This case study seeks to analyse the intended merger between London Stock Exchange Plc and TMX Group, Inc, the operators of London and Canada’s largest stock exchanges respectively. The intended merger is offering TMX Group’s shareholders 2.9963 shares in the newly created entity, for every TMX share owned. The aim of the merger is supposedly to create synergies and shareholder wealth for all shareholders involved. On close inspection of the figures, and with the aid of financial theories, this study found that TMX’s shareholders stand to gain much more than LSE shareholders (35% compared to 10%) in the integration within the new company. Furthermore, synergies such as improved global market share and cost savings have been found to be achievable as a result of the merger, however forecasts for revenue improvements would take careful planning and implementation. The LSE-TMX merger is therefore recommended, given the consolidation of the industry, and the need to achieve scale in order to compete effectively.
Mergers and Acquisitions between stock exchanges have been widespread globally, due mostly to the need to achieve scale and reduce costs through synergies (Guardian.co.uk, 2011). One of these proposed mergers has between the London Stock Exchange Group Plc and TMX, operator of Canada’s largest stock exchange. They have been in merger discussions recently that would see a new corporate entity formed; wherein LSE would own 55%, and TMX shareholders would own 45%, with the LSE CEO Xavier Rolet being the top boss in the newly formed organisation.
This supposed merger is recommended as an ideal move for LSE, given the competitive environment in which it operates, and the need to continuously expand globally after its acquisition of Borsa Italiana (Italian stock exchange). However, it has sparked criticisms and controversy on the Canadian front, as a number of parties, including the government and several top organisations have stated that a merger between both entities would reduce the status of Canada as a financial capital, and could subsequently result in Canadian firms opting to list in London and not Canada. FT.com (2011) describes Canadian authorities as “tricky” when it comes to foreign investments, as they could block bids by multinationals if it is perceived not to be in line with the national interest. Such as was seen in 2010, when the Canadian minister for Industry blocked a ?26bn takeover of a fertilizer group by an American mining group BHP Billiton.
This case study seeks to review whether mergers and acquisition increase shareholder wealth for both parties, and the sort of synergies that can be expected from such a relationship.
2 FINANCIAL PERFORMANCE INDICATORS
The diagrams below show a snapshot of the change LSE and TMX before the merger. Diagram 1 and 2 show the revenue growth in LSE and TMX Plc respectively. Both companies have witnessed steady growth over the past four years.
3 WHY MERGERS AND ACQUISTIONS ARE INTERESTING
Breedon and Fornasari (2000) notes that the main aim of mergers in organisations today is for companies to achieve global competitiveness, reduce costs, diversify and possibly improve growth and revenue by branching out into other sectors. Mergers are particularly rampant in highly competitive industries, where firms may be seen to be highly competitively or very fragmented and joining forces together with other players would assist organisations in achieving critical mass necessary to compete effectively.
With particular reference to shareholder wealth creation and synergies, several organisations attribute synergies and increasing profit as the core reason why they are merging. For instance cost reductions when duplicate processes and roles are eliminated would assist in improving net profit (Devos et al, 2009). Furthermore, the now increased size of the joint company could be leveraged while negotiating contracts, and be used in achieving economies of scale (Salama et al, 2003). Salama et al further note that mergers allegedly offer the opportunity for new customers in new markets, improved marketing, product development, access to distribution channels and cross selling. It would also help improve market leadership, maintain current positioning and can inspire vertical integration.
Even though these assertions are indeed interesting, the most interesting fact about mergers and acquisitions is the argument that down the line, most mergers fail to achieve the profit expectations, shareholder wealth and synergies they initially sought (Salama et al, 2003). This failure could be readily observed in the high price often offered in acquisitions, the substantial, albeit unmet promises given on employee retention, synergies and revenue growth, and the significant costs involved in concluding a merger and synergising operations. This area is therefore very important as a study of what actually makes mergers successful could assist us in analysing the LSE and TMX ongoing merger negotiations and draw recommendations on how they can improve shareholder wealth and achieve synergies.
4 RELEVANT STUDIES
Several studies have been published on merger synergies, and the value created afterwards. Stahal and Mendenhall (2005) theorized that one of the major rationales for mergers and acquisitions is the need for businesses to synergize their activities with that of a target company, which is strategically positioned to provide an increase in value. Therefore companies aspire to merge horizontally with competitors in the same industry or vertically with suppliers/buyers in order to synergize their operational processes in a bid to develop a coherent operational strategy that takes advantage of all elements of the business process, eliminates additional cost through redundancy and generates new revenue streams, thus promoting growth.
Christofferson et al (2004), in what they described as the winner’s cause argued, “when companies merge, most of the shareholder value is likely to go to the target. Indeed, on average, the buyer pays the seller all of the value generated by a merger, in the form of a premium of from 10 to 35 percent of the target company’s preannouncement market value.” A complimentary study conducted by Gomes et al (2007), found that the winner’s cause in this sense mostly materialises as a result of an overestimation of the synergies of a merger. These synergies are usually as a result of economies of scale and scope sought, new markets, leveraging of capabilities, and greater opportunities for the combined company.
Furthermore, Soderberg and Vaara (2003) argued that most acquirers usually have little information about the target company, especially when it comes to the human capital they are acquiring, which often leads to integration issues once the merger is completed. However, Chatterjee (2007), in his study of 264 larger mergers, found that the average synergy gains were 10.03% of the combined equity of both merged firms. Most of which came from tax savings (1.63%) and operational synergies (8.38%). Most of these operational gains were however due to “cutbacks in investment expenditures rather than by increased operating profits”. In conclusion, Holland and Salama (2010) noted “careful and well-planned integration strategies are responsible for sustainable learning occurring, leading to desirable synergies between firms engaged in a merger process”.
5 TESTING MERGER THEORY
The main objective given for the LSE and TMX merger is to create synergies, in a deal that would create the largest exchange globally in terms of the number of companies listed (6,700), and would also create an exchange where mining companies would be most concentrated. Furthermore, the combined companies are targeting an annual cost savings of ?35m by the second year after the merger, and a revenue growth of ?35m and ?100m in the third and fifth year respectively. Even though the revenue growth cannot be easily ascertained, the synergies can be readily verified. If they do merge, according to Breedon and Fornasari (2000) they would objectively increase in size, have the largest listing of mining companies, and be the world’s largest stock exchange based on the number of listed companies. Furthermore, it is indeed realistic that they can achieve cost savings in the second year, due possibly to cost cutting processes as illustrated by Chatterjee (2007).
However, revenue growth in the third and fifth year cannot be easily ascertained, and the likelihood of that happening, may be slim. According to Gomes et al (2007), even though cost reduction and market size synergies are indeed achievable in mergers due to the objective and easy manner in which they can be achieved following a deal, those centered on revenue growth are usually more difficult to achieve, and often result from very optimistic synergy expectations pre-merger.
5.2 SHAREHOLDER VALUE
The LSE and TMX merger is supposed to have a combined value of ?5 billion (including debt), and would be jointly headquartered in London and Toronto. LSE is offering TMX shareholders 2.9963 ordinary shares for every common share they have, and based on Diagram 4, that would result in them owning 45% of the combined company. However, in what way does this actually increase the value of shareholders in both companies?
Diagram 3: Pre and post merger valuation calculation. Source: FT.com (2011)
The diagram above shows the calculation of the pre and post merger valuation of both companies. Based on the market valuation of both companies on 9th of February 2011, when the merger was announced, they had a collective market cap of ?4.2bn. However, by offering TMX shareholders 2.9963 shares for every share held, they would own 45% of a ?5bn combined entity, which takes up their valuation to ?2.25 billion from ?1.70, thus representing a 35% increase on their current shares; whilst LSE shareholders only gain 10%.
Even though shareholders in both companies would increase their wealth as a result of the merger of both companies, TMX shareholders stand to gain a lot more than LSE shareholders. These findings contradict that of Salama et al (2003), who stated that the only shareholders that gain considerably from acquisitions are the target companies. In this situation, both companies stand to gain, just that the target gains a lot more. An explanation for this can be found from Chatterjee (2007), who stated that most mergers have to include a premium valuation for the targets to accept, and the substantial increase in valuation within the new entity could be regarded as a premium payment for the acquisition to take place. It can thus be said that LSE has paid a premium in order to acquire TMX, which has resulted in increased shareholder wealth for TMX shareholders.
5.3 INCREASING BARGAINING POWER AND EFFICIENCIES
In an effort to determine the status of past mergers, Salama et al (2003) reported that up to 60% of acquisitions fail, and this failure is mostly represented in their inability to achieve cost reduction or revenue growth objectives, or in the general lack of integration between both parties. However, Buono and Bowdith (1989) in contradiction noted that horizontal mergers do benefit organisations, even in situations where cost savings and revenue growth is difficult. They further noted that this benefit is usually in the form of market share growth and operational efficiencies that are crucial in multinational businesses seeking to establish critical mass in an increasingly global industry.
FT.com (2011) notes that the most stock exchanges are often chosen for listing based on their market value and popularity amongst investors. Therefore a stock market with a larger market share has more chance of attracting lists, than others. By joining forces with TMX, LSE would be able to gain a larger market share of the global stock exchange industry, thus being able to attract more listings, trading and revenue. Without this, it faces the fear of being taken over by larger players. Therefore, in light of these findings, the merger between LSE and TMX is therefore crucial in order for it to remain competitive and useful in the global stock exchange market.
Diagram 4: Market share of leading stock exchanges. Source: FT.com (2011)
6 DISCUSSION AND CONCLUSION
This study has considered the LSE and TMX findings in light of academic theories, and analyzed existing information with the aim of testing various theories. The major reason given for the merger, which is supposedly to achieve synergies, seems very achievable given the operations of both companies. By creating a multinational entity, the new entity would automatically become the largest exchange for mining companies, and would house the highest number of listed companies. This synergy is also well connected with the theory on bargaining power and efficiencies, as a larger LSE-TMX would attract more companies to list, help reduce overall costs, and improve efficiencies.
The manner and success rate of achieving these however depends highly on the careful planning and execution that goes into integrating both companies (Buono and Bowditch, 1989). If these were not done appropriately, then even though LSE-TMX would still be a large multinational stock exchange, by nature of its merger, it may not uphold its competitiveness or be able to the sort of efficiencies envisioned.
Finally, the merger does seem to create wealth for both shareholders, but the TMX shareholders stand to gain a lot more, mostly due to the premium being included in the price. This is therefore not a “merger between equals” (FT.com, 2011), but an acquisition of TMX by LSE, in a diplomatic manner aimed at appeasing Canadian authorities.
Breedon, F and F Fornasari (2000) FX impact of cross-border M&A., Lehman Brothers, Global Economics Research Series, April
Buono, A.F., Bowditch, J.L. (1989), The Human Side of Mergers and Acquisitions, Jossey-Bass, San Francisco, CA
Chatterjee, S. (2007) Why is synergy so difficult in mergers of related businesses?, Strategy & Leadership, Vol. 35 (2), pp.46 – 52
Christofferson, S, McNish, R, & Sias, D (2004), ‘Where mergers go wrong’, McKinsey Quarterly, 2, pp. 92-99, Business Source Premier, EBSCOhost, viewed 8 April 2011.
Devos, E, Kadapakkam, P, and Krishnamurthy, S. (2009) ‘How Do Mergers Create ValueA Comparison of Taxes, Market Power, and Efficiency Improvements as Explanations for Synergies’, Review of Financial Studies, 22, 3, pp. 1179-1211, Business Source Premier, EBSCOhost, viewed 8 April 2011.
FT.com (2011) LSE and Canada’s TMX agree merger, www.ft.com, [accessed: 03/04/11] Gomes, E., Donnelly, T., Morris, D., Collis, C. (2007), “Improving merger process management skills over time: a comparison between the acquisition processes of Jaguar and of Land Rover by Ford”, The Irish Journal of Management, Vol. 28 pp.31-58.
Google Finance (2011) TMX Group, Inc. financials, London Stock Exchange Plc. Financials, http://www.google.co.uk/finance?q=TSE:X&fstype=ii, [accessed: 03/04/11] Guardian.co.uk (2011) TMX-LSE merger: a timeline of takeover battles, www.guardian.co.uk/business, [accessed: 03/04/11] Salama, A., Holland, W., and Vinten, G. (2003), Challenges and opportunities in mergers and acquisitions: three international case studies: Deutsche Bank-Bankers Trust; British Petroleum-Amoco; Ford-Volvo, Journal of European Industrial Training, Vol. 27 pp.313-21.
Soderberg, A. M., and Vaara, E. (2003), Merging across Borders: People, Cultures and Politics, Copenhagen Business School Press, Copenhagen
Stahal, G.K., Mendenhall, M.E. (2005), Mergers and Acquistions: Managing Culture and Human Resources, Stanford University Press, Stanford
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