Deutsche Boerse Tries to Improve on M&A Record

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A market rocked by the spectacular implosion of Wirecard AG is buying some deep expertise in corporate governance — and paying a full price for it. German stock exchange operator Deutsche Boerse AG will need to handle its acquisition of a majority stake in Institutional Shareholder Services Inc. with care to avoid making the investor advisory firm worth less than it's paying.

Deutsche Boerse’s recent history in M&A hasn’t come to much. That matters when investors are worried about organic growth prospects. A planned merger with London Stock Exchange Group Plc fell apart after the Brexit vote. LSE subsequently agreed a transformational $27 billion deal to buy data giant Refinitiv (which competes with Bloomberg LP, the parent of Bloomberg News). Deutsche Boerse recently lost out to rival Euronext NV in the LSE’s auction of Borsa Italiana. At least the ISS deal is inked and looks likely to go through.

The strategic logic is familiar. The exchange industry has long been diversifying away from traditional stock trading into areas such as index provision, information and analytics. ISS, along with Glass Lewis & Co. LLC, is best known for offering recommendations to shareholders on how to vote at company meetings. It’s a key part of the market’s overall corporate governance infrastructure. The firm also has a sizeable franchise in environmental, social and governance analysis. Investors’ demand for such insights is enjoying secular growth, and Wirecard has reminded everyone just how important the governance piece of the ESG matrix is.

Small wonder that ISS has secured a price that reflects its scarcity value. The deal puts a $2.3 billion valuation on the company. That’s worth more than 20 times expected adjusted Ebitda next year. It looks more reasonable when you consider that credit ratings companies like Moody’s Corp. trade around the same level. Still, the financial payback on the transaction will be several years away. Synergies are modest, with no obvious cost savings to be had. The return on invested capital will be only 5.7% after three years, UBS Group AG analysts reckon, failing to exceed Deutsche Boerse’s own cost of capital in the short-term.

The projected financial benefits are probably conservative. ISS is still mainly a U.S. business so Deutsche Boerse may have some luck expanding its European client base. Cross-fertilization of ISS’s data with Deutsche Boerse’s other so-called pre-trade services could plausibly create new revenue opportunities.

Delivering on this potential faces an obvious challenge: the concern that ISS may lose some objectivity with an owner whose business is partly based on listings of the companies its analysts take to task. Fortunately, ISS’s editorial independence is enshrined in a shareholder agreement, and management keeps a minority stake. But perception matters a lot and ISS’s rivals now have a chance to make a meal of the issue when talking both to clients and potential recruits.

This left-field acquisition is an attractive bolt-on deal. Deutsche Boerse has shown it can buy growth — but it will have to use a loose grip if it wants to keep hold of ISS’s value.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Chris Hughes is a Bloomberg Opinion columnist covering deals. He previously worked for Reuters Breakingviews, as well as the Financial Times and the Independent newspaper.

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