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Students Zone - Answers to Case Study Questions

CASE STUDY 8.2: THE FUTURE OF THE LONDON STOCK EXCHANGE (LSE)

Do you think the shareholders in Deutsche Börse were sensible in forcing the exchange to abandon its bid for the LSE in favour of higher dividend payments?

Answer

There is no definite right or wrong answer to this question. The key question is whether the LSE was over-valued or not. If so, then it would have been better for the shareholders to receive a dividend which they could have invested elsewhere. If not, then they may have been overly short-termist in demanding a dividend. The correct approach would have been to work out the expected future dividends from the LSE and then discount them at an appropriate discount rate, which reflected the risk involved in this kind of business. A major difficulty in valuing this kind of business is the role of the competition policy authorities. One reason for buying the LSE might be to use it as a springboard for future consolidation in the market, but the opportunities available for this would depend heavily on the stance taken by these authorities. The risk involved in this might be difficult for shareholders to assess properly. Another reason why the shareholders might have been wary of the takeover bid was that it did not really involve an explicit strategy for developing the LSEs derivatives business.

What attitude do you think the European Commission should take in the event of a US exchange launching a bid for one of the major European exchanges?

Answer

In terms of the short-term impact of such a takeover there is no real reason for the European Commission to worry about whether ownership of exchanges lies in Europe or elsewhere – shares can be traded as before. Also the merger would not lessen the degree of competition between exchanges within Europe (and might well involve less of a threat of monopoly power in the European market than a takeover of the LSE by either of the European bidders mentioned). However, if the European Commission were to believe that the long-term future of European stock exchanges lies in their coming together as a single exchange (in the way that within individual countries national exchanges replaced regional exchanges in the nineteenth century) then a takeover from the USA would cause a problem. It is basically a question of whether the Commission sees itself simply as maintaining a competitive marketplace for the benefit of consumers of financial services or whether it is trying strategically to develop European finance to compete globally.

What advice would you have given the Competition Commission in April 2005 with regard to the proposed merger between the LSE and Euronext?

Answer

The key worry here is the growth of monopoly power which seems potentially a real problem given the size and market share of the two merged exchanges. Regulating prices would be difficult given the general trend in recent years towards financial deregulation. However, one possible approach might be to approve the merger subject to the new merged exchange divesting some of its business – for example bonds or derivatives. The difficulty here is that the packaging of different kinds of financial instrument together appears to be one of the main things motivating the bid here in the first place. So attempts to split products in order to ensure competitive diversity might well make the bid unattractive to pursue. In fact in November 2005 the Competition Commission approved bids from Euronext and Deutsche Bőrse, subject to structural and behavioural conditions. However, neither takeover actually took place for other reasons and Euronext entered into merger discussions with the New York Stock Exchange (NYSE) while the rival American exchange NASDAQ took a substantial shareholding in the LSE largely in order to stop any rival bids, especially from the NYSE.

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