When it comes to valuing a business as complicated as the London Metal Exchange, you would think the advisers to Hong Kong’s bourse would not have resorted to a kind of numerical feng shui.
Yet the GBP 1.388bn that Hong Kong Exchanges & Clearing has offered in an agreed bid for the venerable British institution is, whether by accident or design, curiously close to the Asian bourse’s own stock ticker of “388″.
It is a strange twist in a deal that underscores yet again the China factor in the global economy. China accounts for 40 per cent of worldwide demand for metals and HKEx believes it has a chance to use its connections there to boost Chinese participation on the LME beyond its current 25 per cent level.
Yet the deal is about more than that. Assuming it is approved by LME shareholders, it signals the start of a shift away from the west to Asia in how prices are fixed between buyers and sellers – a process known as “price discovery”.
For exchanges, where much of that price discovery takes place, this is an important moment. For more than a century, Chicago, with its noisy pits, was the place where prices were set and hedged by farmers and commercial buyers of wheat. The same was true of crude oil at the New York Mercantile Exchange. London also has its massive oil market and the LME, where global benchmarks are set daily in the prices of copper, aluminium and zinc.
It has taken an Asian exchange – with no record of acquisitions – to land the last remaining prize in the exchange business and set that shift towards Asia in motion. HKEx’s western peers have spent much of the past two years entangled in a string of failed mergers – most recently, an attempt by NYSE Euronext, operator of the New York Stock Exchange, to combine with Deutsche Borse. NYSE Euronext was among the losing bidders for the LME, withdrawing after deciding that the auction had bid the LME’s price up too far.
Now investors in HKEx think the same and have been heading for the exits, put off by a price that is 180 times the LME’s earnings last year. Even stripping out the fact that the LME was not run on a for-profit basis, and a fee increase planned for next month, Keefe, Bruyette & Woods estimates the deal is still being done on a forward earnings multiple of 46 times.
Shares in HKEx stand 25 per cent lower than their mid-February level, making them the worst performing of the largest 20 exchanges, according to Bloomberg.
This is knee-jerk stuff. HKEx probably had no choice but to try, precisely because of where exchanges are likely to make a lot of money in coming years: commodities and commodity derivatives in Asia. And there is no shortage of precedents for richly valued deals in the sector, where scarcity value and strategic necessity have driven deals that initially looked crazy.
The London Stock Exchange’s acquisition in April of a controlling stake in LCH.Clearnet is one. Yet securing a clearing house in London was seen as crucial to the UK bourse’s ability to punch its weight globally.
Asia is starting to mature beyond a culture of equities and one where fixed income, currencies, commodities and derivatives are in demand as companies seek more sophisticated risk management tools. That is pushing exchanges to diversify. This month the Thai exchange launched its first foreign currency futures contract, on the US dollar.
Bursa Malaysia has been making it easier for local investors to trade derivatives – mostly the exchange’s benchmark palm oil futures.
This week an Indonesian government official was reported as saying Jakarta plans to allow foreign investors to buy stakes of up to 40 per cent in the country’s commodity exchanges, which already offer palm oil and tin futures. CME Group and IntercontinentalExchange, the two biggest US derivatives exchanges – which lost out to HKEx in the LME battle – are also expanding in Asia, using Singapore as a base.
Against this backdrop, HKEx could hardly stand still. UBS estimates that this will be the fifth straight year that HKEx will have shown little or no earnings growth, thanks to over-reliance on weak equity market volumes and on listings that, though headline-grabbing, still only deliver 12 per cent of revenues.
Nonetheless, Hong Kong’s London venture comes with a health warning. With signs not only of weakening trading volumes globally but also that the much-vaunted commodities supercycle may be over, it would take a brave investor to put any hard numbers on earnings potential. Time to pick a lucky number, perhaps. -By Jeremy Grant
Category: Hong Kong