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LSE's Italian Defense Could Backfire

The London Stock Exchange's expansion could make it even more alluring to Nasdaq.

The London Stock Exchange's bid for Borsa Italiana has been widely touted as a successful defensive coup against a looming takeover bid from

Nasdaq Stock Market


. But some now say it may have the opposite effect.

On Wednesday, Borsa Italiana's shareholders approved necessary changes to the Italian stock exchange's rules, permitting a 1.63 billion euro ($2.31 billion) takeover bid by the London Stock Exchange. The offer was approved by 78% of LSE's shareholders, and accepted by 99% of investors in Borsa Italiana.

Shares in LSE have gained as much as 8.5% since the beginning of the year after Nasdaq and Deutsche Boerse attempted to buy out the stock exchange for the fifth time in two years. Ultimately, the German exchange dropped out while Nasdaq's hostile offer was overwhelmingly rejected.

Wednesday's bid for Borsa Italiana was seen by many as a move to expand the size of LSE, in order to frustrate further potential takeover bids.

The British exchange hopes to bring its widely successful small-cap Alternative Investment Market, or AIM, model to the Italian borsa, which is currently dominated by large-cap stocks. But some observers say this is exactly what may make the exchange more attractive to the Nasdaq, which can bid again for LSE in January next year.

"AIM has been a huge success," says Dru Edmonstone, a director of London merchant bank Seymour Pierce. "If Nasdaq buys the LSE, they will clearly be looking to expand the AIM model across Europe."

Neither the Nasdaq nor the LSE responded to requests for comment. (Meanwhile, the Nasdaq itself is the

subject of takeover speculation Thursday.)

Matteo Ghilatti, an analyst at Italian investment house Euromobiliare S.I.M in Milan, agrees. "What the Borsa Italiana is really hoping for is to attract small- and medium-caps to a new AIM-style market called Mercato Alternativo del Capitale," he says.

Mercato Alternativo del Capitale, or MAC, will be a market for tiny companies where prices are set once a week, and financial statements are quickly audited to avoid the lengthy procedures traditionally associated with the Italian borsa, Ghilatti explains. The LSE's bid for Borsa Italiana is immaterial to the larger-cap companies, which already have established domestic and international trading operations, he adds.

Markets for smaller-cap companies have traditionally fared very badly in Europe, says Edmonstone, one of the first bankers in London involved with AIM, starting in 1995. European investors have traditionally favored larger, multinational large-caps and government bonds over start-ups, which are still predominantly family-run in the region.

London's AIM has bucked that trend. Set up in 1995 after another London small-cap exchange failed due to a lack of liquidity, AIM is now the most successful small-cap market in the world, comprising more than 1,400 companies. Over 200 of those companies are international, and the market has seen $42 billion raised in its lifetime.

Still, the AIM exchange is significantly smaller than the Nasdaq and has never been home to giants the size of


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; rather, smaller Chinese companies tend to list directly on the LSE.

AIM's brokers -- and shareholders of the LSE -- have been widely hostile to the idea of an acquisition by Nasdaq, which they say may upset the successful formula. Many fear the U.S. exchange would tighten listing rules, which are currently much more relaxed than on American exchanges. For example, AIM does not require a company to have any specific trading volume, market capitalization or earnings history.

Stephen Norcross, an AIM-based corporate broker for investment boutique J.M. Finn Capital Markets Ltd. in London, says that almost every week American companies come to enquire about listing on the exchange, a trend

linked to the advent of Sarbanes Oxley.

"We don't want to be regulated out of the market like Nasdaq has regulated itself out of the market," he says.

Another major shareholder in an LSE-member AIM broker put it more bluntly: "I personally think the best thing about this Borsa Italiana deal is that it has diluted the Nasdaq holding in the LSE. The last thing the LSE wants is to be taken over by the Americans."

But the Nasdaq, say others, may be the perfect size to expand small-cap investing across Europe. More to the point, if Nasdaq offers a high-enough price for LSE next year, there's a good chance shareholders might take it, Edmonstone says. "If the price is right then shareholders will be amenable."

Daniel M. Harrison is a business journalist specialising in European and emerging markets, in particular Asia. He has an MBA from BI, Norway and a blog at

. He lives in New York.