HONG KONG Hong Kong Exchanges and Clearing Ltd (0388.HK) said it was confident of winning an auction to take over the London Metal Exchange (LME), the world's largest metals trading market, as it looks to China to drive new business growth in the face of declining stock market activity.
Speaking after the world's second-biggest bourse operator by market value posted a 7 percent dip in quarterly profit, HKEx CEO Charles Li declined to be drawn on a timetable for bids for the 135-year-old LME, which handles about 80 percent of global metal futures trading and could cost up to $1.6 billion (991 million pounds).
"Last week we said we were studying it. There's not a lot we can say on this," Li said through a translator. Noting media reports that other global exchanges were bidding, the 50-year-old former journalist and investment banker said: "Great minds think alike ... if major exchanges are participating, there must be some value."
HKEx ownership would bring the LME closer to China, the world's biggest consumer of commodities such as copper and which accounts for around 60 percent of LME trading volume.
"HKEx's core strength is developing the China markets ... if there is any business involving any opportunity to enhance our ability in this regard we will consider it," said Li, adding the exchange operator would consider issuing new shares if needed.
The LME, which is owned by its members and has Europe's last trading pit where orders are shouted out between traders, has invited binding bids from what is reported to be a shortlist including HKEx, CME Group Inc (CME.O), NYSE Euronext NYX.N and InterContinental Exchange Inc (ICE) (ICE.N).
"We will continue to consider opportunities of this type. Of course we are confident," said Li, who is in his third year as CEO and has previously been China head for both Merrill Lynch and JP Morgan.
A HKEx/LME tie-up would maximise opportunities across commodity-consuming giant Asia, and the runaway success of Shanghai's copper futures contract shows the region's increasingly muscular role in driving demand.
LME Chief Executive Martin Abbott said in Singapore on Friday the exchange plans to invest heavily in Asia, drawn by China's industrialisation and urbanisation. The LME last year had record volumes with 146.6 million lots, equivalent to $15.4 trillion annually and $61 billion on an average business day.
RISK OF OVERPAYING
While funding a bid should pose little problem to the HKEx, analysts have said it may struggle to realise shareholder value from a deal.
Ivan Li, an analyst at Kim Eng Securities, downgraded HKEx shares to a 'sell' rating late last month, citing weak earnings and concerns over an LME deal. "We believe the potential winning bidder is likely to overpay for LME, and a potential takeover is unlikely to create any synergy or bring any substantial profit to HKEx in the short term," he wrote.
Concern that HKEx may overpay for LME, if it goes ahead with an offer, has contributed to an 18 percent drop in HKEx's share price in the past 11 weeks, while the benchmark Hang Seng Index .HSI is down around 3 percent.
"The LME bid is weighing on the shares, with the market assumption being that HKEx will bid high to overcome its lack of experience on the commodities side," Sam Hilton, an analyst at investment bank Keefe, Bruyette & Woods, said ahead of Monday's quarterly earnings announcement.
January-March net profit dipped to HK$1.15 billion ($148.2 million) from HK$1.23 billion a year earlier, as revenue was crimped by a decline in daily stock market activity. Turnover in shares traded on the Hong Kong stock exchange fell to HK$63 billion from HK$75.3 billion a year earlier, and partly explains why HKEx is looking for other sustainable sources of revenue.
Buying the LME would be a potentially transformative deal and HKEx's first major M&A activity. The bourse operator sat out last year's wave of stock exchange consolidation, most of which failed, focusing instead on forming non-equity alliances with its neighbouring Shanghai and Shenzhen stock exchanges.
HKEx has held talks with banks to take out a loan of up to $3 billion to part-fund any takeover, sources have told Reuters, and could easily use its share price as an acquisition currency, without over-worrying about dilution. The shares have been trading at about 25 times forecast 2013 earnings - the most expensive among large publicly-listed exchange operators.
In a recent report, Credit Suisse said a HKEx bid for LME would make strategic sense. "However, such an acquisition is not without its challenges and brings further near-term earnings headwinds for the stock," wrote Arjan van Veen, predicting the HKEx would fund half of any deal with debt or equity.
LME, the world's biggest market for industrial metals, is being advised by Moelis & Co, while HKEx has hired Rothschild to advise on any transaction.
HKEx shares closed down 1.9 percent on Monday, touching the lowest in four months, while the benchmark Hang Seng Index .HSI dropped 2.6 percent in a broader sell-off triggered by euro zone election results.
(Additional reporting by Elzio Barreto; Editing by Ian Geoghegan)