London Stock Exchange Group: Diversification Has Succeeded

London Stock Exchange Group's (LSE.L) interim results have been well flagged by earlier market statistics and the September pre-close announcement. We believe the critical issue for investors is that diversification has worked. Despite appalling equity market conditions, group organic constant currency income was down just 1%. The group is now so much more than just an equity exchange. We also highlight the good cost performance.

Interim results
Reported revenue was up 10% y-o-y driven by the acquisition of FTSE (net increase £58.1m) and a strong treasury income (up £13.8m) offsetting pressure in capital markets and post-trade services. Organic constant currency income fell just 1% despite the market conditions. The only surprise was a positive one in the treasury income. Costs grew 3% on the same basis and were somewhat better than we expected, a performance we have carried forward into our estimates.

Treasury income
The most noticeable beat was in treasury income (H1 actual £68m vs consensus £59m). This number is intrinsically volatile, but some of the H1 beat is generated from, and naturally offsets, the same market macro concerns that have seen weak equity-related income. Management has already moved about a third of its portfolio to be compliant with new regulations and is still indicating that the FY13 outturn will be above current consensus. Taking account of the beat in H1, we estimate the net effect of new regulations will be under £40m and within market expectations.

Strategic issues
Over recent months there have been major regulatory announcements on how central counterparties have to be managed and capitalised, as well as a major diversification of funding. With these results, management most notably commented that it is negotiating with LCH.Clearnet to ensure LSE achieves an appropriate RoI from the deal. We believe this could include not only discussion over price, but also where cost savings are achieved (in LCH.Clearnet, LSE would only get 60% of the benefit).

Valuation: Modest upside
Our valuation methodologies indicate an unchanged fair value of c £10.70 giving some upside.

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