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Market not pricing in DB/LSE deal success, says Morgan Stanley

26 January 2017


Investment bank sees limited downside risk to either Deutsche Boerse or LSE’S earnings

Read more: Deutsche Boerse LSE merger Euronext

Investors are undervaluing the planned mega-merger of European exchange giants Deutsche Boerse and the London Stock Exchange, according to analysts at Morgan Stanley.

Anil Sharma, who leads the investment bank’s European diversified financials research unit, upgraded both bourses on Thursday citing strong balance sheets, a favorable interest rate environment and potential cost savings.

The pair are set to merge this year, creating the region’s dominant exchange operator with pre-and post-trade services spanning stocks, bonds, currencies and derivatives.

The tie-up’s success rests with European competition regulators who will have their say in the coming months on whether the merger places too much market infrastructure in the hands of a single operator.

"Given the binary outcome of this we do not believe the market is pricing in deal success, with our stand-alone price targets implying upside," Sharma wrote in a note to clients.

"Put another way, we see limited downside risk to either Deutsche Boerse or LSE’S earnings or the multiple investors are willing to pay should the deal not go ahead.

"A decision from the EU's anti-trust authorities is due in May (at the latest), the risk/reward appears asymmetric to us – with a deal we see scope for 35-45% upside, without less than 10% downside."

Deutsche Boerse’s central securities depository Clearstream and the LSE’s Italian clearing house Cassa di Compensazione e Garanzia (CC&G) are singled out by Morgan Stanley as key units.

Euronext

Meanwhile, Sharma’s team is also positive on Euronext’s prospects and described the European stock exchange operator’s deal to buy LSE’s French clearing house Clearnet (which is dependent on the success of the Deutsche Boerse/LSE merger) as "transformational."

"Whilst contingent on completion of the LSE-DB transaction, we estimate this deal could deliver 25% earnings per share accretion," Sharma added.

"Post completion, we believe Euronext's competitive positioning would be improved and the group becomes less reliant on cyclical cash & derivatives trading, with post trade growing to 30% of revenues."

Exchanges preferred over asset managers

On a sector basis, Morgan Stanley’s stock pickers favour exchanges over asset managers.

Rising rates and a known regulatory landscape support bourses, the firm believes, whereas pressure is intensifying on the business models of fund houses.

"We see multiple headwinds for asset managers ( fee pressure, regulations, passives, fintech) that could disrupt," wrote equity analyst Adedapo Oguntade.

"The exchange sector is now our most preferred. The regulatory landscape is broadly a known entity, and this certainty together with potential positive tail risks (easing US regulations & taxes) provide optionality around capital allocation, either for shareholder return or accretive M&A."


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