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OPPORTUNITY

Canada’s largest stock market operator, the TMX Group, is recommending that shareholders accept a $50 in cash per common share offer. At Friday’s close it was trading at $45.05 ($43.64 US) representing an 11% discount to the offer price. On Thursday, I received a booklet from TMX outlining the plan and asking me to tender my shares prior to January 31, 2012.

The board of directors of TMX Group has unanimously recommended that shareholders accept Maple’s offer and deposit their TMX shares.

The TMX Group trades in the US over the counter (OTC:TMXGF) and on the Toronto Stock Exchange under the ticker TSE:X.

THE PLAYERS

TMX Group is an integrated, multi-asset class exchange group with a market capitalization of $3.3 Billion and is headquartered in Toronto. It is considered a global leader in the Mining, Oil & Gas sectors and Clean Technology sectors.

Maple was formed in May and its investors comprise 13 of Canada’s largest banks, pension funds and other financial institutions including: Alberta Investment Management Corp, Canada Pension Plan Investment Board, Ontario Teachers’ Pension Plan, Scotia Capital, TD Securities and Dundee Capital Markets.

BRIEF HISTORY

On February 9, 2011 the London Stock Exchange Group (LSE) announced that they had agreed to merge with the TMX. A few months later, on June 13th, Maple made a larger rival offer. After both parties raised their offer a few times, the LSE terminated their offer on June 29th after it became obvious that they would not receive the approval of two thirds majority of the TMX shareholders. On October 30, 2011 the TMX Group Board unanimously agreed to accept Maple’s offer.

THE CON ARGUMENTS

Obviously the market believes that the probability of this deal actually closing is relatively low. Usually in a merger/acquisition you would expect the target (TMX Group) to be trading within a couple of percent points of an all cash offer if it were to be successful. In order for the deal to be completed, Maple’s plan will come under the scrutiny of four provincial security commissions and more importantly the federal Competition Bureau. Their concern is that Maple will have a virtual monopoly, as the country’s largest exchanges would come under the control of the big banks and pension plans (controlling close to 80% of the trading volume). Critics argue that this will result in higher fees for customers or that the government will have to regulate the ‘monopoly’ which it is unlikely to want to do.

THE PRO ARGUMENTS

I believe that the probability of this deal closing is considerably higher than the market is currently indicating for the following reasons:

  1. The merger would not constitute a monopoly as most Canadian shares are also traded in US markets. Many of Canada’s largest companies are now more actively traded on the US exchanges than on the Canadian ones.
  2. Other competitors do exist including: Chi-X trading venues and more recently Goldman Sachs’s Sigma-X which started trading on Oct. 24, 2011.
  3. Counter argument to higher fees is that the combination of the two exchanges will increase efficiency, which should allow for lower fees (or more probably higher profit margins with the same fees as today). I would imagine that as part of the approval process Maple will have to promise to maintain a competitive fee structure.
  4. Without the deal the TMX Group will be left without a dance partner. Consolidation is rampant in the industry e.g. LSE’s failed attempt to acquire TMX and Deutsche Boerse’s ongoing acquisition of NYSE Euronext to name but two. NASDAQ OMX Group had been mentioned as a possible bidder in the past, but the fact that TMX has now embraced Maple’s offer suggests that no competitive bid from NASDAQ will be forthcoming.
  5. A compromise can be reached such as the one that Ontario’s security regulator has already suggested, “A board with independent directors would be in a better position to supervise management and prevent the drive for profit from hurting stakeholders, customers and the public at large"
  6. Let’s not forget that Canadians are a patriotic bunch and the exchange will remain in Canadian hands if the deal with Maple is completed. This was one of the arguments for the LSE offer falling through, apart from the fact that Maple outbid them.
  7. The fact that the TMX’s board has reversed their earlier hostility to the bid is a huge plus.
  8. Finally, at $50/share in cash, the majority of shareholders will tender their shares.

COMPARISON TO PEERS

P/E

Mkt Cap

Dividend Yield

ROE

TMX Group (OTC:TMXGF)

13

3.3B

3.6%

22.7%

LSE (OTCPK:LDNXF)

11

3.7B

3.3%

20.7%

NYSE Euronext (NYX)

11

7.0B

4.5%

9.4%

Deutsche Boerse (OTCPK:DBOEY)

12

10.9B

5.0%

21.9%

The TMX Group has a market cap similar to the London Stock Exchange and is considerably smaller compared to the NYSE Euronext and Deutsche Boerse. It trades at a slightly higher price to earnings ratio (P/E) than its competitors, but also has a higher return on equity (ROE). Prior to the LSE’s bid the shares were trading slightly above $40 CAN compared to $45.05 CAN as of Friday's close. Assuming the deal does not go through it is likely that the shares will trade closer to the pre-LSE bid of around $40/share this would lower the P/E closer to an 11 times multiple.

CONCLUSIONS

Hearings with the Quebec regulator are from November 24-25 and December 1-2 with the Ontario regulator. I imagine that the two parties will soon be starting a publicity campaign to win the public’s approval. You are paid while you wait as you still receive the dividend after you tender your shares. I believe the probability of the deal being consummated is considerably higher than the market indicates with the downside risk being similar to the upside gain. Invest if you believe the odds of the deal being completed are greater than 50%.

Source: TMX Group: Arbitrage Opportunity Spotted