Moody's changes outlook on London Stock Exchange Group's Baa1 rating to positive on Deutsche Boerse AG merger announcement

Moody's today affirmed the Baa1 long-term issuer rating on London Stock Exchange Group plc ("LSEG") and changed the outlook to positive from stable. The positive outlook reflects the anticipated improvement in LSEG's credit profile if the announced all-share merger with Deutsche Boerse AG ("DB1", unrated) is completed. At the same time, we have also affirmed the Baa1 long-term issuer rating of London Stock Exchange plc, as well as LSEG's Baa1 senior unsecured and (P)Baa1 senior unsecured programme ratings, and changed the outlook to positive from stable. Should the merger occur on terms broadly consistent with those announced, LSEG's credit rating would likely be upgraded.

RATINGS RATIONALE

Upon completion, we expect LSEG bondholders to benefit from the combined group's improved revenue diversification, more stable earnings, lower leverage and improved franchise strength.

If consummated in accordance with the announced terms, the merger would result in the formation of a new "UK TopCo" holding company domiciled in the United Kingdom, with LSEG and DB1 as subsidiaries. DB1 shareholders would own 54.4% of UK TopCo, with LSEG shareholders owning the remaining 45.6%. The merger requires the approval of shareholders and numerous regulators, with an estimated completion date by the end of 2016 or early 2017.

The combined business would form a European market infrastructure group comparable in size to its US industry peers. With proforma revenues for 2015 of EUR4.7 billion, LSEG bondholders could benefit from a more diverse revenue base comprised of leading global businesses across capital markets, post-trade and information services and technology. The combined group would reinforce the two firms' leadership positions, notably in European equity trading, clearing and indices. The firms have cited a proposed portfolio margining service between listed and OTC rates derivative clearing markets as a further benefit of the merger. While this would create significant customer benefit through lower margin requirements and hence capital savings, which could translate into higher market share and revenues for the combined firm, the cross-margining protocols would need to be carefully constructed to maintain the robustness of clearing house waterfalls.

In light of the UK referendum on EU membership on June 23, a joint "Referendum Committee" has been established to advise on the implications of a potential "Brexit".

Management has identified cost synergies of EUR450 million, approximately 20% of the combined cost base of the business, with an estimated EUR600 million in costs to achieve these synergies. Targeted synergies are expected to be realised through technology efficiencies, corporate centre reductions and business segment optimisation. These synergies are estimated by the firms to be realized on a progressive basis, with all synergies targeted to be achieved within three years of the completion of the transaction. Moody's considers this target to be ambitious, being higher than savings achieved in similar transactions, although LSEG has had a successful track record at integration and cost reduction, albeit on a smaller scale.

Management has projected net debt/EBITDA leverage to fall to 1.0x over the medium term from an indication of 1.7x for the combined business pro forma as of year-end 2015. According to Moody's calculations, this would be a significant improvement from the rating agency's own gross debt/EBITDA calculation for LSEG of 1.8x (based upon preliminary year-end reported figures at 31 December 2015). In determining the extent of any benefit of the combined Group for LSEG bondholders, we would consider whether the UK TopCo or the underlying LSEG and DB1 subsidiaries support, for example through cross guarantees, the respective legacy debts issued by LSEG and DB1.

As the transaction clears its many regulatory hurdles, Moody's will monitor the merger's likelihood and timing of completion, while also analysing the financial and strategic plans of the new company.

What Could Change the Rating - Up

Should the merger with DB1 go ahead, it is likely that the ratings of LSEG would be upgraded. This is due to the following factors: (a) increased franchise strength through the combined group's broader product offering and geographic breadth; (b) improved earnings stability and higher cash flow generation; and (c) an expected reduction in leverage towards the lower end of the 1-1.5x leverage range over the medium term.

What Could Change the Rating - Down

Should DB1 increase its bid for LSEG and introduce a cash element, the additional debt required to support the higher cost could result in increased leverage for the combined business and ultimately be negative for the rating.

Additionally, the following factors could result in a rating downgrade: (a) departure from the stated financial policy leading to the reduced financial flexibility of the merged business; (b) a material operational failure; or (c) a requirement for substantial capital or liquidity increases related to its post-trade clearing operations that stresses the combined group's financial position. A significant requirement for additional resources in the clearing operation, while beneficial to the clearing houses, could reduce financial flexibility of the combined group.