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London Stock Exchange Group: data deal costs are hard to swallow

The Times

It looks as though London Stock Exchange Group has eyes bigger than its stomach. Digesting the $27 billion takeover of the data group Refinitiv, which it completed in January, is proving more uncomfortable than it had anticipated. It’s causing investors pain, too.

The shares are on course to end this year as one of the FTSE 100’s worst performers, having fallen by almost a quarter since January. That’s a sharp reversal of the big gains made by the stock over the previous two years that led to it looking as though the shares were about to break through the £100 mark.

The group has expanded far beyond the exchange, which started out in the late 17th century as a collection of coffee houses where merchants would arrange deals, and owns a plethora of financial markets businesses, including Turquoise, a trading platform for European equities, LCH, the world’s largest derivatives clearing house, and the Russell and FTSE equity indices.

The news in March that the bill associated with integrating Refinitiv, the carved-out data business of Thomson Reuters, would be bigger than the market had expected spooked investors and raised doubts over the true benefits of the deal. The strategic rationale for the tie-up looked sound enough. Shifting the group towards data and index products increases the proportion of more reliable, recurring revenue and puts it less at the mercy of IPO and broader fundraising activity on London’s capital markets. Data and analytics revenue now accounts for roughly two thirds of the total.

Hopes for the higher growth and cost savings to be derived from the deal had been reflected in a forward price-earnings ratio that peaked at 46 in February, but that’s fallen to a multiple of 24. That puts it above its European peers, Deutsche Börse and Euronext, which earn a higher proportion of revenue from capital markets activity, but far below IHS Markit, the US-listed data provider.

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The group is targeting annual revenue growth at a compound rate of 5 to 7 per cent over the next three years and an annual rise of between 4 and 6 per cent from its core data and analytics division. So far performance against that latter target has been unconvincing. In the third quarter it came in at the top end of the range but over the first six months of the year it was below, at 3.9 per cent. The trading and banking segment, which houses Refinitiv’s highest-profile product, Eikon, is the biggest drag, posting a 0.5 per cent revenue fall in the third quarter at constant currency rates.

This year there have been several outages at Eikon, which is used by traders, fund managers and analysts, because of hardware problems — issues the group said it had worked to fix. As a daily user of the terminal, Tempus can attest to the fact that its general unsteadiness is wearisome. There’s also big competition in the form of Bloomberg. What’s to say the cost of upgrading the technology and fending off competition doesn’t slap LSEG with an escalating bill?

There has been some good news. In August the group lifted the target for cost synergies associated with the deal to about £125 million this year, from the £88 million first expected. Analysts at Jefferies think the greater reliability of data-related revenue is a reason that the derating in LSEG is unwarranted, placing a target price of £85 on the stock this month. The sale of Borsa Italiana in April also cut net debt by about £4 billion.

Investors need a shot of confidence in LSEG but that might not be forthcoming. Annual revenue growth will be harder won during the fourth quarter after a strong performance over the same period last year. It’s going to take more proof for investors to swallow the longer-term credentials of the deal.
ADVICE Avoid
WHY The potential for rising costs and disappointing revenue growth could force the shares lower

IntegraFin

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It’s not only London Stock Exchange Group that might have a problem with costs. A higher wage bill meant that IntegraFin, an investment platform provider, missed pre-tax profit expectations for its past financial year despite posting a 14 per cent rise in profit.

Bringing its recent acquisition of the back-office services provider Time4Advice up to scratch and recruiting more staff for the core business means costs are expected to continue rising next year. Operating margin also came in behind a consensus forecast. The bigger unknown is the toll that wage inflation will take as it tries to attract more platform development staff.

IntegraFin is not like Hargreaves Lansdown or AJ Bell: retail investors cannot sign up to use the platform directly. Instead the platform secures new business by advisers using it to manage their clients’ money. Unlike the direct-to-consumer providers, IntegraFin didn’t see a spike in inflows of the same magnitude during the pandemic. That’s not necessarily a bad thing as it also means there’s less risk of a sharp slowdown in savings and investment rates now consumers have more opportunity to spend.

The profit miss sent shares in the FTSE 250 constituent down by 14 per cent yesterday, interrupting a bull run that had left the stock trading more than three times higher than the 2018 listing price. The sell-off might have taken some heat out of the group’s eye-watering valuation, the likes of which have become commonplace among
UK-listed platform providers but the shares are trading at just over 30 times forward earnings.

Big expectations have been partly justified, chiefly by the impressive pace at which IntegraFin’s platform Transact has taken in funds. Last year it gained £5 billion in net inflows, equivalent to 12 per cent organic growth, which pushed up funds under direction by more than a quarter. Almost all the group’s fees are recurring and levied according to the level of funds under direction.

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Analysts at Peel Hunt, the house broker, cut earnings forecasts for this financial year by 4 per cent to 17.8p a share, ahead of the 15.4p reported last year. While inflationary uncertainty abounds, the shares look too richly valued to buy.
ADVICE Hold
WHY The shares may struggle to re-rate in the near term

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