Project Avatar: ASX-SGX Failed Merger

BMA 5318 Investment Banking

Ameya Patkar, Janhavi Anand, Kang Suk Choe, Prabodh Shahi, Zaheed Tejani

Contents
Industry Background ................................................................................................................................ 1 About ASX............................................................................................................................................... 1 About SGX............................................................................................................................................... 2 How the ASX-SGX Merger Story Began ................................................................................................ 2 Motivations behind Merger...................................................................................................................... 3 Deal Structure .......................................................................................................................................... 5 Approvals Required for Merger ............................................................................................................... 6 Funding of the Deal ................................................................................................................................. 7 Immediate effects on Stock price of ASX and SGX................................................................................ 7 Issues concerning the Merger .................................................................................................................. 8 Efforts to push Merger Through .............................................................................................................. 9 Team Opinion: What SGX should have done........................................................................................ 10 Blocking and the Reasoning behind it ................................................................................................... 11 Effects of Blocking the Deal .................................................................................................................. 12 Team Opinion: Why the Deal Failed ..................................................................................................... 13 Conclusion ............................................................................................................................................. 14 Appendix ................................................................................................................................................ 15 Bibliography .......................................................................................................................................... 19

Project Avatar: ASX-SGX Failed Merger

Industry Background
Due to the advancement and integration of financial markets in 2010, the stock market industry had become highly competitive. Global stock exchanges were working more like individual companies with different customers, including firms, financial intermediaries and private and institutional investors. One of the largest drivers of this competition was technology which increased the speed of trading transactions, while also making them more accessible across the globe. Globalization also played another key role in competition, as mergers and acquisitions and cross-border holdings of financial assets increased. At the time ASX defined its main objective as being able to maintain power in the Australasia market listings, while increasing listings in Southeast Asia. SGX tried to position itself in the market by attracting Asian companies, especially private firms found in China, that were not globally recognized then.

About ASX
ASX was a multi-asset class, vertically integrated exchange. Measured by market capitalization it was amongst the top-10 listed exchanges in the world. Its activities included primary and secondary market services, central counterparty risk transfer, and securities settlement for both, equities and fixed income products. It functioned as a market operator, clearing house and payments system facilitator. It also monitored and enforced compliance with its operating rules, promoted standards of corporate governance among Australias listed companies and helped in educating retail investors.

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At the time, ASXs diverse domestic and international customer base included issuers of securities and financial products, fund managers, hedge funds, commodity trading advisers, investment and trading banks, market data vendors, brokers and proprietary traders and retail investors.

By providing its systems, processes and services reliably and fairly, ASX generated confidence in the markets. This feature was integral to the long-term commercial success of ASX.

About SGX
SGX was Asias second largest, and among the worlds largest listed stock exchange. Being the Asian gateway, SGX was the market of choice for investors wanting to participate in Asias vibrant and rapidly-growing economies, as well as for Asian issuers seeking international capital.

SGX offered an extensive suite of securities, derivatives and commodities products, making it Asias most international exchange. SGX's services include listings, trading, high-speed market access, clearing and settlement to depository services and central counter party services for OTC traded derivatives.

By providing long trading hours in the region, and using cutting-edge technology, SGX was an important conduit for investment flows into and out of Asia.

How the ASX-SGX Merger Story Began

The ASX and SGX chiefs aimed to create Asia's fourth-largest stock exchange through an $8 billion cash and shares merger of the two exchanges. This new entity would benefit through various

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synergies, thus enabling the merged entity to tackle existing and emerging competitors. They codenamed the deal Avatar, chosen after the futuristic Hollywood movie about humans invading a new planet for its precious resources.

It was decided that both exchanges would operate out of Australia as well as Singapore, and ASX would maintain its Sydney headquarters and a local management team. However, the core question about the merger to the Treasurer was if Australias economic prosperity was being adversely affected by the formation of ASX-SGX.

Motivations behind Merger

The merged entity would become the fifth largest securities exchange in the world by market capitalization (Exhibit 1), the second largest listings venue in Asia, and the largest provider of exchange-traded funds, derivative products and real estate investment trusts (REITs) in Asia (Exhibit 2).

The management of both, SGX and AGX were interested in going ahead with the merger. The main reasons as provided by them were-

1. Mitigate threat from the entry of the dark pools of liquidity Competition was anticipated to increase in the near future when Chi-X (dark pool) began trading. Chi-X had the potential to take away up to 60% of the total trading done on the SGX at that time (Exhibit 3 and 4).

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2. Mitigate threat from the rise of China With the rise of China, an increasing number of companies wanted to list in Shanghai rather than in Australia, Singapore, or Hong Kong. A strengthening Chinese market could reduce the ASEAN exchanges to small players, surviving only on a limited supply of local capital. It was then anticipated that China would take away 30% of international investment capital that would otherwise come to the SGX (Exhibit 3 and 4).

3. Promotion of Australia as a regional financial hub Although having an overly domestic focus in its financial sector, Australia had many attractive qualities as a market for financial services such as a skilled and mobile workforce, political stability, a sound legal and regulatory framework, worlds largest pools of funds under management, strong banking system and world-class exchange infrastructure. However these were not translated into significant cross-border activity. Australias ambitions to become a regional financial services hub required stronger international connections, especially into Asia.

4. Increase access to foreign capital and reduced cost of capital ASX-SGX had the potential to increase access to foreign capital, and lower the cost of capital through increased scale, liquidity and diversification. Given the dependence of Australias economic prosperity on continuing access to foreign capital, any proposal that increased access to and reduced the cost of foreign capital to Australia would be in its national interest.

5. Opportunities for diversification

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ASX-SGX merger would create opportunities for Australian savers to diversify their asset holdings more easily across Asian investments, and for Australian issuers to broaden their sources of capital to include the rapidly growing pool of Asian savings.

6. Numerous complementary features of ASX and SGX businesses (Exhibit 5) The complementary and synergetic features between ASX and SGX included-

ASX was dominated by financial stocks, especially banks, and mining companies. SGX on the other hand, was dominated by industrial and materials companies, information and communications technology (ICT) stocks, real estate investment trusts (REITs) and financial stocks.

Bond trading was far more established on SGX than ASX, with the value of bond trading on SGX more than 15 times that on ASX in 2009.

ASX had a wider array of derivative products available to market participants compared to SGX. However, SGX offered a suite of regional index futures contracts covering the Chinese, Japanese and Indian markets, whereas ASX listed only one domestic stock index futures contract.

Deal Structure
The outcome of the merger was to be a new holding company ASX-SGX Limited, listed on both the Singaporean and Australian exchanges. This new entity was to continue to operate out of Australia and Singapore, and have an international board comprising of 15 directors from five countries, including four from ASX. The CEO of SGX was to be the CEO of the combined group. 5|Page

Project Avatar: ASX-SGX Failed Merger

Under the terms of the scheme, ASX shareholders were to be paid a combination of A$22.00 (S$28.04) in cash and 3.473 new ordinary SGX shares for each existing ASX ordinary share. Based on SGXs last traded price of S$9.54, it valued ASX at S$10.7 billion (A$8.4 billion) or A$48.00 per ASX share. This represented a premium of 37.3 percent to the last traded price of ASX shares on 22 October 2010.

The transaction was also expected to create substantial value for SGX shareholders. It was to be accretive to SGXs earnings per share by approximately 20 percent, based on FY2010 pro forma financial results, before taking into account estimated cost synergies. Given the expected increase in SGXs earning per share from the proposed combination, SGX expected its shareholders to be able to enjoy higher absolute dividends per SGX share in the medium term with a minimum dividend payout ratio of 70% of net profit after tax for the combined group.

However, based on a number of analysts and market experts, the real benefit to ASX shareholders was lower than the stated, because the merged company would be taxed in Singapore, thus being unable to give franked dividends to ASX shareholders. Analysts said that after considering these factors, the premium reduced to about 17%.

Approvals Required for Merger

To go through, the transaction would require approval from the following bodies-

Approval from the Treasurer of the Commonwealth of Australia

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Regulatory approval from the Australian Securities and Investments Commission as SGX was to acquire more than 15 percent of ASX Regulatory approval from the Monetary Authority of Singapore Approvals from ASX and SGX shareholders Court approval for the Scheme

Funding of the Deal

SGX had secured funding worth S$3.8 billion and A$750 million through various banks. The lending banks were Australia and New Zealand Banking Group Limited, The Bank of TokyoMitsubishi UFJ, DBS Bank, Oversea-Chinese Banking Corporation, United Overseas Bank and National Australia Bank. The loans were coordinated by Australia and New Zealand Banking Group Limited.

Immediate effects on Stock price of ASX and SGX

Immediately post the announcement of the deal, ASX shares were trading only at $37-$39, which was far below the offer price of approximately $48 a share. This was in spite the fact that it was evident to the market that, due to the synergies and benefits to both sides, the chances of the merger going through were extremely high. The investors it seemed were factoring in all possible risks, including regulatory risk, and the reduction in benefit due to inability of the merged entity to pay out franked dividends. (Exhibit 6)

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Issues concerning the Merger

The following were the issues concerning the merger-

1. National interest of Australia 23.5% share in the SGX was held by SEL Holdings Pte on behalf of the Financial Sector Development Fund, which was controlled by the Monetary Authority of Singapore (MAS). This holding of MAS was a major source of concern for the Australian authorities.

2. Loss of jobs in Australia It was perceived that through the merger, ASX would become a lesser partner to SGX. Furthermore, since Singapore was a direct competitor to Australia as a financial services center, it would lead to loss of financial sector jobs in Australia.

3. Value destruction Another issue was the value destruction factor that both exchanges faced to some extent. SGX was perceived to be diluting its growth potential by merging with the slower-growing ASX. Also, it was thought that SGX would fail to provide ASX with access to large capital flows because SGX was smaller as compared with ASX.

4. Opposition from Tokyo Tokyo Stock Exchange, which was then the second largest shareholder in SGX (5% share) was not comfortable with the merger due to the dilution of its holding as a result.

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5. Opposition from Honk Kong The merger faced opposition from Hong Kong since it would make it more difficult for Hong Kong to win offerings by commodity companies and expand further.

6. SGX down gradation The outlook on the SGX stock was downgraded by OCBC, JPMorgan, and Credit Suisse AG following the announcement of the merger proposal. The reasons for this were the vulnerability of its share price to regulatory issues related to the proposal, the higher indebtedness that would result if the merger was to go through, and that SGX growth would be slower based on ASXs unappealing growth profile.

Efforts to push Merger Through

The following measures were employed by both parties to try and get the approval for the merger-

Changing the board structure SGX and ASX announced changes to the initially proposed board structure of the merged entity, in an attempt to please the Australian regulators. The new board was to have 5 each of Australian and Singaporean directors. The remaining 3 directors would be international. Under the original agreement, ASX would have had only had 4 board seats on a 15-member board. Also, ASX and all of its licensed subsidiaries were to maintain boards with a majority of Australian directors and an Australian citizen as Chair.

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Clarifications and answering queries SGX and ASX together exchanged more than 100 queries with the Australias Foreign Investment Review Board (FIRB) relating to their merger proposal. The FIRB is the regulator that makes recommendations to the Treasurer about whether a takeover is in Australias national interest. However, at the end, the FIRB had advised that the takeover was not fit to the national interest and Swan was of the view that the bid should be rejected.

Lobbying efforts ASX hired senior lobbyists to pitch its case. David Gazard, who once was an adviser to the former conservative government's treasurer, and Cameron Milner, who had worked with current Prime Minister Julia Gillard, led the charge. Well-connected bankers at advisers UBS were also involved. However, as per many analysts, the lobbying may have started too late.

Team Opinion: What SGX should have done

Different as compared to other mergers such as the Deutsche Boerse and NYSE Euronext or between London Stock Exchange and Canadas TMX, the SGX-ASX deal was structured more as an acquisition. SGX should have taken a softer approach, by picturing the operation as a strategic tie-up rather than a takeover.

Also, the merger seemed to satisfy ASXs board of directors and shareholders, and all concerns came from the direction of Australian government officials who were worried about the national interest and the image of Australia. Even though ASX and SGX were quick to point out the numerous benefits of the merger, they were not able to convince the Australian regulators. To win

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over the only opponents, SGX should have followed some non-market strategies, such as lobbying, trying to align the company interests with those of the public administration to get the final approval. Lobbying strategies become crucial when national interests are present.

SGX should have also followed a better communication strategy, because we believe they were reactive, and not proactive in letting the regulators know how this merger could be beneficial for Australia. They should have further warranted that commercial jobs would stay in Sydney and not move to Singapore.

Another alternative to approach the acquisition would have been to start with a minor stake in ASX. SGX should have attempted to gain control in an incremental manner, so as to be able to get representation in the Board of Directors. This way would have helped in understanding the possible reactions against a future takeover.

Blocking and the Reasoning behind it

The Australian government officially blocked the deal on 5th April 2011.This was mainly based on the FIRB submitted report to the Australian treasury. The deal was blocked by the Treasurer under the Foreign Acquisitions and Takeovers Act.

The reasons given for the rejection were, firstly the perception that the deal was not really a merger, but rather a takeover. This would have resulted in Australias financial sector becoming a subsidiary to a competitor in Asia. Secondly, Australian regulators believed that since SGX was a

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relatively smaller regional exchange as compared with ASX, the merger would not provide a gateway to Asian capital flows as per ASXs expectations.

The regulators also mentioned that the takeover would cause many financial sector jobs to move to Singapore, thus benefited Singapore more than Australia. Finally, ceding regulatory control of ASX to a foreign party would raise serious risk to the stability of Australias financial system as ASX clears and settles all trades in the country and plays a key role in guaranteeing the market's integrity and stability.

Effects of Blocking the Deal

Damage to Australias image A major backlash caused by the rejection of the merger proposal on loosely defined grounds of national-interest was that it generated a high level of sovereign uncertainty regarding future M&A activity involving Australian companies. This also dealt a major blow to ASX's hopes of finding a partner against a back drop of consolidation amongst exchanges globally.

Uncertainty over future of SGX The decision threw a spanner in the works for the wave of exchange consolidation sweeping the globe and left a cloud hanging over the future of the SGX, which needs to find new partners or face the risk of being swallowed up itself.

Cost to SGX

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The Singapore exchange booked costs of $S12 million in relation to the takeover bid.

Retirement of Elstone Finally, immediately after the blocking of the deal, Robert Elstone, CEO of ASX, announced his retirement.

Team Opinion: Why the Deal Failed

Some of the reasons stated for blocking the merger seem emotional and xenophobic, and important only from the political viewpoint. In spite of the Singapore central bank (indirectly Singapore government) having a 23 per cent non-voting stake in SGX, the merger terms did allow the Australian government to retain full sovereignty in relation to the regulation of securities trading within its borders. Hence, national security risk reason does not seem credible.

The real reason for failure of the deal could have been that even though SGX had the ASX management and its shareholders on board, they underestimated the Australian treasury and governments role in the deal. Under Australian law, a single shareholder could not own more than 15% of the ASX, and a proposal to lift that threshold would have to be tabled in Parliament for 15 days of debate.

Also, it was possible that ASX shareholders felt that they were getting a bad deal, since ASX was a much bigger exchange and had 4 times the listings of SGX. The costs of trading on SGX were among the highest on the world. The exchanges did not intend to combine their clearing houses, as it would have restricted the potential of the merged entity to build trading volumes.

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Market sentiment regarding the deal can also be estimated looking at the behavior of the SGX share price at the time. On first announcement of the deal, it fell about 15%, while news of the merger rejection led to a 6% rise from its pre-announcement value. This could have been because ASX was a slower growing company (P/E 16) as compared to SGX (P/E 26).

All the factors combined together indicated that the deal would have failed even without the interference of the Australian treasury and government.

Conclusion
With increasing competition from Chi-X and the estimated loss of 25% in the equity-trading market share, it was important for ASX to consider a merger or a strategic partner to help increase its efficiency and reduce operating costs. Also, if the merger would have gone through, the proposed Chairman of new entity, Magnus Bocker would have been able to better utilise his years of experience to deal with outside competition.

If ASX were to consider a merger at a future date, its best possible bet would still remain as SGX, due to a dearth of options available. With a market capitalization of USD 6 billion, ASX was larger than the Nasdaq/OMX and the LSE. Also, due to their recent merger, Deutsche Boerse and NYSE Euronext would not be interested in another merger in the near future. The only remaining option was the Hong Kong Stock Exchange, which will probably present a national-interest threat to Australia. Thus, weighing the developments and the scenario at the time, a merger or strategic partnership with SGX seemed to be ASXs best option.

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Appendix
Exhibit 1

Exhibit 2

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Exhibit 3

Exhibit 4

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The boxes in blue shows the situation if no change takes place and SGX and ASX remain in status quo. The size of each box represents the allocation of capital to each area. Light blue shows the allocation of global capital. As shown, of the total capital, a small amount would be allocated to each individual exchange, and a larger amount to the dark pools. The China market too would get a substantial share.

The dark blue area shows the flow of local capital. It shows a small amount to the local exchanges, a larger share to the dark pools, and slightly larger amount to China. As the local exchanges would be starved of liquidity, their listed companies would have to chase international capital by listing on other exchanges. This could potentially accelerate the drift of trading activity to China.

The light green boxes show the expected allocation of local and international capital with the SGX/ASX merger. The allocation of global capital would be more evenly balanced. There would still be a leakage to the dark pools and China, but the loss would be much less. The allocation of domestic capital would also change. The bulk of capital would remain on the local combined exchange and the dark pool. A smaller amount would be diverted to the China exchanges as there would be enough liquidity in the local combined SGX/ASX exchange to meet the requirements of most listed local companies. They would not need to go overseas for capital.

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Exhibit 5

Exhibit 6
50.00 15.00

45.00

13.00

40.00

11.00

35.00

9.00

30.00

7.00

25.00 2010-07-05

5.00 2010-11-05 ASX 2011-03-05 Offer Price 2011-07-05 Adj. Offer Price SGX 2011-11-05

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Bibliography
(2010). ASX and SGX combine to create the premier international exchange in Asia Pacific - the.

ASX-SGX: why the combination is in Australias national interest. (2011).

How the ASX SGX Merger Failed. (2011).

How the ASX-SGX merger failed. (2011, April 21). Retrieved March 18, 2013, from www.smh.com.au: 1dqb2.html http://www.smh.com.au/business/how-the-asxsgx-merger-failed-20110421-

SGX and ASX agree to terminate merger after Wayne Swan blocks move . (2011, April 08). Retrieved 03 18, 2013, from www.theaustralian.com.au:

http://www.theaustralian.com.au/business/markets/sgx-and-asx-agree-to-terminate-merger-afterwayne-swan-blocks-move/story-e6frg916-1226035892602

Singapore Stock Exchange. (2011, October 13).

(25th October 2010). Wall Street Journal.

(6th April 2011). Reuters.

Guppy, D. (2011). Global Markets and the SGX and ASX. 19 | P a g e