LSE to buy 50% of FTSE but is it overpaying?

13th December 2011

FTSE believes it can ride the increasing trend for index tracking. As David Lester, the FTSE chairman and LSE director says the firm will benefit from the increasing trend for index tracking and passive management. "Around 70% of our revenue comes from the buy side. People are indexing more, there is less active management," he said.  

This is London notes that for Pearson, the Financial Times publisher which owns the 50 per cent, the deal is another move away from financial data. It sold its 61% stake in financial information provider Interactive Data Corp for $2 billion last May.

And it echoes News Corp's decision to sell Dow Jones to Chicago Stock Exchange group in early 2010 as the Guardian reported at the time.

The Independent suggests that the big FTSE buy at £450m shows that LSE boss Xavier Rolet still has some fight in him. And stock market reporter James Moore rates the LSE a buy.

"It is the only big Western exchange which is not part of the two major blocs: the Deutsche Borse/NYSE combination and the Nasdaq. With Asian consolidation yet to get going it should command a premium rating, not least because if the LSE falls to a predator it will not go cheaply with Mr Rolet at the helm."

"And yet, trading on a multiple of 10.4 times forecast 2010 earnings, with a respectable yield of 3.6 per cent, it is not expensive. We are a trifle concerned about rising debt levels – deals could yet push debt to twice earnings before interest, tax depreciation and amortisation," he writes.

FT Alphaville, incidentally owned by Pearson, however is not so sure.

It writes: "Rolet's paying 50 times earnings before interest! Admittedly the price does fall once £10m of synergies are taken into account, plus an £11m royalty payment that falls away."

And it quotes a report from Numis Securities which does not sound impressed.

"The valuation of £900m means the LSE is paying a huge 96x historic net income of £9.4m. This equates to 22.5x EBITDA (earnings before interest, tax, depreciation and amortization) but there were significant (£22.6m) of royalties to JV owners. Assuming the deal goes through, we would expect a huge gain to be recorded through the P&L for the valuation adjustment on the current LSE stake in FTSE. This is however pure accounting trickery."

FTAlphaville mulling the rationale for the deal concludes thus. "We're guessing the rationale must be something do with giving the LSE a brand name it can use more fully in the ETF and derivative markets. Whether that's worth £450m is another question."

More from Mindful Money:

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9 thoughts on “LSE to buy 50% of FTSE but is it overpaying?”

  1. David Lilley says:

    I am not sure about this argument. It seems to fall into the category “it takes two to tango, lenders and borrowers, and that both should share the responsibility”. “But with the edge that if lenders had not been so willing to lend the sovereigns might not have over-borrowed and therefore more blaim lies with the banks than the sovereigns.”

    There are some holes in the argument, as follows:

    1. The banks are a mixed bag and do different things. Some are still essentially building societies and don’t have a trader in the building. Some are traditional high street banks taking deposits and providing loans and making a living from the spread. Some are merchant banks with no connection with the man on the street. You are assuming that they are all like RBS or Barclays with a traditional high street banking division and a casino arm after taking over a merchant bank.

    2. It was Basel 2’s decision by the banking industry to keep mandetory reserves almost exclusively in AAA rates sovereign bonds that put their money into state paper and not traders belonging to the few banks that employed traders.

    3. The explosion in mortgage lending across the world in the easy money decade (sometimes refered to as the nice decade) following demutulisation of building societies, the FED reducing base rate 1/4% every six weeks 11 times in a row and finally with the invention of “mortgage securitised bonds” that allowed mortgage lenders to fill their mortgage book, package it up as MSBs and sell it on and start over, led to massive growth in the financial sevices sector. As house prices tripled so banks tripled in size and there need for AAA rated state paper tripled.

    Conclusions:

    a. Nothing to do with traders.

    b. Investment bankers, traders, are like salesmen. They have a modest salary but they can earn a bonus if, and only if, they are successful. An excellent system that would be well suited to football as it would prevent clubs going bankrupt due to big wages irrespective of success. No trader is going to get a bonus investing in gilts ranging from 1.7% to 7% pa.

    Going forward:

    A. It would be nice if one or all of the PIIGS held a public enquiry(s) into how they got into a pig sty. The Greeks may reclaim their/our Democratus and their trust in parliamentary democracy and not be forced by poverty into the situation where they have no choice but to re-elect the criminals who got them into the mess they are in.

    B. It would be nice to know why the credit ratings agencies were denominating so much junk as AAA right up until the “debt crisis” broke.

    C. But going forward for real. The PIIGS, the UK and the US only dived into massive debt because they couldn’t make ends meet and not because the banks were hungry for mandetory safe reserve storage. Its a competitive/solvency issue stupid. They work in China but have a choice in the West.

    1. Peter Morgan says:

      One of the arguments you miss is the investigation of the stability of the investment. This has not been done properly or they would have appreciated the debt levels. The exchanges would have known the debt was high because of the volume of trades. Why did the BIS not do anything?

      I still think the traders are responsible for the situation they did not research the long term viability of repayments that is their job, regardless of who they work for. Also the bank has a responsibility to make sure the funds they direct the money they have been lent should be successful. They are failing in that respect.

      The debt situation accumulated before basel II so the methods implemented there are post event so irrelevant to my arguments. The traders should have been aware of the over saturation of debt and should have made it their responsibility to find out.

      Your claim about bonuses is not fair because they may have received short term bonuses but at a long term cost. This is part of the problem they are investing in poor products for their own benefit not the benefit of the investor. What ever makes them their bonus not what is the best investment for the saver.

      It is not just the banks in the US and UK that have invested in these products lots of countries have. There is no excuse for traders who put the money there. They did not research the products porperly and allowed the over saturation in the market. If traders did not buy the debt there would have been a bond strike.

      The situation only arose because the traders allowed it to happen by buying poor products. The banks might not have employed those traders but they did use the funds who employed the traders who invested in the poor products. I feel that the ultimate responsibility lies with them.

  2. David Lilley says:

    Thank you for your response.

    I hope you understood that I was paraphrasing Clinton’s much repeated phrase “its the economy stupid” when I used the expresion “Its a competitive/solvency issue stupid” and not a comment on your text. 

    I have put my own thoughts on “Avioding a Leman 2 and a Second Great Depression” on a number of sites. Perhaps the most accessible is Terry Smith’s Straight Talking site. You will note from my paper that there are far bigger problems than wayward traders. Basically an ageing population in the West and sovereign debt due to failing to make ends meet rather than profigacy (uncompetitiveness/insolvency).

    You are more than welcome to shoot me down.

    My approach to our ills is born from reading a number or fact and thinking “wow, that is totally unsustainable, thats going to hurt”. My paper is littered with such numbers and facts.

    For example. 2m US citizens are over 40 stone. Or a child suffers from infantcide every 28 minutes in the US (we loose two per week but it had peaked at 6 per week).

    Good luck with your book.

    1. Peter Morgan says:

      Thank you.

      I am fully aware of the problem and have my own opinion to the real problem behind the current situation. The banking system calculations are based on principal investment. The amount of money invested when it was produced. Over time the debt accumulates and becomes impossible to pay back with the current level of output. Here is a link to a more detailed explanation.

      http://morganisteconomics.blogspot.co.uk/2011/03/have-macroeconomists-misdiagnosed.html

      My blog is very much geared to what you aspouse to so you might find it interesting. I may take a look at your paper thank you for the link.

  3. Anonymous says:

     

    This is a graph you should all ponder. It shows Fed, BOE,
    and ECB central bank lending rates over the past decade. The point to consider
    is this: why did Greek Debt balloon around 2007 after having remained stable
    for a decade? We all read in the media how Goldman Sachs, and JP Morgan taught
    the Greeks how to fiddle the books using swaps around 2001 – a neat trick
    involving fake exchange rates. But as you can see in the graph the debt
    remained the same or thereabouts from 1998 (pre membership) to 2007.  By then Greece had joined the EU, and opted
    into the Eurozone, and the drachma was replaced by the Euro. Others joined the
    EU, and the Euro strengthened significantly on the back of dollar weakness
    caused by ballooning debt in the USA.

     

    Now look at the Fed rate, clearly it ‘leads’ the BOE and ECB
    rates by about 6 months. Around this time, there are repeated jibes from the
    Fed and Treasury that Europe needs to drop rates and stimulate its’ economy,
    which in reality was doing just fine and consistent with a greying population
    and largely socialist region. The real problem for the EU is more subtle. In
    March 2006 the Federal Reserve stopped reporting ‘M3’ measure of money. Up to
    the point the Fed reported as follows:

     

     

    M0: Federal Reserve notes, coins and bank notes.

     

    M1: The total amount of M0 (cash/coin) outside of the
    private banking system plus the amount of demand deposits, travelers checks and
    other checkable deposits.

     

    M2: Represents money and “close substitutes” for
    money. M2 is a broader classification of money than M1. Economists use M2 when
    looking to quantify the amount of money in circulation and trying to explain
    different economic monetary conditions. M2 is a key economic indicator used to
    forecast inflation.

     

    M3: M2 + all other CDs (large time deposits, institutional
    money market mutual fund balances), deposits of eurodollars
    and repurchase agreements..

     

    Mull on this for a moment. The United States Code of Federal
    Regulation states M3 is superfluous and therefore it’s a waste of money to report
    it. Clearly an outright lie and intended deception. M3 includes money held in
    Eurodollar accounts which don’t appear as part of the USA’s monetary base. What’s
    really going on?

     

    Let’s recap, after the dot.com financial collapse, and from
    around 2001 the USA and in particular Goldman Sachs and JP Morgan are teaching
    relatively unsophisticated  countries,
    without major financial centers like The City and Wall Street, how to cook the
    books. This allows the Greeks (and others) to disguise their debts, which effectively
    prevents markets from correctly pricing risk in the global markets. Life is
    good, and bankers are able to claim superstar status and get paid grotesque
    bonuses – all while 99% of America is in decline and paying for its debts using
    borrowing from China and elsewhere (As of today, 1/3 of all US government
    spending is debt – madness and it seems even idiots can get the Nobel Prize for
    economics!)

    Now back to Greece. A year after the Fed stops reporting M3
    there’s another crisis in the making. Subprime. The Fed and US Treasury know
    the United States is facing financial collapse, and it’s a matter of record
    that Hank Paulson literally gets on his knees and begs Bush for a Government
    bailout. And imagine what this situation means for the USAs competitors. Europe
    would become the worlds strongest economy! At the time of the 2008 crisis more
    trade was being done in Euros than Dollars, and several countries were starting
    to switch from trading commodities in dollars to Euros, this would only
    accelerate the ascendance of Europe whose socialist leanings are more in tune
    with China and Russia.  So much for the far
    rights (Rove, Cheney et al.) ‘Project for the New American Century’.  It was no coincidence that China’s maglev
    (levitation) train was designed by Germans.

     

    The non-reporting of M3 allowed the USA to start QE
    programmes which in most countries would have caused rapid inflation. But not
    the USA, they could dump dollars in Eurodollar accounts with no impact on
    supply and demand in the USA. But what would that mean? Those dollars would
    need conversion into Euros before Greece, Portugal and Spain, etc. could spend
    them – this meant more demand for Euros and I suspect led to the rapid increase
    in the Euro exchange rate starting in 2002 and then kick-started in 2006. This
    resulted in a relatively rapid and damaging rise in the Euro which reached 1.6
    from a base of 0.95. This conjecture is supported by the cartoon showing the exchange
    rate. Was this planned or an unhappy consequence? I would like to hear your
    views.   

     

     

    1. Peter Morgan says:

      Hi

      Thank you for the detailed analysis. I think the problem is really down the way the banking calculations are set. They use the principal investment which is based on the amount invested at that time. It is based on what was produced in the past and it accumulates over time. If the economy contracts it becomes impossible to pay that money back because the obligation was based on a more productive and cumulative amount. The interest rate has lowered so the additional return on the principal investment has gone however the principal investment still has to be paid back. This is the problem as I said as it has reached such a enormous amount over the long period of low interest flooding the market with debt it has become impossible to repay. The central banks are using QE to plug the gap between the amount that has to be repaid and the amount that is produced. This is what they are really trying to achieve. Everything else in my opinion a cover up that there is a fundamental flaw in the banking system. If that got out all hell would break out.

      I wrote an article about it you can read below.

      http://morganisteconomics.blogspot.co.uk/2011/03/have-macroeconomists-misdiagnosed.html

      Is this helpful?

      Peter Morgan.

      1. Anonymous says:

         Peter – here are some questions you should seek to answer:

        1. Why did the Fed stop reporting M3
        2. Was the Eurodollar market flooded by excess dollar liquidity
        3. Was the exchange rate affected by the result.

        I may have some of the story wrong, but its better to base arguments on data and evidence as opposed to using effects to infer cause.

        1. Peter Morgan says:

          Hi

          1. Why did the Fed stop reporting M3

          Answer.

          Because they have loads of debt that is not backed my any asset they know will collapse.

          2. Was the Eurodollar market flooded by excess dollar liquidity

          Yes to try to prop up the Euro.
           
          3. Was the exchange rate affected by the result.

          I don’t know perhaps but It seems pretty constant. There hasn’t been a long term change in the value in my opinion. If there is a huge change in the exchange rate or inflation like Weimar then I will think something is going on.

          I think you are reading too much in to data evidence. They fix the data anyway as you are aware. I think they are trying to cover up a huge debt loss with creative accounting and currency debasement. Any figure you get will have been altered to cover that up.

          Like I said all other factors are irrelevant the outstanding debt is unpayable. It was based on past products not current output. It is inevitable that it will fail it is just a matter of time.

          1. Anonymous says:

            Tanks Peter. We’re starting to head in the same direction. I don’t disagree with some of what you’re saying, but the issues really are deeper than you think, and I suspect you’re looking through the wrong end of the telescope. That said, I do agree the Fed is hiding its MASSIVE debts, however, the question is what else are the strategists up to. BTW – put your hands up if you know what the total US and Eurozone sovereign debts are! Anyone?

            If you have not done so, please google Project for the New American Century. It will shock you that the likes of Rove, Cheeney, Wolfowitz, Kristol etc. are purveyors of hegemony at anyever cost. I like the part about sponsoring research into genotype weapons, i.e.  diseases, or bacteria that target specific genes (i.e. ethnicity). 

            Take another look at the M3 definition. If I am correct the key thing not apparent from M0,1,2 is large overseas deposits and Eurodollars. That’s something you must mull on. Its EXTREMELY important.

            As for propping up the Euro. Please look at the graphs and then explain using the data how you come to the conclusion the USA was propping up the Euro? It went from 0.9 to 1.65. Who did a weak dollar and strong euro favor – not Airbus for sure!!

            My conjecture is that problems in the EU were created by US and UK investment banks chasing fees on loans to countries like Greece and Portugal. The data seem to support this so show the data that refute it. If you can’t then it’s a stretch so say ignore the data and choose something less worrying. The data seem to support the idea the US is printing vast amounts of dollars (4trln by most estimates) and that deflation and exporting the dollar is hiding the inflation you mention. As for deflation, Fed data show that the median wealth of americans fell 40% over the past 5 years. Scary.

            If this is a correct analysis then clearly I am not the only one thinking this and the EU as a whole probably has a fight on its hands.

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