Blocked Merger Is Credit Negative for NYX, and Resets the Playing Field Among Exchanges

Blocked Merger Is Credit Negative for NYX, and Resets the Playing Field Among Exchanges

Last Wednesday, the European Commission decided to prohibit the merger between Deutsche Boerse (unrated) and NYSE Euronext (NYX, A3 positive), stating that the merger would have created a “near monopoly” in European derivative exchanges. The merger prohibition is credit negative for NYX, whose bondholders would have benefitted from the creation of the world’s largest exchange operator by revenue. The combined entity would have had a very strong presence in derivatives and cash equities (in both the US and Europe), complemented by listing, clearing and trading revenues, and the potential for cost synergies. NYX bondholders would have become part of a firm with larger and more diversified cash flows.
NYX performed well for bondholders in 2011. We estimate that debt/EBITDA is down to 1.6x, compared to 2.2x at year end 2010. In response to the deal’s cancellation, NYX announced that it would reactivate the $550 million still available under its share repurchase program. We expect the firm will comment regarding its strategic alternatives on its 10 February fourth-quarter earnings call.

The prohibition of this game-changing merger also resets the industry playing field among securities exchanges. There are clear networking benefits and scale economies to be achieved by aggregating liquidity pools and merging trading and clearing platforms. Such benefits motivate exchanges to combine. Indeed, shortly after the EU Commission announcement, the deputy CEO of NYX announced that the firm will continue to pursue mergers and acquisitions.

Still, regulatory approvals have not been easy to come by. In April 2011, the takeover attempt of the Australian Stock Exchange by the Singapore Exchange was blocked by Australia’s treasurer as not being in Australia’s national interest. Similarly, in June 2011, the proposed merger agreement between the London Stock Exchange and the Toronto Stock Exchange (TMX) collapsed after provoking a nationalist backlash in Canada and failing to secure the required two-thirds majority from TMX shareholders.

Exchange managers will have to rethink their consolidation strategies. Firms might consider minority interests in smaller exchanges combined with technology licensing agreements. To win regulatory approval, firms might consider semi-mutualizing acquired platforms by selling stakes to major end users. Exchanges may continue to acquire upstart alternative trading systems to protect their market share.

Exchange managers will continue to try and solve the regulatory riddle and bondholders of securities exchanges will remain exposed to event risk until the industry is more fully consolidated. For bondholders, credit risk depends on the method of financing chosen by management. Exchanges have high operating leverage and can throw off strong cash flows when volumes are robust. This can tempt managers to borrow against these cash flows to finance acquisitions, with an eye toward rapidly repaying acquisition debt through the sale of non-core assets and the realization of synergies. Alternatively, if firms choose a share exchange, as NYX and Deutsche Boerse had planned, this can be positive for bondholders.

The exhibit depicts the financial flexibility that firms have to pursue consolidation. The y-axis depicts the relative attractiveness of a firm’s stock as merger consideration, the x-axis depicts debt capacity and the bubbles represent market capitalization. At one extreme is BMF Bovespa, which enjoys a $13.4 billion market cap, trades at a rich 16.9x EBITDA multiple and has a debt/EBITDA multiple under 1x. BMF Bovespa has strong financial flexibility to pursue strategic alternatives. At the other extreme is NASDAQ OMX with a $4.4 billion market capitalization, a 5.1x market cap/EBITDA multiple and debt/EBITDA of 2.5x. Accordingly NASDAQ OMX has less financial flexibility to pursue consolidation.

Financial Flexibility of Major Exchanges Drives Their Strategic Options