TOKYO (Reuters) - The Tokyo Stock Exchange will takeover its smaller rival in Osaka in 2013 to create the world's third-biggest bourse with listed stocks worth $3.6 trillion, aiming to build scale to cope with a weak home market and compete with a flurry of global tie-ups.
The Tokyo Stock Exchange's $1.7 billion takeover of the Osaka Securities Exchange Co 8697.OS brings together two bourses that have operated separately for more than a century with the exception of a brief merger during World War Two.
The Tokyo market controls more than 90 percent of cash equity trading while Osaka, located in the economic center of western Japan, draws the top volumes in Nikkei index futures and other derivatives.
"This will create a well balanced exchange," said Sadakazu Osaki, a senior researcher and exchange expert at Nomura Research Institute.
The combined value of stocks listed on the exchanges would trail only NYSE Euronext NYX.N at $14.5 trillion and Nasdaq OMX Group Inc (NDAQ.O) at nearly $4 trillion, figures from the World Federation of Exchanges show.
Still, the new exchange lacks a strong international strategy, seen as an important factor for growth since its home market is mired in deflation and has suffered years of economic stagnation.
Globally, exchanges have announced $83 billion of mergers and acquisitions over the past five years, rushing to cut costs and diversify in the face of dwindling revenues from the traditional stock trading business and new upstarts.
"The global environment surrounding exchanges has changed dramatically, and the presence of the Japanese markets has been in decline," said Michio Yoneda, chief executive officer of the OSE, told a briefing. "We are up against a big paradigm shift."
The two said they would merge operations in January 2013 after the larger but unlisted TSE buys up to two-thirds of the listed Osaka exchange in a public tender offer. The tentative name for the merged entity is Japan Exchange Group, Inc.
The TSE will offer 480,000 yen per share, or a 14 percent premium to Monday's closing share price. The price values the Osaka bourse at 130 billion yen ($1.7 billion).
Shares of OSE, where companies such as Nintendo 7974.OS and Murata Manufacturing 6981.OS are listed, rose as high as 5.5 percent before closing up 4.6 percent at 440,050 yen.
The OSE will keep its listing as the surviving entity, though the combined firm would eventually look to re-list on the Tokyo exchange's main board, allowing the TSE to recoup its takeover costs, Tokyo bourse CEO Atsushi Saito said.
The merger ratio values the TSE at roughly 1.7 times the OSE, implying a combined market value of 350 billion yen ($4.55 billion), which would put it roughly on par with Nasdaq OMX, the 9th most valuable exchange, according to Thomson Reuters data.
Based on combined profits of the fiscal year ended in March, the Japan exchange would trade at about 19 times past earnings, higher than NYSE Euronext at 11 times but below top operator Hong Kong Exchanges and Clearing Ltd (0388.HK) at 24 times.
"Trading volumes are weak and they are operating in a shrinking market. Even after the merger there is little hope for a big jump in profits. It doesn't look like an attractive investment," said Ryosuke Okazaki, chief investment officer at ITC Investment Partners.
Saito is due to become chief executive of the new exchange, while Yoneda will assume the post of chief operating officer.
Asian stock exchanges have largely stayed out of this year's global exchange consolidation and the only attempted deal -- the $8 billion bid by the Singapore stock exchange SGX Ltd (SGXL.SI) to buy the Australian stock exchange ASX Ltd (ASX.AX) -- was blocked by the Australian government.
Talks between the TSE and OSE started in March and hit several snags as the two sides struggled to agree on the merger ratio and the structure of the deal, with the TSE originally aiming to list its own shares before merging.
Saito, a former banker with Nomura Securities where he had two postings in New York, said the merger with Osaka would create a "one-stop shop" that would boost liquidity and allow for the offering of a wider range of products and services.
"When I came to the TSE I believed it should be merged with the OSE," said Saito. "During my time abroad looking at Japan I thought that if the Tokyo and Osaka exchanges were separate Japan would lose."
The deal was struck against an increasingly dismal outlook for the Japanese equities market. While new listing have recently picked up slightly, trading volumes are at half of 2007 levels and slumped to a new low for the year last month.
At the peak of Japan's asset bubble in 1989, the Tokyo exchange's market capitalization accounted for about 40 percent of the value of global markets. It now contributes 7 percent, reflecting Japan's loss of economic position.
Japanese exchanges have not been aggressive in seeking out alliances and overseas growth. The TSE has a minority stake in the Singapore Exchange and runs a fledgling joint venture with the LSE, but gets virtually all of its revenues from its core business in Japan.
The TSE's $140 million investment to introduce a high-speed trading system in 2010 was seen as a way to invite more hedge funds and high-frequency trading to Japan, but that has had little positive impact on volumes.
Tokyo and Osaka said they would integrate trading systems, eventually leading to cost savings of 7 billion yen per year.
The merger is seen by some as an important measure to strengthen Japan's markets. The government has long worried about Tokyo's declining importance as a financial hub compared with fast-rising markets in Shanghai and Singapore.
Japanese banking minister Shozaburo Jimi said earlier on Tuesday that the merger would be a positive step toward the establishment of one exchange combining securities and commodities, an idea being pushed by some in the government.
While combining forces should help the exchanges drum up new listings and streamline certain operations it would not do much to address the fundamental issue of sluggish interest in Japanese shares, Nomura Research's Osaki said.
Some analysts are worried of the long-term fallout from an accounting scandal at medical equipment and camera maker Olympus Corp (7733.T), which has put a spotlight on perceived weak points of corporate governance in Japan.
"A merger of the two, in theory it's a good idea, but the issue is more fundamental. How to do you get interest going again, in the underlying shares," said Naomi Fink, head of Japan strategy at Jefferies (Japan) Ltd.
Additional reporting by Lisa Twaronite and Mari Saito in Tokyo and Denny Thomas in Hong Kong, Editing by Edwina Gibbs and Miyoung Kim