HKEx's LME bid raises hackles in London

At its heart, HKEx’s successful bid for the London Metal Exchange (LME) demonstrates Asia’s ability to take long-term strategic positions, while the West scrabbles around for short-term infusions of cash.
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HKEx: Speculating on the future of the renminbi
<div style="text-align: left;"> HKEx: Speculating on the future of the renminbi </div>

The £1.4 billion bid by Hong Kong Exchanges & Clearing (HKEx) for the London Metal Exchange (LME) is raising hackles in the UK, where some people see it as yet more hollowing out of the British economy by cash-rich plunderers from overseas.

From houses in Kensington, to water companies in Northumbria, to train lines in Kent, there really isn’t much that hasn’t been sold to Asian buyers. The LME is just the latest asset to be picked up.

The deal itself makes good sense, especially for HKEx, which can use it to diversify away from big-ticket Chinese IPOs and the fast-growing equity derivatives business. As Charles Li, chief executive of the exchange, said at the beginning of his analyst presentation: “This is a big day for HKEx.” Indeed.

The fact that HKEx can fund this deal in cash while also maintaining its dividend payout ratio at around 90% highlights the financial firepower that Asian buyers have at their disposal. The bridging loan that will be used to finance the purchase is being supplied in part by China Development Bank.

This Chinese government involvement worries many in the UK market, who like to think of LME as a strategic UK business falling into the hands of communists. Yet they could not be more wrong. The LME is owned by the banks and trading companies that use the exchange, and their ownership level is based on how much they use it — which means that J.P. Morgan and Goldman Sachs are the biggest shareholders.

It is therefore misleading to look at this deal as another example of UK Plc selling out to foreigners. Rather, it makes more sense to see it in the light of the Visa IPO — a deal that was launched during the first quarter of 2008 as US subprime losses were mounting. Visa was a highly lucrative asset owned jointly by most of the world’s financial institutions. Its sale was a monetisation exercise by those who knew that trouble was looming on the horizon.

The dash to cash made sense then. And while the LME deal is far smaller than the $18 billion Visa IPO, the thinking behind the sale is the same. The fact that the LME is being sold two days before the Greek election adds to the perception that it is a liquidity exercise, even if the size of the transaction is something of a rounding error when broken down among all the participants.

Looking at the structure, price and valuation of the deal, one can also see the LME shareholders are opting for short-term gains, in lieu of long-term growth. At 181 times last years’ earnings, the deal certainly looks good for the sellers. But the LME has just this year started to increase its fees to something approaching commercial levels (the deal is reckoned to be priced at 58 times 2011 earnings based on the higher fee rates). And it will increase them much more in the future. Which suggests that the shareholders — who are the users — are electing to take an upfront payment in cash that they will, in turn, use to pay for much higher future fees. In effect, they are agreeing to fund the transaction themselves; unless of course they move their business to a rival exchange.

HKEx is clear that it does not expect this to happen. At the analysts’ briefing the management suggested that, even after the increase, LME’s fees would still be less than those of the Chicago Mercantile Exchange and the Shanghai Futures Exchange — although it is not clear that both of those offer a direct comp to the LME, given their markedly different contract structures and business models.

Even if there is some slight loss of business away from the LME in light of future fee increases, the long-term increase in business from expanding into China and the rest of Asia should compensate. And it is the long-term strategic capacity to invest for the future that makes this bid so indicative of where the world is going.

In his presentation, Li specifically referred to the internationalisation of the renminbi as one of the strategic rationales behind the deal. That process might not be immediately obvious to the LME’s members, who have more pressing concerns. But along with China being the end buyer of 42% of the global commodities market and the growth of South-South trade, the internationalisation of the renminbi will be one of the defining trends of this generation. This deal will allow HKEx to take advantage of all three trends.

There will be the usual comments from blowhards complaining that HKEx has overpaid, while the Little Englanders will moan about the loss of a national asset (it isn’t). But this deal needs to be judged in HKEx’s and the Asian market’s long-term context; just as the motivations of the sellers should be viewed through their short-term exigencies. Being able to take such long-term strategic positions (in cash) is a luxury that those in the West just do not have at the moment.

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