Do these analysts need analysis? This way to the couch...
Sunday, September 30, 2012 7:00 PM
The headline might have read, “Lex issues strong BUY recommendation on shares in the London Stock Exchange.” Did the Investor Relations Department, hoping for a rebound from Friday’s 8% drop, hack the FT? We’ll never know, but the tone of the article can hardly surprise readers of column inches from earlier last week, in which a lapdog financial press took dire LSE trading volumes as a cue to praise the company’s “diversification” strategy. Down, down, down was every number, but PR flunkies managed to convince most coverage that the Stock Exchange had low exposure to, well, stock exchanging.
Shrewd investors will look carefully for signs of real diversification. Derivatives? Fail. Bonds? Fail. New listings? Fail. Trading in European shares? Fail. Mergers and acquisitions? Fail. Presumably diversification would require something like a success in the mix, somewhere, anywhere. The news that triggered Friday’s plunge was that the soon-to-be-acquired LCH would not be such a cash cow after all. The LSE will be wishing for the deal to die if terms can’t be restructured. Flashback to their winning bid: according to accounts at the time, the next highest bidder valued LCH at half what the LSE was paying. Looks now like the runner-up was twice as smart.
For anyone not addicted to free lunch with copious Cote de Rhone, the LSE strategy is easy to identify, because it’s the same as everyone else’s. Let’s take the NYSE Euronext as a proxy for massive global operators. Led by CEO Duncan Niederauer, the NYSE was also a virtual monopoly facing regulatory sea-change and an onslaught of competition from new platforms. So NYSE bought Archipelago. (LSE? Turquoise. Check.) Cash equities had limited upside, so the NYSE acquired the Amex to compete in options. (LSE? Derivatives. Check.) Facing monstrous costs for technology, NYSE made selling systems into a business. (LSE? Check.)
Lex and other commentators failed to spot it, but larger problems loom. First, the dependence of modern exchange operators on high frequency trading looks increasingly like a habit they’ll have to kick, with regulators and public opinion moving quickly to curb the practice. Second, while market data revenues continue their robust growth, real reform of this sector may be next. Sure, exchange members hate the high data fees, vestige that they are of the old monopolies, but nobody cares about banks and brokers. The real issue is that asset managers pay, too, and all the costs are ultimately a tax on investors and their pensions. Exchanges know they’re one populist politician away from parting with their most stable income.
Given the challenges of running these businesses, is it any surprise that the LSE would follow the NYSE’s lead? Not when you know the history. After all, LSE CEO Rolet cut his teeth across the Goldman Sachs trading floor from Duncan Niederauer who he’s known for decades. And Duncan is a very smart guy, an inventor of businesses who made Partner before leaving to help save what was then a scandal-plagued NYSE. Rolet, on the other hand, left Goldman early and took executive roles at Credit Suisse, Dresdner Kleinwort and Lehman Brothers. That two of these brands now rot in the dustbin of failed experiments in finance is a sign of the times, and a measure of leadership that took risks they didn’t manage until after their own cheques had cleared.
Me-Too strategies in business are nothing new, and sometimes they are absolutely brilliant. As they say, imitation is the sincerest form of flattery. But investors will hope LSE shares don’t imitate the NYSE, whose stock is down more than 75% from its highs. That LSE shares are off only 50% suggests that, barring real creativity, they have further still to fall.