the London Stock Exchange raises more questions than it resolves.

When it officially withdrew its interest – while reserving the right to renew it under flexible circumstances – the US-based exchange offered no official explanation. But it hinted privately that it saw no purpose in pursuing a tie-up with a business it would have to perenially pursue.

“We were disinclined to make an offer that they were not inclined to accept,” says one adviser. When investors saw Nasdaq coming, “the cash registers started ringing”.

Complicating the task are the LSE’s shareholders, who took Nasdaq’s indicative offer of 950p to be a floor, not a ceiling, for the price a successful bidder would ultimately pay. The shares hit a high of £11.90 on merger fever.

Still, the economics of consolidation between stock exchanges remains so compelling that few LSE shareholders really believe that Europe’s largest cash equities market can stay independent forever.

Stock exchanges, analysts say, are akin to large sausage machines; once enough meat is put through the grinder to cover the cost of manufacturing that grinder, any more throughput is pure profit. Merging two or more exchanges while bearing the cost of operating only one trading platform offers opportunities for fantastic profit margins.

Even better, exchanges demonstrate what economists call “network effects”. Like on-line poker games or eBay, the online auctioneer, the more users an exchange attracts, the more valuable it becomes to other customers. In exchange platforms, bigger is definitely better.

Indeed, the LSE’s share price yesterday reflected just that. In dramatic trading that initially sent LSE’s shares as low as £10, the stock recovered to end 7 per cent lower at £10.43½, a drop of 76½p.

Analysts are widely predicting another bid, most likely from the New York Stock Exchange, Nasdaq’s rival. The rivalry between the two is heating up, just weeks after the NYSE became a quoted company for the first time.

Earlier this week, Nasdaq crowed that it had hit a trading record for NYSE-listed shares executed on systems it operates.

With new regulations that spur competition for trading between US trading platforms, neither is prepared to allow the other an edge in global trading either.

Valuations of the world’s publicly-quoted exchanges have soared in recent months on speculation as investors and analysts have grasped the implications of creating few, but very much bigger trading platforms.

Earlier this week, the Australian Stock Exchange announced plans to merge with the domestic derivatives exchange, while Deutsche Börse yesterday signalled its interest in pursuing the creation of a European behemoth.

Kurt Viermetz, the Frankfurt exchange’s supervisory board chairman, said: “After extensive discussions we are convinced that a merger of partners with Euronext [the Paris-based exchange] is the best possible approach to create a truly European exchange organisation.”

However, Euronext, which last year came close to agreeing to merge with the LSE, is understood to be reluctant and would like to be left free to resume its talks with London. Indeed, no sooner had Nasdaq approached the LSE, than the LSE’s bankers called their counterparts advising Euronext.

The final alignment of Europe’s exchanges, analysts say, remains cloudy.

NYSE declined to comment on Nasdaq’s move. But people close to the exchange have said that while John Thain, chief executive, views a potential Nasdaq-LSE tie-up as formidable, he remains more interested in acquisitions that would augment the NYSE’s competitive position in the growing options trading market.

Large NYSE shareholders had also warned management of attempting a complex cross-border transaction while the exchange is still digesting its purchase of electronic trader Archipelago.
But other observers say they still expect the NYSE to eventually make a friendly bid for the LSE, a move which could draw Nasdaq back into the fray.

“I think Nasdaq made a bid on a piece of waterfront property and were told their bid was way too low,” says Doug Atkin of Majestic Research, who is a former chief executive of Instinet. “I think they are sort of walking away now to see what happens. If anyone else steps up, they’ll be back.”