Can Nasdaq Break Up the NYSE-DB Deal?

Within a week of the New York Stock Exchange parent NYSE Euronext announcing a mega deal to merge with Deutsche Borse, the grapevine is full of speculation on the next wave of exchange mergers.

The rumor mill got very interesting on Friday when Fox Business News broke the story that Nasdaq OMX had hired an investment bank to weigh its options. Nasdaq OMX is somewhat threatened by the NYSE combination with Frankfurt –based Deutsche Bank (symbol DB1) which operates Eurex, the world second largest derivatives exchange. I am being diplomatic here: Charles Gasparino of Fox News said that Nasdaq was “desparate.”

According to the Wall Street Journal and other media reports, Nasdaq OMX is exploring a joint bid to acquire NYSE by teaming up with either Chicago Mercantile Exchange (CME) or Intercontinental Exchange (ICE).

CME Group has downplayed the rumors but everyone know that CME is not happy about NYSE Euronext combining NYSE Liffe with Eurex to become the world’s largest derivatives exchange. If this were to happen, Frankfurt would eclipse Chicago as the world’s risk management capital.

On the other hand, ICE might benefit from gaining access to NYSE Euronext’s derivatives trading business (NYSE Liffe). ICE has a big foot in the OTC derivatives clearing business, which is an area that NYSE Euronext plans to enter as well.

If Nasdaq pursued a joint bid, it could capture the Big Board’s stock trading business, which would make it the dominant U.S. stock exchange, and help beat back those pesky electronic rivals – BATS and Direct Edge. This would also quiet politicians such as Democratic Senator Charles Schumer who is upset about the iconic NYSE brand disappearing in the transatlantic merger. Of course, if Nasdaq were to takeover the NYSE equity trading business, that might lead to a brawl over which name comes first as well. But all kidding aside, with passions flying over how the U.S. could lose a piece of its trading history, an all-American deal would win kudos with certain factions. However, I’m not sure this matters at all to the exchange’s customers – high frequency traders.

While these various scenarios are plausible, there are some obstacles in the way, or as singer/songwriter Neal Sedaka said, “Breaking up is hard to do.” First as the WSJ reported, there is a high break-up fee of $337 million and matching rights if another offer is made for NYSE. In addition, analysts at Keefe, Bruyette & Woods point out, that all of the three exchange deals announced so far this year have been large cross border franchise listings companies and derivatives combinations. So far, the LSE/TMX merger announced two weeks ago, the Singapore/ASX combination in October 2010 and the NYSE/DB1 merger announced yesterday, all meet that profile.

Still, KBW notes that some of the U.S. exchange stocks (NDX, CBOE, ICE) have risen lately in light of the exchange merger deals leading market participants (i.e., prop traders, market makers) to speculate on potential tie-ups.

Long term, KBW’s research analysts say that the three announced cross-border deals could drive further consolidation, but that could take until 2010 at the earliest, after these announced mergers go through regulatory approvals. Also, CME and ICE are more focused on potential business combinations in international markets, namely, Asia or South America, note KBW’s analysts.

While everyone is distracted by defensive reactions to the NYSE-DB1 deal, I think an interesting deal, albeit, smaller one to watch, is BATS’ Global Markets decision to buy pan-European equities trading platform Chi-X Europe. The WSJ calls it “ a deal that combines the least-staffed yet most-formidable competitors to Europe's incumbent stock exchanges.”

While the traditional exchanges are focused on gobbling up transnational competitors, BATS is keen to increase market share in pan-European stock trading. Data from Thomson Reuters says the LSE and Borsa Italiana unit’s share of European equity trading fell to 39 percent from 45 percent last year. Meanwhile, the combined share of Chi-X and BATS has increased to 19.2% from 16.6%. BATS could also turn out to be a real thorn in the LSE’s side and push that exchange into another merger, with Nasdaq, perhaps.