Hong Kong Exchanges & Clearing Ltd.’s bid for the London Metal Exchange, the most expensive bourse merger over $1 billion, may succeed in gaining the approval of regulators who’ve scuttled $32 billion of similar cross-border deals.
Hong Kong Exchanges shares dropped 4.5 percent in Hong Kong, taking declines to 26 percent since Feb. 18, when the South China Morning Post first reported the bid. The Bloomberg World Exchanges Index has dropped 14 percent in that time. The offer of 107.6 pounds a share, or 180 times LME’s 2011 net income, requires approvals from LME’s shareholders and the U.K. Financial Services Authority. It doesn’t need shareholder consent in Hong Kong.
The offer price is “extremely expensive,” according to a client note from Morgan Stanley written by Anil Agarwal and Isabella He. The London bourse will remain under the watch of the FSA, meaning the deal may avoid national interest and market power concerns that prompted market regulators and politicians to block other exchange mergers.
“There’s a much lower level of political concern about the LME than there would be about the takeover of the London Stock Exchange,” said Ruben Lee, chief executive officer of Oxford Finance Group, a London company specializing in financial and commodity markets. “U.K. regulators will maintain their control over the operations of the exchange. There will be concern about the fitness and the properness of any new owner, but I’m sure that Hong Kong Exchanges & Clearing are going to satisfy that.”
Hong Kong Exchanges had the biggest decline among the 49 companies in the Hang Seng Index as investors had their first chance to react to news of the bid today. Shares of Intercontinental Exchange Inc., which lost out to Hong Kong in the bidding for the LME, fell 0.2 percent in German trading after jumping 4.3 percent on June 15.
The takeover would give Hong Kong control of a business that sets global prices for base metals, while LME stands to gain greater access to China, the biggest consumer of metals including nickel, aluminum and copper.
The Chinese bourse was cut to underperform by analyst Sam Hilton at Keefe, Bruyette & Woods, and had its earnings estimate reduced by Credit Suisse Group AG analyst Arjan van Veen. Both analysts have a HK$100 target on the shares.
LME shareholders, led by JPMorgan Chase & Co., Goldman Sachs Group Inc. and closely held Metdist Ltd., are expected to vote on the offer by the end of July. If they approve it, the transaction will be reviewed by the FSA. The regulator has three months to consider a completed application from a buyer once it’s received, according to Joseph Eyre, a spokesman for the FSA in London.
The FSA’s sole concern is that Hong Kong Exchanges doesn’t “pose a threat to the sound and prudent management” of the markets operated by the LME, according to the regulator’s handbook. While there are no fixed criteria for the review, the regulator will consider the financial soundness of the bidder and the influence the new owner may exert, David Blair, head of financial regulation at Osborne Clarke, a law firm, in London said by e-mail June 15.
“The FSA will obviously want to understand the change of ownership and more about the new owners of the exchange,” Niki Beattie, chief executive officer of Market Structure Partners Ltd., a London-based consulting firm, and a former managing director at Merrill Lynch & Co., said in a phone interview. “If, as they say they will, HKEx continues to operate the same model for the time being, there is unlikely to be further scrutiny of the model.”
Singapore Exchange Ltd’s $8.3 billion bid for Sydney-based ASX Ltd. was blocked in April 2011 by Australia’s government on national interest grounds. The European Commission vetoed NYSE Euronext’s $9.53 billion sale to Deutsche Boerse on Feb. 1, saying the deal to create the world’s biggest bourse owner would have led to a “near-monopoly” in European exchange-traded derivatives.
“This is different from NYSE-Deutsche Boerse or ASX-SGX mergers,” said Diego Perfumo, an exchanges analyst at Equity Research Desk in Greenwich, Connecticut, who has been analyzing exchanges for 12 years. “You have a global market of metals that doesn’t affect directly the economy of the U.K. The FSA will have the last word. That should give confidence to any market participant that there won’t be manipulation.”
The Office of Fair Trading doesn’t have an open investigation into the London Metal Exchange acquisition, said Frank Shepherd, a spokesman in London.
At 180 times trailing net income, Hong Kong Exchanges’ bid is the most expensive of any bourse deal above $1 billion since at least 2000, according to data compiled by Bloomberg. The next highest multiple was 66 times net income paid for CBOT Holdings Inc. in 2007 by CME Group Inc. Chicago-based CME overtook Hong Kong Exchanges as the world’s biggest exchange operator by market value earlier this year.
LME’s fees have historically been kept low to benefit members, according to Hong Kong Exchanges’ offer document. A fee increase to take effect in July would have tripled profit had it been in place during 2011, according to the document. Hong Kong Exchanges said as part of the bid that it won’t increase fees until at least January 2015.
The bid price is almost 22 times the 4.925 pounds that LME stock last changed hands for in July last year, before the bid process began.
“The major approval they need is from shareholders, that’s the first hurdle they need to clear,” said Gurjit Kambo, a London-based analyst at Credit Suisse AG, by phone June 15. “At the moment as a shareholder you have much more control over what the LME will charge you, and that could change. They will have to make a tradeoff in terms of getting a cash injection versus potentially losing out in terms of higher fees.”
Hong Kong Exchanges doesn’t need shareholder approval for the deal, Henry Law, the bourse’s head of corporate communications said by phone. At 1.39 billion pounds ($2.17 billion), it’s worth less than 25 percent of the bourse’s $15.66 billion market value, meaning it’s merely a “disclosable” transaction under the city’s listing rules.
Hong Kong is the only place in China where investors can freely buy and sell shares in Industrial & Commercial Bank of China Ltd., the biggest lender by value, and PetroChina Co., Asia’s largest company. The deal would be Hong Kong Exchanges’ first overseas acquisition. The 135-year-old LME’s network of warehouses doesn’t currently extend into China, the biggest consumer of the metals it trades.
“Hong Kong is very much known for its link to China and its initial public offerings in equities, so this is a very smart way to diversify their revenues,” Simmy Grewal, London-based senior analyst at Aite Group LLC, said in a phone interview. “The fact that Hong Kong doesn’t have experience in commodities is a plus. They’ll let the LME do the job since they are the experts. That’s what’s needed for this deal.”