HKEx to acquire London Metal Exchange; Maybank Kim Eng thinks it is bad news

There would be negative impact on HKEx’s balance sheet, says the analyst.

Maybank Kim Eng noted:

• HKEx announced that it would acquire London Metal Exchange at a total consideration of GBP1.39b or HKD16.7b. The acquisition itself is widely expected, though the consideration to be paid is higher than expected, and is equivalent to 180x LME’s FY11 earnings.

Analyst comment:
We believe that the news is negative to HKEx’s share price, because:

1) The acquisition is expensive even if we price in the upcoming trading tariff hike. LME is going to raise trading tariff (by almost 200%) in July12, but HKEx promised not to further raise it before 2015. There are also possibilities that HKEx may have to make goodwill impairment if LME is not generating the expected cashflow.

2) Earnings contribution would be minimal and remote. HKEx pointed out that LME it would take at least 3 years before LME can contribute profit.

3) The negative impact on balance sheet. HKEx would finance the deal with bank loans (HKD13.2b) and its internal cash resources, and we believe that it may need to carry out rights issue later. We believe that HKEx’s premium valuations in the past (despite slow profit growth) were partly due to its balance sheet strength, and this factor may now be under threat. Though we expect HKEx to keep its dividend pay-out policy.

4) HKEx intends to keep the current LME management, but supervising a non-equity, overseas Exchange house would be a huge challenge for the HKEx management.

• Note that China Development Bank was among one of the banks that provide banks loans (the others are Deutsche Bank, UBS and HSBC), and it seems that there were some political reasons behind the LME bid.
• The deal is still subject to the voting of LME shareholders and UK Financial Service Authority, but does not require approval from HKEx shareholders and HK regulatory bodies. Expected completion date is 4Q12. We maintain our bearish view on HKEx.