'Historic' deal for Tullett Prebon and ICAP

Just five days after confirming talks were underway, and a week after issuing a profits warning, interdealer broker Tullett Prebon has announced it will shell out over £1.1 billion on rival ICAP's global voice broking business. Make no mistake, this deal is massive; an "historic moment," according to ICAP boss Michael Spencer.

Indeed, industry profits are shrinking amid dwindling trading volumes, and a deal of some kind has looked increasingly inevitable. Currently, however, the market thinks this a better outcome for ICAP than Tullett.

"The rationale for the acquisition is compelling: it fast-tracks our growth strategy and offers a powerful value proposition to our clients," explains Tullett chairman Rupert Robson.

"We shall benefit from greater scale, resources for technological development and new product development and we believe that the acquisition can deliver attractive financial returns for shareholders."

But the deal has been very much forced on the pair. The so-called over-the-counter (OTC) market, whereby firms like Tullett and ICAP act as middlemen on huge deals done in private rather than on an investment exchange, is less transparent and has, historically, been subject to less stringent regulation. But clients, which include the big investment banks, have not and business is suffering.

There are also concerns about low liquidity following record levels of issuance of corporate and government bonds. And last week's third-quarter update from Tullett was disappointing.  Revenue rose by 9% to £255 million in the three months, but strip out oil broker PVM and they were down 5% at constant currency. Chiefs also warned that full-year underlying operating profit margin would now be 1.5 percentage points lower than last year.

(click to enlarge)

Obviously, management believes there's a future, but not alone.

"Notwithstanding the current challenging market conditions, Tullett Prebon's recent strategic review concluded that the central role played by inter-dealer brokers in providing liquidity in many asset classes across the OTC spectrum remains secure and that there are opportunities to provide that valuable service to a wider range of participants," the firm said Wednesday.

Once the dust has settled and the exercise of an option arrangement, ICAP shareholders will own 36.1% of Tullet and so-called ICAP NewCo 19.9%. Existing Tullet shareholders will own 44% of the business.

Combining the two businesses will create the largest player in the industry and potentially save £60 million of costs a year. Of course, it could be more. This figure only eliminates duplicated management and support costs, and savings in the second year post-deal should offset any revenue dilution.  

Last week, Barclays stuck its thumb in the air and suggested savings could be as much as £250 million before tax. That includes £130-175 million which the new Tullett might save by trimming the number of voice brokers - it will have 45% of the industry total.

(click to enlarge)

Without a deal, Barclays thought Tullett's share price could slump from 358p to 295p. But they're down around 7% Wednesday at 335p with a deal in place. ICAP, on the other hand, is up 6% at 500p.

Traders clearly think it's done the right thing exiting broking to focus instead on its post trade risk and information, and electronic markets divisions. Alongside today's announcement, ICAP reported a 4% drop in half-year revenue to £595 million - revenue from post trade rose by 8% and electronic markets by 1%, offset by weakness at the soon-to-be-jettisoned broking operation.

According to Barclays, ICAP's remaining businesses are comparable with the exchanges of London Stock Exchange, Deutsche Börse, CME and ICE as well as data providers such as McGraw-Hill, Thomson Reuters, Markit and Factset. These peers trade at an average of 18 times earnings per share estimates for 2016, which could, in time, feed through to ICAP.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.