P&L Check Deutsche Börse: Once Bitten, Twice Shy

Stung by the failed merger with London Stock Exchange, Deutsche Börse will shun mega-deals in the future. But business is still booming, with hopes to profit from growing trading volumes, US rate hikes and Brexit.
Quelle: dpa
Deutsche Börse has ruled out more big mergers after the failed tie-up with the London Stock Exchange.
(Source: dpa)

In many ways, it’s been an annus horribilis for Germany’s Deutsche Börse, whose grand plan to create one of the world’s largest securities and derivatives markets operators by merging with the London Stock Exchange collapsed in the wake of the Brexit vote.

The fiasco has left Chief Executive Carsten Kengeter weakened and grasping for a new growth strategy. Shareholders are unhappy, even though they’re getting a 10 cent dividend increase to €2.35, or $2.60, per share because Deutsche Börse’s business remains sound and profitable. Last year, the company delivered an 18 percent increase in net profit to around €722 million.

For the moment though, the results are secondary to the failed merger, which cost Deutsche Börse millions in fees. Added to that, Mr. Kengeter faces an insider trading probe, with prosecutors examining whether a share purchase plan created for him in 2015 came at a time when Deutsche Börse was aware that a merger with the LSE was likely.

Carsten Kengeter, the Chief Executive of Deutsche Börse, may have some explaining to do to shareholders.

Mr. Kengeter has said the allegations are unfounded but the notion that the guardians of the DAX stock market index may have broken one of the principal rules of share trading is weighing on Deutsche Börse’s image.

As if that weren’t enough, Mr. Kengeter has raised eyebrows for receiving a remuneration totaling around €8 million last year, more even than the head of automaker VW, Matthias Müller, who got €7.8 million. Shareholder consultancy Hermes has called for the payment to be lowered in light of the collapsed merger.

Nevertheless, important major shareholders remain faithful to the management, which isn’t surprising given that Deutsche Börse’s share price has climbed 27 percent since Mr. Kengeter became CEO in June 2015. Investors are also looking forward to a promised share buyback program of around €200 million. In addition, the company did brisk business in the first quarter.

Deutsche Börse is promising to boost revenues and cut costs. But that depends in no small measure on market trading volumes which it cannot control. As the lion’s share of its costs are fixed, a slowdown in market activity inevitably hits profits.

The problem is evident in its Xetra cash market section. Trading volume last year slid 16 percent from the record level in 2015, and earnings before interest and tax fell 34 percent to €63.8 million. However, last year’s market lull hit Deutsche Börse’s European competitors as well. And the drop was more than offset by strong earnings generated by the custody business of its Clearstream unit and by its Eurex futures market subsidiary.

Clearstream earns most of its money from settlement and custody services for international bonds, which yield interest income as well as fees. The interest income jumped last year to €62.6 million from €34.1 million and will likely keep increasing if the US Federal Reserve goes on hiking interest rates. Deutsche Börse is also pinning hopes on TARGET2-Securities, a European platform for settling securities, which is expected to boost business volumes.

Futures exchange Eurex meanwhile profited from increased demand for index-linked derivatives and from brisk trading at its unit EEX, the European Energy Exchange, where revenues rose 23 percent to €234.2 million last year.

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New regulations will likely help Deutsche Börse this year and in 2018 because EU member states decided in the wake of the financial crisis that market participants must increasingly conduct financial transactions via regulated trading platforms. For example, the European Market Infrastructure Regulation, or EMIR, requires a step-by-step expansion in clearing obligations, which will boost income for Deutsche Börse’s clearing services.

The aim is to make the financial system safer by forcing traders to settle their transactions via clearing houses. That’s good news for Deutsche Börse but on its own won’t be enough to fulfill its growth targets. The financial firm wants to increase its revenue by between 5 and 10 percent this year. That's even more ambitious for group net profit, which it wants to boost by between 10 percent and 15 percent.

How to achieve that? A merger is out of the question. Deutsche Börse has lost its appetite for mega-deals following a string of failed attempts. “We have learned that consolidation in the core business of stock exchanges is quite difficult and doesn’t get political support,” Chief Financial Officer Gregor Pottmeyer said at the presentation of the first-quarter results in April.

Instead, Deutsche Börse might opt for strategic acquisitions to forge into new business areas. Internal documents seen by Handelsblatt outline a three-pronged strategy for future growth consisting of expanding the trading platform to accommodate new asset types, earning money with big data and digitalizing the exchange.

The stock exchange also sees a “historic opportunity” to expand its derivatives business in the wake of Brexit because the lucrative clearing of euro derivatives could be relocated from London to the European continent. It’s unclear, however, whether Frankfurt will win that business. Paris is also vying for it.

As Deutsche Börse has no influence on trading volumes, it will have to focus on cost reductions to boost its earnings. Outlays rose to €1.32 billion last year, partly due to the LSE talks that cost €66 million in legal, auditing and PR consultancy fees. Efficiency programs cost €11.1 million and a criminal investigation into a US subsidiary of Clearstream cost €19.7 million. Excluding all those extraordinary items, costs were little changed, and that’s the way Mr. Pottmeyer, the finance chief, wants to keep it. He’s factored in a cost increase of between zero and 5 percent, depending on earnings growth.


Michael Brächer is a financial editor in the investment team in Frankfurt. To contact the author: [email protected]