Investors only buy half of the logic of splicing together London Stock Exchange (LSE) and Deutsche Boerse. The two European exchanges announced on March 16 that their proposed merger would create Euro 450 million in annual cost synergies, in three years time. The market has factored this in, but little more.
Since February 23, when the deal was announced, LSE shares have risen 14 per cent from their three-month average of £25.30. Deutsche Boerse's are up four per cent from 57.74, the sterling value of its undisturbed share price average at the current exchange rate. Collectively, that's a premium of £1.7 billion.
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The newly revealed cost synergies are worth about the same. Turn them from euro into sterling, tax them at 25 per cent, and then discount them back at an assumed eight per cent cost of capital to reflect that they don't appear for three years. Stripping out a Euro 600-million to achieve the savings implies an uplift of £1.6 billion.
If that was all the merger offered, it would be wide open to a rival approach from US rival Intercontinental Exchange, which is already sniffing around. But LSE and Deutsche are confident they can generate revenue synergies too - from incentivising higher volumes through their LCH.Clearnet and Eurex clearing houses. The theory is that "cross-margining" kicks in, and clients can put up less collateral if they deal with a combined exchange than they would today.
Imagine the two exchanges could produce the equivalent of 11 per cent of LSE's revenue - an average of the last 10 years of exchange mergers, according to Credit Suisse. Apply that to the £1.6-billion top line analysts expect for LSE in 2017, then tax, capitalise and discount it, and there could be a hidden £1.1 billion of value.
One worry might be that regulators or competition authorities may intervene. Another is that customers could claw those gains back for themselves. The fact is that investors don't seem to buy this half of the story. In order for the deal to go smoothly, they probably need to.
