Exchange valuation convergence

16Mar06

While not strictly arbitrage the prospects for a cross-Atlantic exchange merger seem bright given the valuation disparity between U.S. exchanges, the NYX Group (NYX) and the Nasdaq Stock Market (NDAQ), and the U.K. exchange, the London Stock Exchange (LSE). According to Aaron Lucchetti and David Reilly in the Wall Street Journal note the potential bidding war that is setting up over the LSE.

But by one measure, at least, LSE’s suddenly lofty shares don’t seem expensive — Nasdaq’s own stock, which trades at a far higher valuation. That raises the question of whether LSE is undervalued, as many of its shareholders and the exchange itself have argued since LSE management has rejected a series of approaches, or if Nasdaq is overvalued.

The answers will have a bearing on how the trans-Atlantic chess game plays out between financial exchanges that have stepped up talks to merge with each other. In a research note published earlier this week, investment-bank boutique Sandler O’Neill found that major U.S. exchanges sported valuations about 75% higher on average than European counterparts.

But many investors say these valuation discrepancies are likely to change, especially with global deals in the works. European exchanges have a lot of advantages that are being overlooked, they say. These include lucrative clearing businesses and growing listings businesses for companies that want to sell their shares outside the U.S., where they aren’t subjected to tough U.S. Sarbanes-Oxley financial-reporting rules.

We previously discussed the logic behind a merger between the NYX Group and the LSE. Our argument was predicated in part on the potential for “regulatory arbitrage” between the two different oversight regimes. As long as the valuation disparity across the Atlantic remains the “urge to merge” will remain difficult to ignore.

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