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London Stock Exchange

FIN 3560-01: Financial Markets and Instruments

Ryan Kahn

Kelly E. Sullivan

Nico von Stackelberg

December 5th

, 2011

Professor Michael Goldstein

I pledge my honor that I have neither received nor provided any unauthorized assistance during the

completion of this work.

London Stock Exchange Kahn, Sullivan, & von Stackelberg

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Executive Summary

The London Stock Exchange is one of the largest and most iconic exchanges in the world. While

most people have heard of the LSE, few understand its business model, sources of revenue, the overall

industry structure, as well as the regulatory and competitive landscapes facing the LSE. In this paper, we

explain these elements. In addition, given that the LSE has been involved in several M&A transactions

(some failed, some successful) over the past several years in an effort to remain competitive and to

consolidate, we use these deals to test the Synergy Trap Hypothesis. This hypothesis posits that the stock

price of an acquirer (target) tends to fall (rise) just before and after an announced M&A transaction.

Acquirers are typically believed to overpay in deals and therefore the markets punish their actions.

Movements before the announcement of a transaction occur due to leaked information or simply

anticipation of a transaction. After performing a statistical analysis on 11 diverse deals over several years

involving the London Stock Exchange, we concluded that 5 of these deals supported the Synergy Trap

Hypothesis, while 2 of them did not. The remainder had statistically insignificant results. We looked into

several elements such as the dates of the deals, the industry of the acquirers/targets, and the currencies

used in the deals, and we were unable to come to any definitive conclusions regarding which deals tended

to support or reject our hypothesis. Given that just five out of eleven deals supported our hypothesis, we

cannot conclusively support the Synergy Trap Hypothesis in its application to the LSE’s M&A deals.


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London Stock Exchange Overview

The London Stock Exchange Group Plc (LSE) is Europe’s leading diversified stock exchange

group, created through the incorporation of Borsa Italiana, London Stock Exchange, and MillenniumIT.

Through these subsidiaries, the LSE operates diversified exchange platforms for international equities,

fixed income, and derivatives markets in Europe. The LSE provides its clients with a diversified offering

through its ability to develop and provide innovative products and services across a range of asset classes

that respond to both the evolving needs of investors and the changing dynamics shaping the industry. The

LSE is actively engaged in the admission and listing of securities for trading, the distribution of exchange

platforms and trading systems, post-trade clearing and settlement services, the distribution and provision

of real-time market data, technology and information services, and the coordination and regulation of

securities markets.1

The LSE operates four distinct business segments, which contribute to the Group’s ability to offer

diversified exchange trading services. Its Capital Markets division assists companies with raising capital

(both debt and equity) for investment purposes as well as providing investors with access to deep and

highly liquid secondary markets which facilitates greater ease of trading and also serves to reduce the cost

of capital for these firms.2 This business segment has also had success in the primary markets,

experiencing a recent increase in the number of new companies listed on the Group’s exchanges through

initial public offerings. Through its subsidiaries, the LSE lists in excess of 3,000 companies on its equity

markets and provides clients with the ability to trade equities, fixed income, and derivative products on

exchanges across Europe. The LSE’s Post Trade Services segment offers a broad range of risk

management services in addition to securities clearing, settlement, and custody services facilitating the

successful completion of trades. This segment has readily adapted to the recent policy reform impacting

1 ThomsonOne. London Stock Exchange Group Plc – Company Overview, pg. 1. Retrieved from

https://www.thomsonone.com/Workspace/Main.aspx?View=Action%3dOpen&BrandName=&IsSsoLogin=True. 2 London Stock Exchange Group Plc – Annual Report 2011, pg. 16. Retrieved from

http://www.londonstockexchangegroup.com/investor-relations/financial-performance/financial-key-documents/lseg-

annual-report-2011.pdf.

https://www.thomsonone.com/Workspace/Main.aspx?View=Action%3dOpen&BrandName=&IsSsoLogin=True

http://www.londonstockexchangegroup.com/investor-relations/financial-performance/financial-key-documents/lseg-annual-report-2011.pdf



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the post trade landscape by making adjustment to how the Group manages its clearing services (through

CC&G and Monte Titoli) across multiple exchange platforms. Additionally, this division has diversified

its post-trade services to more efficiently manage counterparty risk, trade matching, and confirmation.

The Information Services division delivers to clients an expansive set of real-time, reliable market data,

including data on trading volumes, share prices, index information, current and historical data, and

company announcements. The objective of this segment is to provide investors with “extensive market

intelligence”3 for the purpose of strategic decision making. The LSE has significantly expanded its

information management systems (primarily through acquisitions) including Proquote, UnaVista,

SEDOL, and Turquoise to better serve the trading information and market data needs of its clients across

a range of asset classes. The LSE’s Technology Services segment delivers, implements, and supports

technology platforms and trading software for clients of its subsidiaries – Borsa Italiana, London Stock

Exchange, and MillenniumIT. This division works to optimize the speed, performance, connectivity, and

trading flexibility4 of its exchange platforms as well as to deepen the scope of its technology offering by

successfully adapting to technological innovations in order to maintain the LSE’s leading edge in the

speed and efficiency of its technology capabilities. The vast breadth and scope of the LSE’s service

offering, evidenced by the end-to-end provision of trading services through its four business units, clearly

demonstrates the Group’s significant diversification within the exchange trading industry. This

diversification is in large part the value proposition that the LSE offers its clients, investors, and capital

market participants.

The LSE’s strategy for growth is structured around three strategic imperatives: “getting in shape,”

“leveraging assets,” and “developing opportunities.”5 “Getting in shape” refers to the LSE’s vision to

increase the efficiency of the products and services provided to its clients. The Group is currently

pursuing initiatives to improve the operational management of its technology services aimed at reducing

costs; affording the LSE an advantageous position relative to competing exchange firms which face

3 London Stock Exchange Group Plc – Annual Report 2011, pg. 22.




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intense price competition. Furthermore, the LSE is working to develop incentives to increase volumes and

boost overall competitiveness through new tariff structures in an effort to create a need among investors

for its increasingly streamlined and efficient service offering. The strategic focus on “leveraging assets

and developing opportunities” refers to the LSE’s strategy to improve its ability to serve customers across

the globe by increasing the scale and scope of its operations. The LSE has positioned itself to achieve this

objective primarily through strategic mergers and acquisitions that closely align with the Group’s

overarching business strategy. The LSE has pursued a series of recent acquisitions and strategic

partnerships that have enabled the firm to remain competitive within the industry and to keep pace with

the evolving demands of its clients and investors. These acquisitions have served to expand the

geographic presence of the Group’s exchange operations – penetrating previously untapped markets in

Mongolia, Japan, India, Scandinavia, and Sri Lanka. In addition, these strategic partnerships have

enhanced and further diversified the scope of its service offerings in trading and exchange and promoted

the globalization of capital markets and development of market relationships by providing networking

technologies and exchange trading platforms. These various strategic initiatives – and in particular the

alliances, business partnerships, and merger and acquisition activities – pursued by the LSE are in large

part driven by the Group’s ambition to be “a world leading diversified exchange group.”6 Taken together,

this three-pronged growth strategy has been developed to afford the LSE the financial and operational

flexibility to respond to the dynamic forces shaping the financial markets and position the Group to

remain a competitive and dominant participant in the exchange trading industry.

How the LSE Generates Revenue

The London Stock Exchange generates revenue from the four major activities noted above. In the

capital markets segment, the LSE charges companies for listing on its exchange based on the market

6 Data Monitor. London Stock Exchange Group Plc – Company Profile. October 18, 2011, pg. 4. Retrieved from

www.datamonitor.com.

http://www.datamonitor.com/


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capitalization of the company7 and annual fees thereafter. Admission fees would be roughly £57,000 for

a firm with a market capitalization of £250M, whereas the annual fees are £5,350.8 Fees are also charged

for secondary issues and public announcements. It also assesses membership fees on firms that belong to

the exchange (£10,000 to join and £12,500 annually).9 The LSE even earns money on each trade that is

executed, and the pricing follows a tiered structure, such that the cost ranges between 0.20bps and

0.45bps based on the value of equity and derivative orders executed.10

The capital market segment

generated 42% of the exchange’s revenue.11

Post trade services relates to clearing and settlement of trades as well as custody of assets. Once a

trade occurs, a clearing house essentially guarantees the trade and nets all of the buy and sell orders of

firms. The settlement process involves assets being transferred between parties and the custodian can hold

and service the assets on behalf of these parties. In FY2011, the LSE cleared roughly 116 million

contracts, processed 70 million settlement instructions, and was the custodian for over €3 trillion of

assets. It also generated revenues through treasury services afforded to firms whose trades were cleared.

Post trade services accounted for £150.6M or 23% of the firm’s revenue.12

Information services relates to real-time data feeds of pricing and trading data. The 2011-2012

price list shows that data licensing (to disseminate the data outside the organization) can range from a few

thousand pounds per year to over £45,000, depending on the type of customer and the medium through

which the data is transferred.13

Other data feeds are only a few hundred pounds per month. 93,000

subscribers access LSE data and 139,000 access Borsa Italiana data through these services. The LSE

7 Thus, this source of revenue fluctuates with market conditions

8 LSE AIM Fees Calculator. Retrieved from http://www.londonstockexchange.com/exchange/companies-and-

advisors/main-market/listing-fees/aim-fees-calculator.html. 9 London Stock Exchange. Membership. April 1, 2011. Retrieved from

http://www.londonstockexchange.com/traders-and-brokers/membership/faqs/pricing.pdf. 10

London Stock Exchange. Trading Services (On Exchange and OTC). October 1, 2011.Retrieved from

http://www.londonstockexchange.com/products-and-services/trading-services/pricespolicies/trading-services-price-

list-1-october-2011.pdf. 11

London Stock Exchange Group Plc – Annual Report 2011, pg. 4. 12


London Stock Exchange. Real Time Data Price List 2011/12. December 1, 2011. Retrieved from

http://www.londonstockexchange.com/products-and-services/market-data/realtimedata/pricesandpolicies/price-

list.pdf.

http://www.londonstockexchange.com/exchange/companies-and-advisors/main-market/listing-fees/aim-fees-calculator.html


http://www.londonstockexchange.com/traders-and-brokers/membership/faqs/pricing.pdf

http://www.londonstockexchange.com/products-and-services/trading-services/pricespolicies/trading-services-price-list-1-october-2011.pdf


http://www.londonstockexchange.com/products-and-services/market-data/realtimedata/pricesandpolicies/price-list.pdf



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collects other fees for providing access to other exchange data services and systems as well. One example

is Proquote which is a desktop tool that can display “quotes, news, and security profiles.”14

This area

accounted for £184.7M or 27% of the LSE’s revenue in the most recent fiscal year.15

Lastly, the technology services segment is comprised mostly of revenue from MillenniumIT

which is an Indian company specializing in capital markets’ systems and was acquired by the LSE in

2009.16

The LSE’s main objective in purchasing this firm was to transition clients from its current trading

platform known as TradElect to Millennium’s new system which can handle multiple asset classes and

has extremely low latency which is a major differentiator amongst exchanges. Millennium Exchange’s

latency is under 1 millisecond versus 1.41 for TradElect.17

Other services reported under this segment

include co-location services which allow firms to take hosting space in the LSE’s data center to ensure

rapid execution. Order routing services also contribute to sales. This group contributed just 7% of the

company’s sales or £48.6M.18

It is obvious that the market conditions greatly affect the LSE’s sales and profitability. Much of

the firm’s costs are fixed and therefore a decline in sales hurts the bottom line. The capital markets

segment is heavily dependent on market conditions given the fact that the LSE generates money based on

trading volumes and market values of new issues. Moreover, all post trade services are predicated on

market conditions as they are all tied to trading volumes. In terms of information services and technology

services, these areas seem to be in high demand, yet pricing pressures from competition can hurt the

exchange’s income as well.

Regulatory Environment

As one would expect, the London Stock Exchange is a heavily regulated entity as it is at the

backbone of capital markets and the entire financial system requires trust and security. The Financial

14



MilleniumIT.com. About Us. Retrieved from http://www.milleniumit.com/about/index.php. 17


London Stock Exchange Group Plc – Annual Report 2011, pg. 4.

http://www.milleniumit.com/about/index.php


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Security Authority (FSA) is the primary regulator of the London Stock Exchange. It oversees trading

firms and investing institutions, securities trading, clearing and settlement, and trading venues such as the

LSE.19

On June 7th, 2010, George Osborn, the Chancellor of the Exchequer finalized plans to abolish the

FSA and release the responsibility of policing the city and the new banking system to the Financial

Conduct Authority (FCA).20

This transition will be overseen by Hector Sants, the current Chief Executive

of the FSA, and will be completed by the end of 2012 to ensure market confidence, financial stability,

protection of consumers, and that the reduction in financial crime is monitored under one statutory body.

The introduction of an amended law known as the Markets in Financial Instruments Directive

(MiFID),21

implemented in 2007, obligated companies to report using an Approved Reporting Mechanism

(ARM) to detect and investigate cases of market abuse, insider trading, market manipulation, and also as

a part of monitoring of supervised firm activity.22

Subsequently, the FSA developed its own ARM called

the Transition Reporting System (TRS). Since the LSE operated its own Approved Reporting Mechanism,

the UnaVista platform, the FSA entered into an agreement to sell the TRS to the London Stock Exchange

to fulfill ongoing reporting obligations and to migrate current TRS customers to the UnaVista Platform.

This was yet another one of the LSE’s recent acquisitions.

The Financial Markets Security Act (FMSA) of 2010 outlines the objectives to maintain market

confidence, securing the appropriate degree of protection for consumers, fighting financial crime, and

contributing to the protection and enhancement of the stability of the UK Financial System.23

The FSA

and the FCA (the foreseeable successor to the FSA) have established that the LSE will continue to meet

these regulatory standards in the event of a take-over.24

19

Financial Services Authority (FSA). London Stock Exchange Mergers Enquiry. Retrieved from

http://www.fsa.gov.uk/pubs/other/fsa_submission.pdf. 20

Vina, Gonzalo. U.K. Scraps FSA in Biggest Bank Overhaul Since 1997. Bloomberg, June 17, 2010. Retrieved

from http://www.bloomberg.com/news/2010-06-16/u-k-scraps-fsa-in-biggest-bank-regulation-overhaul-since-

1997.html. 21

We will discuss other implications of MiFID later, as it relates to MTFs 22

Financial Services Authority (FSA). FSA enters into an agreement to sell TRS to the London Stock Exchange.

August 2, 2011. Retrieved from http://www.fsa.gov.uk/pages/Library/Communication/PR/2011/068.shtml. 23

Financial Services Authority (FSA). FSA enters into an agreement to sell TRS to the London Stock Exchange. 24

Financial Services Authority (FSA). London Stock Exchange Mergers Enquiry.

http://www.fsa.gov.uk/pubs/other/fsa_submission.pdf

http://www.bloomberg.com/news/2010-06-16/u-k-scraps-fsa-in-biggest-bank-regulation-overhaul-since-1997.html


http://www.fsa.gov.uk/pages/Library/Communication/PR/2011/068.shtml


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Security & Commodity Exchange Industry Overview

The exchange industry is aggressive and highly competitive. While the LSE competes directly

with three major exchange firms – NYSE Euronext Inc., NASDAQ OMX Group Inc., and Deutsche

Boerse AG – the Group also faces intense global competition from existing and new exchange firms.

Given the recent trends toward globalization and the liberalization of international capital markets, this

has resulted in a significant increase in capital mobility among international market participants thereby

intensifying the competitive pressures among exchange firms in their competition to attract securities

listings and trading services across a broad range of asset classes. Exchange firms also compete with

market participants on “the cost, quality and speed of trade execution, market liquidity, the functionality,

ease of use and performance of trading systems, the range of products and services offered to customers

and listed companies, technological innovation and reputation.”25

To be successful in the exchange trading industry, firms seek to increase the scale and scope of

their operations though a diversified product offering, lower prices and transaction fees, and global

expansion. Given this set of objectives, growth and financial success for exchange firms like the LSE is

heavily dependent upon mergers and acquisitions, strategic partnerships, business alliances, and joint

ventures. However, such a strategy of global growth and diversification is not without risks. Firms in the

exchange industry are subject to a series of risk factors beyond their control that pose a significant threat

to financial performance and operating results. There is significant risk, exposure, and uncertainty

associated with a financial strategy of expansion through strategic mergers, as exchange firms look to

penetrate previously untapped markets and offer new and untested financial instruments. In addition,

adverse economic conditions have the potential to negatively impact firms’ profits by reducing the

demand for their services – restricting trading volumes, reducing the number of securities listings, and

causing a decline in transaction fees. Furthermore, given the dynamic forces at play in the financial

markets, exchange firms are constantly at risk for being negatively impacted by regulatory reform, new

25

NYSE Euronext 10K Annual Report 2010, pg. 22. Retrieved from http://phx.corporate-

ir.net/External.File?item=UGFyZW50SUQ9ODU5NzN8Q2hpbGRJRD0tMXxUeXBlPTM=&t=1.

http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9ODU5NzN8Q2hpbGRJRD0tMXxUeXBlPTM=&t=1



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financial policies, and technological innovations that fundamentally change the nature of competition and

require significant capital expenditure to adapt to in order to remain competitive.

Competition

As mentioned earlier, the Markets in Financial Instruments Directive (MiFID) was implemented

in 2007 with one of the main goals of increasing competition in financial products trading. As part of this,

multilateral trading facilities or MTFs came into existence as an alternative to the “incumbent”

exchanges. This meant that the trading of UK securities, for example, no longer had to be transacted over

the London Stock Exchange, as new exchanges existed to handle these orders. The MTFs are the most

formidable competitors to the LSE. Looking at the FTSE 100 index (UK-focused), the LSE still has the

largest market share of trading of 51.79%.26

However, MTFs have a very significant share of the market:

Chi-X has a 31.44% share, Turquoise (acquired by the LSE in 201027

) has an 8.74% share, and BATS has

a 7.83% share. Other exchanges, such as the NYSE, facilitate a negligible amount of trades.

Despite the fact that MiFID is still a relatively new law, the competitive effects are evident. The

introduction of MTFs automatically put pressure on incumbents such as the LSE to innovate and provide

better and more enhanced technology and services to their clients.28

Moreover, the trading venues all

compete primarily on price, but liquidity and order depth also factor into the equation. For example, a

study published in 2010 from the Karlsruhe Institute of Technology indicates that roughly “96% of order

flow is routed to the LSE when they are at the best price alone.”29

That said, when some of the MTFs post

lower prices than Chi-X (the MTF leader) or the LSE, the orders do not necessarily get placed on these

cheaper alternatives. Liquidity – measured by the effective spread – is another major determining factor

26

Fidessa Fragmentation Index. Week ending 10/28/11. Retrieved from

http://fragmentation.fidessa.com/indexstats/euindexstats/?index=.UKX&indexdesc=FTSE%20100&region=EU. 27

Competition Commission. Summary of hearing with London Stock Exchange and Turquoise Global Holdings

Limited, pg. 1. Retrieved from http://www.competition-

commission.org.uk/inquiries/ref2011/bats_chi_trading/pdf/summary_of_hearing_with_lse.pdf. 28

Riordan, Ryan, Andreas Storkenmaier, and Martin Wagener. "Fragmentation, Competition and Market Quality: A

Post-MiFID Analysis." Campus for Finance. Karlsruhe Institute of Technology, 11 Aug. 2010. Web. 6 November

2011. http://campus-for-finance.com/filebrowser/files/Papers/49a40613086_name.pdf. pg 5 29

Riordan, Storkenmaier, & Wagener, pg 14.

http://fragmentation.fidessa.com/indexstats/euindexstats/?index=.UKX&indexdesc=FTSE%20100&region=EU

http://www.competition-commission.org.uk/inquiries/ref2011/bats_chi_trading/pdf/summary_of_hearing_with_lse.pdf


http://campus-for-finance.com/filebrowser/files/Papers/49a40613086_name.pdf


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for customers choosing to trade on various platforms. Interestingly, the LSE has higher effective spreads

than its competitors, yet it executes many more trades. This is certainly due to its better pricing, and the

researchers also attribute this to the fact that traders demand even “better terms of trade” on MTFs in

order to trade there.30

This essentially lowers any switching costs associated with changing trading

venues.

Statistical Analysis

As exchange firms seek to remain competitive – providing customers with the most cutting edge

trading technologies, competitive pricing, diversified product offering, and access to highly liquid global

capital markets – this has led to a significant increase in mergers & acquisition (M&A) activity among

leading exchange trading firms, including the LSE. Businesses mentioned above, such as MillenniumIT

and Proquote, are now part of the LSE as they were acquired by the exchange in recent years. Given the

overarching trend towards M&A activity within the exchange industry, the following line of statistical

analysis seeks to test whether the announcement of the LSE’s recent M&A transactions impact the firm’s

stock price in a such a way that is in line with the currently accepted models. Currently accepted models

state that acquirers tend to pay a premium to improve the core of the business. Especially in hostile bids,

excessive premiums are paid and the markets typically view this as a desperate act, thereby negatively

affecting share price of the acquirer.31

The premium paid can best be explained by the acquiring firm’s

expectation of synergistic benefits.32

The benefits can oftentimes be overstated. According to the

Synergy Trap Hypothesis, just prior to and after the announcement of an M&A deal, the target (acquiring)

firm’s stock price rises (falls).33

Stock price movements prior to the announcement are a result of leaked

information and/or anticipation about the transaction. Stock price changes after the announcement are a

result of investors punishing the acquiring firms which tend to overpay and rewarding the target firms

which often receive “too much.”

30

Riordan, Storkenmaier, & Wagener, pg. 13. 31

Travlos, pg. 962. 32

Wansley, Lane, & Yang, pg 16. 33

Shaheen, pg. 27.


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We tested the Synergy Trap Hypothesis to determine if it holds true for the M&A transactions in

which the LSE was involved (see Exhibit #2 & #3 for summary and regression results). In order to do

this, we first ran a regression of the London Stock Exchange’s stock price five days before and five days

after the announcement of a transaction. We then analyzed the results, paying attention to the p-values

which indicate whether or not our results are statistically significant. Regressions with p-values of less

than 0.05 are all considered significant. The x-values in our analysis represent days 0 through 10, and the

y-values represent the stock price in British pounds. Of the eleven deals we analyzed,34

four of the

regressions were not statistically significant and therefore do not have any bearing on our overall

hypothesis test. Five deals did indeed support the hypothesis we were testing. In four of these deals, the

LSE was the acquirer and in one of them, the LSE was the target in the transaction.

On December 9, 2002, the LSE announced its purchase of the Equity Derivative Operations from

OMX to expand its position in the equity options markets. The linear regression equation for the stock

price surrounding this deal is y = -3.7811x + 327.7964, and its p-value is 0.0003, indicating that the

regression is statistically significant. The negative x-variable is in line with the hypothesis that the stock

price of the acquirer (the LSE) falls before and after the announced transaction.

On March 10, 2006, NASDAQ OMX Group made a bid for the LSE (one of several made over

the years) in an effort to expand its exchange operations across the globe. In looking at the regression

output related to this deal (OMX #3), the linear regression equation is y = 43.8609x + 780.7252 and the p-

value indicates statistical significance. The coefficient of the x-variable is positive, which is in line with

the hypothesis that the target’s (LSE’s) stock price would rise both just before and after the announcement

of the deal. This deal was terminated, yet that occurred outside of the dates in our analysis.

On June 23, 2007, the LSE announced its acquisition of Borsa Italiana in order to recognize

synergies with the Italian exchange. The regression equation for this deal is y = -5.5133x + 1380.812 and

the p-value is under 0.05. The negative x-variable corroborates the hypothesis that the LSE’s stock price

should fall in the event it acquires another firm like Borsa Italiana.

34

All deals analyzed had been announced and either completed or terminated.


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On December 21, 2009, the LSE acquired Turquoise Trading in order to keep pace with the

shifting market in which MTFs were gaining significant share as a result of the MiFID regulations

discussed earlier. The linear regression equation in this deal was y = -4.7971x + 747.8652 and the p-

value of less than 0.05 indicates that the results are statistically significant. The negative x-variable

coefficient is in line with the hypothesis that the acquirer’s stock would fall just before and after a

transaction.

More recently, on August 2, 2011, the LSE announced that it would purchase the FSA’s

Transaction Reporting Service which was discussed in the regulatory section. The linear regression for

the five days before and after the deal is y = -19.1927x + 1055.872 and the p-value is well below 0.05.

The negative x-variable coefficient indicates that as the days progressed, the LSE’s stock price fell, which

was to be expected given that it was the acquirer in the deal.

There were two deals whose regressions were statistically significant and they did not support our

hypothesis. The first was the LSE’s acquisition of MillenniumIT in 2009 (described earlier as the Sri

Lankan firm that forms backbone of the LSE’s technology services division). The regression equation for

the days surrounding this deal is y = 9.9299x + 789.9483, indicating that the LSE’s stock rose despite it

being the acquirer. We saw a similar situation earlier this year with the LSE’s failed acquisition of the

TMX Group, the Canadian exchange that the LSE had hoped to merge with and recognize many

synergies. The regression equation in this instance is y = 5.2345x + 874.115, also indicating a positive

correlation between time and stock price. We tried to isolate why these two deals may have contradicted

the hypothesis, and can only surmise that they were so transformative that investors believed that it would

be quite accretive to the LSE. The MillenniumIT deal gave the exchange a super-fast, new trading

platform which is a major competitive advantage. The TMX deal would have likely been synergistic as

two major exchanges could have combined to form a global powerhouse. Once again, this is just

conjecture; we investigated other elements of the deals including their dates and the type of currency used

in the transactions (i.e. cash or stock), yet all analyses in this regard were inconclusive.


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The second regression set we ran sought to test the Synergy Trap Hypothesis over a broader time

period of one month prior to the announcement of a merger (Exhibit #3). This line of analysis was

performed in an attempt to capture the impact that potentially leaked information or investor speculation

regarding an upcoming acquisition announcement had on the LSE as either the target or acquiring firm.

Applying the principles of the Synergy Trap Hypothesis to this theory would imply that if information

were leaked to the market in advance of the formal announcement date the target firm would expect to see

its stock price increase and the acquiring firm would experience the opposite stock price reaction. In order

to test this, we ran a regression of the LSE’s stock price one month before and five days after the

announcement of a merger transaction. We then analyzed the results, noting that regressions with p-values

less than 0.05 were statistically significant. The x-values in this analysis represent days 0 through 30, and

the y-values represent the stock price in British pounds. Regressions that support the Synergy Trap

Hypothesis will have x-variables with a negative sign if LSE were the acquirer and positive x-variables if

LSE is the target of the acquisition.

The results of this regression set, testing stock price movement over a longer time period, yielded

the same results as the previous analysis which looked at only five days prior to a deal’s announcement.

Of the eleven deals analyzed, four of the regressions were not statistically significant – OMX #4,

Macquarie, Proquote, and EDX London – and were therefore excluded from our final analysis regarding

the applicability of the hypothesis being tested. Five deals were statistically significant and supported the

Synergy Trap Hypothesis. For those transactions in which LSE was in the position of the acquiring firm

(Equity Derivatives, Borsa Italiana, Transaction Reporting Service, and Turquoise), the regression

equations for these deals had extremely low p-values and strongly negative slope variables, indicating that

in the run up to the announcement date the LSE saw its stock price decline. For the one deal that supports

the hypothesis and in which the LSE was the target firm (OMX #3), the results showed a p-value

significantly less than 0.05 and a positive slope variable, which confirms the theory that in the month

prior to the deal’s announcement the LSE’s stock price increased. Two of the transactions analyzed

(MillenniumIT and TMX) did not support the Synergy Trap Hypothesis. These deals, with the LSE in the


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position of acquiring firm, had a positive impact on the LSE stock price which runs counter to the theory

being tested. As previously discussed, the reason for this divergence may be a consequence of the

potentially synergistic alliances that would have resulted from these two mergers which resulted in a

positive effect on the LSE’s stock price. Although approximately 45% of the LSE acquisition deals tested

in this analysis were statistically significant and supported the Synergy Trap Hypothesis, the results are

not conclusive enough to confirm the validity of this theory in its application to the London Stock

Exchange’s recent transactions.

Conclusion

The London Stock Exchange is a well-diversified exchange which has relied significantly on

growth through mergers and acquisitions over the past several years. Not only has the LSE purchased

other firms to complement its existing operations and offerings, it has only been the target of transactions,

although none have been completed successfully. Our tests of the Synergy Trap Hypothesis on the LSE’s

stock price over two distinct time periods showed that the hypothesis was unreliable, at best, for the LSE.

Our analysis determined that we were unable to definitely prove the hypothesis.

The competitive environment is such that the LSE will likely continue its push to supplement

organic growth with acquisitions. From our analysis, we would warn investors not to apply the Synergy

Trap Hypothesis to the London Stock Exchange’s shares as our historical analysis suggests that doing so

is not always a winning proposition.


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http://www.datamonitor.com/

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http://www.fsa.gov.uk/pubs/other/fsa_submission.pdf

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http://finance.yahoo.com/q/hp?s=LSE.L+Historical+Prices


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Exhibits

Exhibit 1 – LSE Stock Price Graph, in Great Britain Pounds (GBp) (2001 – 2011)

Source: Bloomberg.


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Exhibit 2 – LSE Regression Set #2: 5 days prior to M&A announcement and 5 days after

Summary of Regression Results


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2-A


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2-B


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2-C


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2-D


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2-E


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2-F


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2-G


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2-H


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2-I


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2-J


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2-K

Source: Yahoo! Finance.


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Exhibit 3 – LSE Regression Set #1: 1 month prior to M&A announcement and 5 days after

Summary of Regression Results


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3-A


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3-B


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3-C


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3-D


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3-E


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3-F


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3-G


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3-H


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3-I


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3-J


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3-K

Source: Yahoo! Finance.


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Exhibit 4 – LSE Acquisitions Details

Borsa Italiana

EDX London


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Equity Derivatives Ops

Macquarie


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MillenniumIT

OMX #3


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OMX #4

Proquote


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TMX

Transaction Reporting Service


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Turquoise

Source: Bloomberg.


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“The authors of this paper hereby give permission to Professor Michael Goldstein to distribute this paper by hard

copy, to put it on reserve at Horn Library at Babson College, or to post a PDF version of this paper on the internet.”

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