TORONTO/NEW YORK Final approval of a bid for the operator of the Toronto Stock Exchange opens the door to a bigger role for the new entity in the global exchange industry, with expanding into U.S. markets apparently first on the agenda.
TMX Group, which will control some 85 percent of Canadian stock trading after the C$3.8 billion takeover by the Maple Group, is already in talks to buy Direct Edge Holdings LLC, the No. 4 U.S. stock exchange, for up to $500 million, according to people familiar with the matter.
The Direct Edge talks highlight the strategy that Maple, comprised of major Canadian banks, pension funds and insurers, had in mind when it launched a formal bid for TMX a year ago.
"The exchange has the opportunity to become more important in the world of trading," said Michael Smedley, chief portfolio manager at TMX stakeholder Morgan Meighen & Associates.
Acquiring Direct Edge would let TMX boost its revenue on securities that are dually listed in Canada and the United States, said Sang Lee, managing partner at Boston-based research firm Aite Group. Trading of Canadian stocks in the U.S. market accounts for around half of all Canadian trading volume.
"My guess is TMX is looking at these numbers and thinking why not capture some of that revenue for themselves, as opposed to letting a U.S.-based trading platform win that market share and enhance their revenue," Lee said.
GLOBAL DESIGNS WERE NO SECRET
TMX Chief Executive Thomas Kloet, who will remain in the job after the Maple deal is completed this summer, has made no secret of wanting to expand globally once the Maple is complete.
"Between the banks and pension funds, who have capital, who from my engagement with them are interested in the international expansion that I want to bring to the institution, we are going to be uniquely positioned to be an acquirer of other exchanges around the world," Kloet said in a recent Reuters interview.
Kloet, a former Singapore Exchange CEO, said he would look to the United States, Europe, Asia and South America for deals.
Under his watch, TMX has acquired or taken major stakes in the Boston Options Exchange, the Bermuda Stock Exchange, and Australian risk-management technology firm Razor Risk.
It has also sought to lure international listings from countries such as China, South America and Australia. It currently has around 350 global listings. Around 180 of its listings are U.S.-based.
Direct Edge was started in 1998 as an electronic communications network, matching equity trades. Knight Capital Group bought it in 2005 and spun it off two years later, while keeping a stake. Citadel Securities and Goldman Sachs came on as partners at that time, sending Direct Edge substantial volume.
After obtaining a license through a deal with International Security Exchange in 2008, Direct Edge became a full-fledged U.S. securities exchange, competing with NYSE Euronext, Nasdaq OMX, and BATS Global Markets.
Direct Edge's market share has hovered around 10 percent of U.S. equity trading for the past several years, and its investors are ready to cash out, said a former executive at one of Direct Edge's major stakeholders. Market share isn't growing and other goals of owning Direct Edge, such as lowering prices and influencing market structure talks, have been achieved.
"The backdrop of industry volumes is poor, so there is not a lot the owners can do to positively affect the investment, so at that point, you are just growing and shrinking with the market and you might as well take some money off the table," the person said, asking for anonymity.
Plus, the owners stand to make a good profit by selling now. Citadel and Goldman, which each own just under 20 percent of Direct Edge, put in $25 million to $30 million for their stakes, two sources familiar with the matter said. Those stakes would be worth $100 million if the deal values Direct Edge at $500 million.
TMX may also be looking to use the platform to launch a U.S. listings business, according another source close to the company. Direct Edge's CEO, William O'Brien, is a former head of new listings at Nasdaq.
A deal could also help the Canadian exchange expand outside of North America, as Direct Edge said last year it plans to enter Brazil's cash equities market.
"It's consistent with its other projects in that it's measured and not overly ambitious," Ed Ditmire, an analyst at Macquarie in New York, said of a potential TMX-Direct Edge tie-up. "Hopefully not overly expensive."
FENDING OFF THE COMPETITION
The global exchange industry has seen a flurry of attempted merger activity recently, though many of the biggest deals were unsuccessful.
In the past two years, regulators blocked an attempted merger between Deutsche Boerse and NYSE, as well as Nasdaq and Intercontinental Exchange's attempted takeover of NYSE.
Singapore Exchange Ltd's bid for Australia's ASX Ltd was blocked by the Australian government. The London Stock Exchange's bid for TMX was halted by TMX shareholders, who leaned more toward the Maple transaction.
Buying Direct Edge would help TMX achieve a size that would make it difficult to become a target itself, said Justin Schack, managing director at Rosenblatt Securities.
"If you're playing to be one of the end-game winners in an industry that is consolidating it's important to be big enough to survive independently," he said. "Doing Maple and then potentially doing another deal in the U.S. makes them harder to swallow for an acquirer."