LONDON Shares in London Stock Exchange (LSE) fell sharply on Friday as weak underlying earnings from its takeover target LCH Clearnet raised fresh concerns over the deal.
The LSE plans to pay 366 million euros ($488.3 million) for 60 percent of LCH, which as a clearing house makes its money by acting as a middle man in financial trades and guaranteeing to complete deals if one of the parties involved can't.
The acquisition offers the LSE diversification from its equities base into the many debt and currency markets in which LCH operates, but the exchange has already cut its offer price after regulatory demands that clearing houses like LCH hold more capital.
Results from LCH showed underlying operating profit fell 13 percent to 92.8 million euros in 2012. Operating costs rose 8 percent to 298.7 million, as savings from a transformation program were more than offset by investments in infrastructure and regulatory-driven demands.
Phil Dobbin, analyst at Espirito Santo Investment Bank, said while the headline revenue figure - which was up 24 percent on a net basis - was OK, the underlying performance was less so.
"EBITDA (earnings before interest, tax, depreciation and amortization) fell on the year and that is what you take into the deal, which is disappointing," said Dobbin.
Other London-based traders also pointed to LCH Clearnet's rising costs and shrinking EBITDA as cause for the fall in LSE stock, in addition to the exchange's strong advance into the results.
Shares in the LSE were down 5 percent at 1,278 pence by 1136 GMT, having fallen as low as 1,242p, wiping out the stock's gain over the past week which carried it to a more than four-year high.
"We wouldn't comment on the reasons for a rise or fall in the share price," an LSE spokesman told returns. "We maintain that the LCH deal is a very positive development for the group."
LCH - owned by its clients and exchanges - also reported 2012 operating profit of 99.9 million euros, more than double 2011's 45.1 million euros.
Chief Executive Ian Axe told Reuters the clearing house's growth would be "steady" in 2013, as it rolls out new services and extends its reach in areas like Asia.
"We won't be looking to generate those sort of profit rises year on year," he said, referring to the doubling of operating profits in 2012.
LCH Clearnet's appeal to the LSE is enhanced by the clearing house's potential to benefit from new European and U.S. rules that will force the use for middlemen for customized "over the counter" derivatives trades, to increase transparency and minimize risks to the financial system should one side not be able to pay up.
Fees from those so called "OTC" derivatives were LCH Clearnet's fastest-growing area in 2012, with fee income rising 62 percent to 71.6 million euros.
Axe said the company had invested in its OTC offering ahead of the new rules and had found demand for the services before the new rules kicked in. "The buy side are starting to see the value of having these kinds of insurance vehicles," he said.
LCH anticipates further OTC revenue growth as the rules come into force, but Axe would not be drawn on whether it would be in the same region as 2012's.
Axe said LCH was making good progress in efforts to raise up to 375 million euros in fresh capital by the first half of 2013, to comply with new European rules on how much it has to hold to deal with potential client defaults.
Axe declined to say whether the cash would all be raised from LCH clients and exchanges that own the clearing house and its incoming 60 percent shareholder LSE, which cut its offer by a quarter last December because of the new capital demands.
Press reports have meanwhile said Singapore Exchange Ltd (SGXL.SI), Asia's second-largest bourse operator by market capitalization, may join LSE in its LCH deal or may invest separately.
Axe declined to comment on the reported Singapore interest or on whether the LSE deal would be completed by the end of February, as previously announced. "We are making great progress (on the LSE deal}," he said.
($1 = 0.7495 euro)
(Editing by David Holmes)