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Opponents of TMX-LSE deal see profit in Canadian option

London Stock Exchange CEO Xavier Rolet, left, and TMX Group CEO Tom Kloet speak to the media at the TMX Broadcast centre.

Mark Blinch/Reuters/Mark Blinch/Reuters

Banks and pension funds looking at alternatives to the TMX Group Inc.'s proposed merger with London Stock Exchange Group PLC are seeking a deal that keeps the national stock exchange in Canadian hands.

But they have another motivation as well: They think there may be money to be made in buying back an asset that Bay Street sold off to the public nearly a decade ago.

There has been opposition to the TMX-LSE deal from Toronto-Dominion Bank, National Bank of Canada and Canadian Imperial Bank of Commerce, all of which say there's too much risk that control of TMX will shift out of Canada. Sources say banks that are against the TMX-LSE transaction are having discussions about ways to keep the exchange locally owned. One option said to be under consideration, though no decisions have been made, is to make a counteroffer for TMX.

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Large pension funds that include Ontario Teachers' Pension Plan, Alberta Investment Management Co. and Caisse de dépôt et placement du Québec have been approached for backing as the financial institutions attempt to discern whether there is a profitable way to thwart the TMX's plan to marry the LSE.

The talks are preliminary, and sources say that the financial questions the players are trying to answer include whether there's a way to use the Canadian exchange business as a basis to profitably expand outside the country.

Banks and brokerage firms once owned the exchange and ran it as a not-for-profit utility. But in the 1990s they changed that model, turned what is now the TMX Group into a profit-making business, and ultimately sold their shares to investors, starting with an initial public offering in 2002.

TMX remains highly profitable, despite the loss of trading-market share to new entrants such as Alpha Group, the rival stock market that the country's big banks created to compete with TMX Group.

There aren't a lot of places where banks can invest excess capital that they are generating and get the kinds of returns that TMX has produced for shareholders. TMX produced a return on common equity of about 24 per cent in 2010. Compare that to the returns big banks have made on some of their other investments, such as expanding in the United States, and the TMX starts to look pretty good.

Any move by the banks must be "commercially viable," said one person familiar with the situation.

For pension funds, which are seeking infrastructure investment opportunities, the TMX can be viewed as the financial equivalent of a waterworks or power grid, only instead of water or electricity flowing through the system for a fee, it's trade orders and stock quotes.

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TMX Group has a market capitalization of about $3-billion, not huge relative to banks and multibillion-dollar pension plans. It's also cheap by other measures.

"If they can buy the TMX back, it's not like it's really expensive," said Jason Donville, head of Toronto-based Donville Kent Asset Management. "It's not like it's a lofty price-earnings ratio, relative to its return on equity," added the money manager, who has followed TMX for a decade.

Despite the perception that the business is embattled, the competition is mostly on the stock-trading-fee side, and TMX has other solid moneymakers such as listing fees and energy trading, he said. "The core of the business is excellent, but the trading part has become a scale game," he said.

Any deal, however, would not just be a matter of economics.

Answering the financial questions is only the beginning. There are questions surrounding the idea on a regulatory front, such as whether competition watchdogs would allow TMX, the No. 1 player in Canadian stock trading, to be owned by the same people who own Alpha, the No. 2 player. Between them, the two have almost 90 per cent market share in Canadian equity trading.

Sources say there's a good chance that the talks will go nowhere, for such reasons.

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"I think there's a fair bit of wishful thinking going on, in the sense that people would like an alternative to the deal with the London Stock Exchange, but I don't think anybody has found a formula that works," Leo de Bever, head of Alberta Investment Management, said in an interview on Business News Network. He didn't directly answer questions about whether his firm was involved in the talks, other than to say that "on any deal of this nature, the big pension plans are going to be approached."

Mr. de Bever went on to say that "some people feel that there is some benefit to having the exchange locally owned, and they're obviously working on something that might fit that model." He told BNN that "if the banks were to go it alone, they might face some trouble." He did not respond to a request for comment.

The TMX-LSE deal includes a break fee of $39-million if a better offer comes for either side. Both TMX and LSE would have the right to match a new offer for the other party.

TMX spokeswoman Carolyn Quick said her company is "100-per-cent focused on pursuing our agreement with LSEG. We are very confident in the value that this merger will bring to Canada and its capital markets."

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