Hong Kong Exchanges & Clearing Ltd.’s bid for the London Metal Exchange, the most expensive bourse merger over $1 billion, is seen as a way for the LME to expand into China, the world’s largest buyer of metals.
China became the largest copper user in 2001, beating the U.S., and now accounts for 40 percent of global copper demand, compared with 13 percent in 2000, according to Royal Bank of Scotland Plc. The offer of 107.6 pounds a share, or 180 times LME’s 2011 net income, requires approvals from LME shareholders and the U.K. Financial Services Authority. It doesn’t need shareholder consent in Hong Kong.
The LME has 732 approved storage facilities in 37 locations in 14 countries from Singapore to the U.S. China has prohibited foreign futures exchanges from establishing warehouses in the country for physical delivery since 2008 to ensure market stability. The Asian nation now accounts for 20 percent to 25 percent of LME trading, according to the Hong Kong Exchanges.
“The Hong Kong bid has proximity to the Chinese market and potential entry to the Chinese market,” said Nic Brown, an analyst at Natixis SA in London. “China is certainly very important.”
The Hong Kong Exchanges’s ability to bid for the LME signals that the hurdle on warehouses appears to have been cleared, according to Thomas McMahon, a former chief executive officer of the Singapore Mercantile Exchange. “To do that independently in China, no one has ever been successful before,” McMahon said by phone today from Singapore, referring to attempts by a foreign exchange to establish warehouses in China.
The LME wants to expand its warehouse network into China, Martin Abbott, the exchange’s chief executive officer, said in May. It opened its first Asian office in Singapore in 2010 and introduced new contracts with the Singapore Exchange Ltd. to attract investors. BOCI Global Commodities (U.K.) Ltd., a Bank of China Ltd. unit, became the first Chinese company member of the LME this year.
“Their full potential will not be realized until they can tap the geography,” Charles Li, chief executive officer of the Hong Kong Exchanges, said June 15. “They need China expertise. They need Asia expertise. And we have a lot of it.”
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.
Hong Kong Exchanges shares dropped 26 percent since Feb. 18, when the South China Morning Post first reported the bid. The Bloomberg World Exchanges Index has dropped 15 percent in that time.
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, climbed 0.6 percent in New York trading today.
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.
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.
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 ($2.18 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 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.”
The LME hired Moelis & Co. to advise it on the takeover, while Freshfields Bruckhaus Deringer LLP handled the corporate work and Jones Day acted as antitrust counsel. Hong Kong Exchanges is being advised by UBS AG and N.M. Rothschild & Sons Ltd. Allen & Overy LLP served as legal counsel to the Asian bourse.