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London Stock Exchange Group (LSE) — shares fall as M&A deal breaks

  • London Stock Exchange Group (LSE) shares fall by almost 5% on news that Hong Kong Exchanges and Clearing (HKEC) is ceasing its interest in a merger.
  • LSE’s stellar performance has seen the shares post returns to long term investors in excess of 2,000%.
  • Merger and acquisitions can provide healthy returns for investors, but today’s news might have been particularly bad for hedge funds.

Shares in the London Stock Exchange are trading almost 5% lower on Tuesday following the news that potential suitor Hong Kong Exchange and Clearing (HKEC) is ceasing its interest in a takeover of its London based rival. HKEC initially made a £30bn ($37bn) bid for the LSE in September. The proposal was to combine the two companies in a share and cash deal worth £29.6bn, or £31.6bn ($39bn) including debt. This formed an alternative long-term plan for the LSE which was (and still is) in the process of tying up a merger with data firm Refinitiv in what has been dubbed ‘the deal of the century’.

LSE (LSE:LSE) share price — one day — intraday price chart in percentage terms:

Source: TradingView

News broke of interest from the Hong Kong firm on 11th September and caused a jump in the price of LSE shares of 12%.

LSE (LSE:LSE) share price — three-month price chart:

Source: TradingView

The ‘ratchet’

The London exchange is often touted as a takeover target and the price falling away by half as much as it initially rose suggests investors think another bidder may emerge. Another alternative, despite protestations, is that the HKEC M&A team may come back with a higher offer. CEO of HKEX (HKXCF), Charles Li, fanned those particular flames when he wrote in a blog post:

“We still believe the strategic rationale for the combination of our two businesses is compelling and would create a world-leading market infrastructure group.”

Source: CNN Business

Whereas this may be wishful thinking, the label ‘potential takeover target’ has served the share price well. As with the HKEC bid, even failed interest can be good news — each rumour can help the price ratchet upwards.

 

Long-term gains

Long-term investors will note that the LSE share price has risen by 1,847% since it was listed in 2001. The fundamental business model has benefited from the firm being in the right place at the right time. As well as charging fees to companies that want to list on its exchange, the LSE has successfully developed a substantial income stream related to the sale of price data.

LSE (LSE:LSE) share price — 2001–October 2019 — price chart in percentage terms:

Source: TradingView

The 18-year period during which the LSE has itself been listed has seen a revolution in the financial markets. A move away from discretionary trading to systematic has meant the tech analysts at quant firms require price data — lots of it. Tick data going back decades can be used to back-test and improve systematic trading models, which then go on to make their owner substantial returns. As the owner of the price data LSE (and other exchanges) has been able to sell the data for ever-increasing fees. Not only has the pricing point moved upwards, but demand has actually increased as the investment space moves towards automated trading being the norm.

 

Hedge funds

The news today that the HKEC deal has broken has seen price come off from all-time highs and long term investors may think they have missed out on the cherry on the cake. For M&A hedge funds who were trading Even Arbitrage positions, the losses could be disastrous.

M&A Hedge funds may have had a speculative position in LSE, as part of a ‘potential targets’ watch list, but the purest form of M&A involves taking a position after the news is released. By scaling up to considerable size, the funds can make millions of dollars from relatively small price moves. Operating at high leverage means that hedge funds that are long make considerable returns — particularly if there is a small ‘sweetener’ to the deal. There is even the chance that the presence of the funds acts as an incentive for the bid price being raised, the bidder aware that a small increase would likely ensure the votes of those funds now holding considerable positions.

The deal involving brewer Greene King demonstrates how the price edges upwards as the deal completes. The percentage return is small, but if you own enough shares in the name, the cash equivalent is a boost for P&L.

Greene King (LSE:GNK) — share price — Three-month price chart:

Source: TradingView

The alternative is to bet against the deal going through. The price move associated with a ‘break’ can be considerable, and any funds holding short positions in LSE will be posting gains on the back of this morning’s price move. Those holding long positions, however, will be suffering considerable losses.

The ShortTracker tool is based on data shared by the FCA. There are understandable disclosures about the source of the information, but ShortTracker is today showing zero short interest in LSE.

Source: ShortTracker

From a fundamentals point of view, this makes sense — the underlying strength of the stock would have attracted investors looking to go long rather than short. This is a number worth monitoring, as intuitively, it’s possible to consider scenarios where hedge funds take short positions in LSE off the back of the failed HKEC proposal.

LSE shares — trade volumes spiking in September:

Source: London Stock Exchange

 

Doomed from the start

The break in the deal doesn’t actually come as too much of a surprise due to the perceived oversight that the mainland Chinese authorities have over HKEC. The political sensitivities were flagged up early. Even back on 12th September, John Colley, a professor of strategy and international business at Warwick Business School was reported by CNN as saying:

“This is very unlikely to pass government scrutiny. There will be significant concerns around Chinese ownership… One suspects that the UK government will view this as an unsuitable owner of such an important central element of the financial community in London.”

Source: CNN Business