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Why the LSE bid collapsed

""Look, it's not rocket science, it's about money. The funds have gone `long' on Deutsche Borse and have `shorted' the LSE."

Werner Seifert, CEO of Deutsche Borse

We met at a cafe in the heart of the old City of London, the financial district which accounts for just a square mile in the center of the British capital.

He looked like any other investment banker -- mid-thirties, a smart suit, well-spoken, and oozing confidence.

But for a moment the charm evaporated. "Put that notebook away, this is all off the record," he snapped.

The topic was the sudden decision of Deutsche Borse, led by Werner Seifert, to drop its ?1.3 billion (US$2.5 billion) bid for the London stock exchange.

He wanted to talk about the role of the often secretive hedge-funds, which had played a critical role in forcing the Germans to walk away, for now.

"Look, it's not rocket science, it's about money. The funds have gone `long' on Deutsche Borse and have `shorted' the LSE," he said.

For the uninitiated, what this adds up to is the following: DB walks away and shares in the Frankfurt exchange rise as the market breathes a sigh of relief that it is not splashing out on a bid; and the hedge-funds collect a bundle.

While many believed that the stakes were acquired because the holders supported the benefits that would accrue from consolidation among Europe's stock exchanges, the hedge-funds clearly had a different agenda -- to make money, fast.

But also, so they said, to prevent DB from overpaying.

The funds, along with other investors representing more than 40 per cent of DB, were threatening to oust the supervisory board as part of their campaign to block the bid.

That tied Seifert's hands in negotiations with the LSE, which twice rejected his 530 pence-a-share offer.

Last week, he ditched the whole idea, but reserved the right to re-enter the fray if French rival Euronext tables a formal offer.

As for the LSE, the funds have been shorting the stock.

Short-selling involves traders selling shares they do not own -- they borrow them from long-term holders such as insurers -- in the hope of buying them back more cheaply later and pocketing the difference.

The short-sellers stand to gain as long as DB has gone away for good and a bid from Euronext fails to materialize.

Without a bid, the LSE's shares will probably crash to 400p. They have already fallen from a high of 590p to 492p because the market is now confident that there will not be a bidding war between DB and Euronext.

The banker warms to his theme: "What is happening here is that the hedge-funds are creating situations, rather than just reacting to them.

If they can get a return of about 8 per cent a month, that amounts to around 100 per cent for year."

Whether this is good for liberal capitalism is open to question, and the banker is definitely worried.

"A lot of the hedge-funds are highly leveraged -- in other words, they borrow heavily to invest.

"If they do well, lenders will offer them even more credit, but that could encourage the funds to take foolish risks. If they make too many mistakes, they could pose a threat to the entire financial system," he said.

Up to last week. it was always assumed that European stock exchange consolidation was inevitable.

Now things do not look so clear-cut, although Jean-Francois Theodore, the workaholic head of Euronext, surely has a chance to secure LSE after DB's retreat.

But high-profile hedge players, such as TCI under Christopher Holn, and David Slager's Atticus Capital in New York, were not alone in demanding that DB scrap a bid which they viewed as against shareholder interests.

They were joined by blue chip, long-term holders such as Fidelity and Merrill Lynch, Standard Life and the Italian group, Generali Asset Management.

So, although the hedge-funds can claim they made history by spearheading an investor revolt that turned a large public company's strategy upside down, a number of blue chip investors agreed with their sentiments.

There were also widespread concerns about standards of corporate governance at DB.

Two things wrankled: first, the chairman of DB's supervisory board, Rolph Breuer, is also head of Deutsche Bank, which had offered to partly fund DB's all-cash offer.

If ever there was a conflict of interest, this was it.

Second, despite pressure from DB's American and British investors, who make up two-thirds of the German company's shareholder register, Seifert resolutely refused requests to hold a shareholder vote on the merger.

But, if no one bids, how will things look for the LSE's bosses, chief executive Clara Furse and chairman Chris Gibson Smith?

The LSE's shares will dive and questions are bound to be asked as to why LSE's management failed to secure a deal.

Furse and Gibson Smith, however, ay, assuming that equities markets continue to recover.

But much else could change in 12 months -- the mighty New York Stock Exchange under John Thain is looking at demutualizing to facilitate mergers and acquisitions.

What could be more sensible than to bring together London and New York, the world's two biggest equities trading platforms?
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