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Tokyo-Osaka Seen as Best Bet After Deals Fail: Real M&A

Shares of Osaka Securities Exchange Co. (8697), the smaller of the two main venues in the world’s second-largest equity market, are trading about 3 percent lower than the 480,000 yen offer from Tokyo Stock Exchange Group Inc., according to data compiled by Bloomberg. With the operator of the Toronto Stock Exchange valued at 12 percent less than its own pending takeover bid, arbitragers who profit from acquisitions are signaling that Japan’s merger is the more likely of the two remaining bourse deals to be completed, the data show.

While regulators and politicians in Brussels, Washington and Canberra helped scuttle $32 billion of exchange takeovers in the past year, Japan’s need to revive its standing as a financial hub ensures the TSE-Osaka deal will be approved, according to JPMorgan Chase & Co., as the government looks to create a “comprehensive exchange” that unifies Japan’s nine bourses. The country’s Financial Services Agency was involved in discussions between TSE and Osaka before the deal was announced, according to two people with direct knowledge of the talks.

“There’s a tremendous amount of pressure to get this merger done,” Jonathan Foster, Singapore-based director of Global Special Situations at Religare Capital Markets Plc, said in a telephone interview. “The whole of the government wants to encourage the merger.”

Edo Period

Eight months after TSE president Atsushi Saito said he was planning to hold merger discussions with Osaka, the companies on Nov. 22 announced an agreement that would combine Tokyo’s dominant position in equities with Osaka’s derivatives platform. The deal valued Osaka at 129.6 billion yen ($1.6 billion).

The 133-year-old Tokyo exchange, home to Toyota Motor Corp. (7203) and Canon Inc. (7751), accounts for 96 percent of Japan’s equity trading, the bourse’s data show. Osaka, which was established in 1878 and has its roots in a futures exchange for rice during Japan’s Edo period, is the only domestic venue for futures on the Nikkei 225 Stock Average. (NKY)iBKQXEkCqG7I

The exchanges described the merger as “a step toward the revitalization of the Japanese economy,” and said the tie-up would save 7 billion yen in annual costs by integrating computer systems, according to the deal announcement.

Shares of Osaka fell 500 yen, or 0.1 percent, to 464,500 yen today.

Two Steps

The transaction will be conducted in two steps, with TSE first bidding for as much as 67 percent of Osaka in a tender offer. Once that purchase is complete, Osaka’s shares will be swapped for those of the unlisted TSE, so the new exchange remains publicly traded. The companies project the acquisition will close in January.

The TSE-Osaka announcement brought the total of proposed exchange acquisitions since October 2010 to almost $40 billion as venues from Asia to North America tried to cut costs and offset declining profits from equity trading with options, futures and derivatives. None of the deals have been completed, with at least four derailed by opposition from regulators, politicians or shareholders.

Australia’s government scuttled Singapore Exchange Ltd.’s bid for Sydney-based ASX Ltd. (ASX) last April, while Nasdaq OMX Group Inc. (NDAQ) of New York and Atlanta-based IntercontinentalExchange Inc. dropped their hostile offer for NYSE Euronext (NYX) in May after U.S. regulators signaled they would block it. A month later, London Stock Exchange Group Plc (LSE)’s deal for Canada’s TMX Group Inc. fell apart due to a lack of support from shareholders.

‘Really Different’

Frankfurt-based Deutsche Boerse AG (DB1)’s bid to buy NYSE Euronext and create the biggest exchange operator was rejected last month by European Union regulators who said the deal would hurt competition by creating a “near-monopoly” in derivatives.

The wave of failed merger deals hasn’t shaken the confidence of traders in the TSE-Osaka tie-up. Osaka’s shares reached a high of 465,500 yen last month even after the Deutsche Boerse-NYSE deal collapsed, and closed last week 3.2 percent below TSE’s offer.

“What’s really different about this deal compared with the other exchange mergers” that failed is that it involves one country, Sachin Shah, a Jersey City, New Jersey-based special situations and merger arbitrage strategist at Tullett Prebon Plc, said in a phone interview. “It seems like they’ve been in contact with the government to see how this would go over and it’s looking pretty good.”

‘National Champion’

Putting the country’s top bourses together has been a priority for Japan’s government since at least June 2010. The ruling Democratic Party of Japan that month announced an economic growth strategy that called for restoring the country’s position as Asia’s top financial hub by 2020 and laid the groundwork to create an exchange that combines the nation’s derivatives and commodity markets in one entity by 2013.

Japan’s cabinet this month submitted legislation that will give the Financial Services Agency oversight of stock, commodity, and grain exchanges, a step that will make it easier to eventually combine the markets. Regulation is currently divided between the FSA and the trade and agriculture ministries.

“This is about building a national champion,” said Jesper Koll, head of equity research at JPMorgan in Tokyo. “The big driver is the Financial Services Agency.”

Japan’s securities regulator participated in monthly discussions about the TSE-Osaka deal with representative of both exchanges, according to two people with direct knowledge of the talks, who asked not be identified because the discussions were private. Ryutaro Hatanaka, the FSA’s top bureaucrat, held a meeting with TSE president Saito and Osaka president Michio Yoneda around the end of October, one of the people said.

Nikkei’s Slump

The government didn’t push for the merger, spokesmen for the bourses said last week. The exchanges met with the FSA only to update them on the deal’s progress, said Kazuhiko Yoshimatsu, a spokesman at TSE. There wasn’t any assistance from the government, according to Osaka spokesman Masahiro Yada.

Officials at the FSA weren’t immediately available to comment on the nature of the regulator’s role in the merger.

Japan’s standing as a financial center has declined as the Nikkei 225 average posted the biggest slump among major stock indexes since the end of the 1980s and China overtook the country as the second-largest equities market in 2008.

While Japan has since regained its lead over mainland China, more than five times as many shares are now traded in Hong Kong than in Tokyo. Japan’s main exchange also held less than 1 percent of the world’s initial public offerings last year, data compiled by Bloomberg show.

Relative Value

Investors are currently willing to pay 19.9 times earnings to own shares of the Osaka bourse, almost 30 percent less than for Hong Kong Exchanges & Clearing Ltd. (388), Asia’s biggest venue with a market value of $18.3 billion, data compiled by Bloomberg show. Singapore Exchange (SGX), which has a market capitalization of $5.9 billion, trades at a 25 percent premium to Osaka.

Following up the TSE-Osaka merger with acquisitions of Tokyo Commodity Exchange, which deals in metals and oil, and the Tokyo Grain Exchange could add 2 billion yen a year to operating profit for the new company, Stephen Barker, a Credit Suisse Group AG analyst in Tokyo, wrote in a report on Feb. 21.

A merger is also a prerequisite to any expansion outside of Japan to close the gap with rivals in Asia, according to Fukoku Capital Management Inc.’s Yuuki Sakurai. Average daily volume in Hong Kong almost doubled in the five years through 2011 to 12 billion shares, while the number of shares changing hands in Tokyo rose by only 8 percent, according to the exchanges.

‘Capable of Negotiating’

“We may have much more tie-ups with Asian stock exchanges,” Sakurai, chief executive officer at Fukoku Capital, which oversees $7.4 billion in Tokyo, said in a phone interview. “To do those deals you must have one combined exchange which is capable of negotiating with exchanges in other regions.”

The combined exchange’s potential is one reason the current share price “appears to underestimate the value of the company that will result from the planned merger,” Credit Suisse’s Barker wrote. Osaka is worth 500,000 yen per share, he said.

“Osaka has a strong derivatives trading business and, compared with equities trading, derivatives is growing faster,” said Ichiro Takamatsu, who helps oversee $2 billion at Bayview Asset Management Co. in Tokyo. “That’s one of the reasons that some investors are saying the bid price was too cheap.”

The number of options and futures contracts traded on the Osaka exchange more than tripled to 194.1 million last year from 60.6 million in 2006, data from the bourse shows. Equity trading in Tokyo grew less than 10 percent in the period.

‘Blow it Up’

Saito and Yoneda have both said the deal price won’t be changed. Osaka’s shareholders, the largest of which are overseas funds, will have an opportunity to raise the issue in June, at the annual shareholder meeting.

Traders remain confident the deal will close. Osaka’s shares finished last week about 0.1 percent below their highest level since a magnitude-9 earthquake and tsunami struck Japan a year ago, leaving 19,000 people dead or missing and triggering the world’s worst nuclear disaster in a quarter century.

By contrast, shares of Toronto-based TMX (X) are trading 12 percent below a C$50-a-share takeover offer valued at C$3.73 billion ($3.7 billion) from 13 Canadian banks and pension funds known as Maple Group Acquisition Corp. Canada’s competition watchdog has said it has “serious concerns” about combining TMX, the operator of the Toronto Stock Exchange, with Alpha Group and Canadian Depository for Securities Ltd. as part of the deal to create an entity that would control most of the country’s trading and clear all its transactions.

In Canada, “I am not sure that all of the regulators and public sentiment is fully behind the transaction,” Larry Tabb, chief executive officer of research firm Tabb Group LLC in New York, said in an e-mail. In Japan, “the government is behind this as well as both exchanges and there is no one outside of the deal that is looking to possibly blow it up,” he said.



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