The aborted merger with the LSE opened new horizons. Officially vetoed by the EU commission in virtue of antitrust regulations, the deal was in fact too hard to swallow for the German government, not exactly keen to surrender their national champion to the longstanding British rival.
Deutsche Börse's portfolio is split into three segments: the index management and data feeds businesses (11% of revenue), built upon a similar model with S&P Global's; the financial exchanges (54% of revenue), which include Eurex, Europe's leading marketplace for derivatives, and Xetra; post-transaction services (35% of revenue), finally, with trade settlement operator and custodian Clearstream.
Focused on Europe (88% of consolidated revenue), unlike widely diversified LSE's, this portfolio favors index products and equities (50%), ahead of fixed income (25%) and commodities (9%). Management claims that half of revenue should be regarded as recurring, whereas the other half depends on transaction volumes — a higher exposition than peers to market fluctuations.
Banking on its unrivaled scale, Deutsche Börse can offer a full range of integrated services to investors — the actual "plumbing" modern capital markets require to function — on top of remarkably low transaction costs and reliable, liquid and regulated marketplaces. All these features consecrate the group's unassailable competitive advantage in continental Europe.
Operating margins north of 40% shed light on such moat. There remains ample room for improvement to align efficiency with American peers — a performance management has committed to deliver — but these ambitions will be challenged by continuous and necessary investments in technology and regulatory affairs.
Returns on equity average 20%, below peers. This is because Deutsche Börse sports a different business mix and employs less leverage, having to deal with strict capital requirements in the heavily regulated trade settlement business. In effect, akin banks or insurers, Clearstream must hold significant reserves against its commitments.
All in all, major efficiency gains have been accomplished since the latest strategic plan in 2015. Lackluster earnings and cash-flows are history. They now grow at a faster pace than revenue, and this trend looks built to last after the foray in lucrative index management services (a.k.a "DIY indexing"), where Deutsche Börse competes head-to)head with MSCI, LSE and S&P. Together, these three heavyweights control two-thirds of the market.
Forex stands out as the other fast-growing business the German group has set its sights on. Banks are withdrawing from currency trading, a low-margin business with heavy capital requirements. Here lies the opportunity to emulate what CME Group and ICE did across the Atlantic, even if the failed merger with LSE has jeopardized Deutsche Börse's ambitions to acquire FXall — the dominant player with a 40% market share.
Management won't concede defeat. However, a capital raise will inevitably precede any transformative acquisition, for the group must maintain net debt below x1.75 EBITDA in order to remain in compliance with Clearstream's obligations. No doubt this concern has weighed on the stock price for some time, in particular within current economic climate.
Still, the arrival of Theodor Weimer — a restructuring and M&A specialist — two years ago did set the tone for what lies ahead. After their first achievements mentioned above, management's chief challenges will be to ensure the successful roll-out of higher-margin services, and to make up for the lag in terms of recurring revenues — 50% at Deutsche Börse versus 80% at LSE — by scaling up a more resilient and less "transactional" offering.
In that respect, they anticipate additional improvements in efficiency, and assume profit growth of 10-15% for expected revenue growth of 5% — on an annualized basis. Analysts have deemed such scenario credible before they jointly raised their price targets. Yet, at roughly x20 FY20 and FY21 earnings, Deutsche Börse trades at a lower multiple than LSE (x40) in spite of equivalent revenues.
Deutsche Börse is a new position of MarketScreener's European portfolio.