Theories rife over prospects for LSE-Russell deal

Speculation abounds that the London Stock Exchange Group PLC is on the verge of making the biggest acquisition in its 213-year history with a potential deal to buy Russell Investments, allowing the LSE to gain a bigger U.S. foothold.

The LSE on May 20 announced it was in “exclusive discussions” with Northwestern Mutual Life Insurance Co. to acquire Russell. As Pensions & Investments went to press three days later, no further details had been revealed.

While spokesmen for the LSE declined to comment on any potential deal, the money management industry was buzzing with theories and views on what could be a $3 billion transaction.

The overwhelming conclusion is that the London-based powerhouse wants to ramp up its presence in the U.S. market, particularly when it comes to the index business. The LSE already owns index provider FTSE Group.

The deal would “mark (the LSE's) boldest push into the U.S., where Russell is best known for its equity benchmarks such as the Russell 2000,” James Hamilton, London-based analyst at Numis Securities Ltd., wrote in a note published May 20. “Should the LSE acquire the index businesses of Russell, it would plug the strategic gap (the U.S.) in the FTSE portfolio.”

According to its website, Russell's U.S indexes have $5.2 trillion of assets benchmarked to them.

One big question is what the LSE would do with Russell's $259.7 billion manager-of-managers business.

“LSE has emphasized the intellectual-property basis, infrastructure and risk management aspects of its businesses, and the strategic fit of asset management in this model is unclear,” said Mark Thomas, London-based analyst at Edison Investment Research Ltd.

“I would expect that LSE would be looking to sell on the asset management side.”

Numis' Mr. Hamilton said analysts “do not see the strategic logic of purchasing the asset management business of Russell and would need to be convinced.”

Another source in the money management industry, who requested anonymity, said: “I don't think they do want (the money management business. Any deal) is very much for the index business. There is the possibility that they acquire the whole business but immediately sell part of it — that could be a very smooth structure. There would be a buyer for the asset manager — that would be the easy bit to sell.”

But there is no reason the LSE couldn't keep the money management business.

Mr. Thomas and a source in the financial industry, who asked not to be named, said it is known that Northwestern Mutual would like to sell Russell as one unit.

“In an auction of this sort, it is very difficult to break up the business in practice,” said the source. “Maybe the LSE (sees this) as an exciting sort of diversification — why not diversify into the manager selection business? Russell is a superb name.”

The source added: “The question is, "is this a good investment for the LSE?' There is a sense that, if this is to develop the U.S. footprint, it is much more substantial to keep both businesses,” he said.

Nor does there seem to be a reason the LSE couldn't branch into money management. “I am not aware of any constraints from the regulatory perspective of the LSE running an asset management business,” said Mr. Thomas. “Indeed, you could argue that the LSE's competitive advantage over some other potential bidders is that it is well-used to operating in a strict regulatory environment.”

But any deal and its structure is heavily dependent on what the group decides to do with the money manager arm.

“If the LSE has someone lined up to buy it, it is likely to adopt a different financing structure from one where it retained that business, even for a relatively short time,” said Mr. Thomas. He thinks the LSE, which said it would sell equity to partially fund the deal, would likely take more debt on the deal if a buyer is lined up, as proceeds from that subsequent sale would “quickly bring it back within target levels.”

On the index side, meanwhile, the deal “goes to further build (its index business) in a most magnificent way,” said another source in the finance industry, who asked not to be named. “If the deal comes off, they will be such a strong player globally in terms of the index business.”

It would allow the LSE to “compete more effectively with MSCI,” Peter Lenardos, an analyst at RBC Capital Markets, London, wrote in a May 19 note.

MSCI Inc. had been a rumored bidder for the index business. MSCI officials did not respond to questions on whether it had been interested in buying the business, but did comment on the potential LSE deal.

“Whether this deal goes through or not, MSCI will remain the clear leader in global benchmarking — including the important and emerging field of factor indexing,” Baer Pettit, London-based managing director and global head of the MSCI index business, said in e-mailed comment. “We will continue to invest in, and grow our business through, constant innovation ... ”

The LSE has not hidden its desire to become more global. At a May 15 presentation of the group's full-year results, that global ambition was reiterated by CEO Xavier Rolet, who said diversification of the group occurred in a “disciplined” way.

About FTSE, he said: “In information services, FTSE continues to build its global operations, including China and — why not — North America.

“FTSE continues to work closely with customers to develop innovative new benchmarks ... and ETF assets under management linked to FTSE now stand at almost $200 billion.”

Mr. Rolet said FTSE also has strengthened its fixed-income offering through joint ventures and acquisitions, such as the integration of electronic fixed-income markets firm MTS Group, London — in which the LSE acquired a majority share in 2007 — and its fixed-income indexes.

He also highlighted a May acquisition by MTS' U.S. subsidiary of U.S.-based electronic trading platform Bonds.com Group. The acquisition of that platform, he said, addresses “the growing customer and regulatory demand for access to transparent, electronic, cost effective platforms for the trading of fixed-income securities in the largest fixed-income market in the world.”

The focus on the U.S. has not gone unnoticed by analysts.

“LSE businesses are global and in that context, the U.S. is a very important market, and one with a high strategic priority,” said Edison's Mr. Thomas.

The deal would put the LSE on the map geographically, and in terms of market share, Mr. Thomas said.

In the index market “in particular, there are a number of very strong national champions, but few global ones: MSCI and FTSE stand out. With the potential acquisition of Russell, the LSE would be materially increasing its presence in that market, and accessing clients that it doesn't already have in order to cross-sell FTSE products,” he said.

Analysts are split on the timing of any deal. One, who asked not to be named, said it is “weeks away” while Mr. Thomas said an asset disposal could increase the time required to complete. The source in the financial industry said now that the LSE has revealed its discussions, the group might be keen to strike a deal sooner, rather than later.

Whatever the outcome, Kevin Pakenham, London-based co-founder and managing director at Pakenham Partners Ltd., a boutique investment bank, warned that LSE executives need to move quickly.

“Whether the LSE decides to keep the asset management arm of Russell Investments, the most important point is that they make up their minds quickly. Clients will be concerned about a change of ownership, and so will the staff. I think this speculation is dangerous for the LSE, and they need to make up their minds whether it is a keeper or whether to sell.”