HKEx paying too much for LME, say FA readers

Hong Kong’s stock exchange provoked a few raised eyebrows last week when it bid £1.4 billion ($2.2 billion) for the London Metal Exchange (LME).

At that price, Hong Kong Exchanges & Clearing (HKEx) is paying a whopping 181 times more than the LME’s 2011 revenues (of just £7.7 million). It is easy to understand why some critics have accused HKEx of paying over the odds, so we asked our readers what they thought in last week’s online poll.

More than half of respondents said the price was too high.

In a statement, HKEx rationalised the valuation in two ways: first, a fee increase due to take effect next month will substantially boost earnings; and, second, HKEx is in a unique position to help the LME gain access to China.

Earnings have been low in the past because the exchange is member-owned, and the members have chosen to charge themselves low fees. HKEx told shareholders in its statement that the LME would have earned profits of £23.8 million — or more than triple its actual earnings — if the higher fees had applied to last year’s trading volume.

Using this assumption, HKEx is paying a not-so-eye-popping 58 times more than 2011 earnings. That might still seem high, but at least two other exchange mergers have produced higher valuations.

Critics counter by pointing out that the LME cannot have its cake and eat it. “The adjusted valuation is a ‘what if’ number,” said one source. “The unstated assumption is that raising charges does not reduce volume — obviously not a real-world assumption.”

Even so, the opportunity in China is clearly real. The 135-year-old LME is the world’s leading metal exchange and controls roughly 80% of global trading in metals futures. China, on the other hand, consumes about 40% of the world’s metals.

“While the LME is a global exchange, it has yet to realise fully the growth opportunity in Asia, and China in particular,” said HKEx. “Improving access to the LME’s market for Chinese users is expected to significantly enhance the LME’s business and that of its existing members through increased trading volumes.”

Unless Chinese officials have given HKEx a wink and a nod, that seems a bit of a gamble. China already has its own metal futures market in Shanghai and has so far been reluctant to grant greater access to the LME and other foreign exchanges — despite their best efforts.

HKEx seems confident that it will have more luck, but shareholders do not share the enthusiasm. Since rumours of the acquisition first appeared in February, HKEx’s share price has fallen from HK$147 to HK$108.70 at yesterday’s close.

The assumptions about the LME’s revenue growth and access to China may eventually prove true, but changes will have to happen quickly if the deal is to create value for shareholders.