LME Deal ‘Potential Disaster’ for Hong Kong Exchange

London Metal Exchange shareholders voted on Wednesday to accept the $2.2 billion takeover offer by Hong Kong Exchanges and Clearing (HKEx), which will give the commodities trading platform further access to China, but one analyst says the deal is “a potential disaster” for the Hong Kong Exchange.

Traders sit at their desks at the Stock Exchange in Hong Kong.
Mike Clarke | AFP | Getty Images
Traders sit at their desks at the Stock Exchange in Hong Kong.

“It’s a value destructive deal. They've hung a ton of goodwill on the balance sheet,” Thomas Monaco, Managing Director of Mizuho Securities, told CNBC Asia’s “Squawk Box” on Thursday.

“It’s (the deal) dilutive to EPS (earnings per share). And there's a massive potential for a dividend cut here. I mean they're paying out 93 percent of earnings (as dividend). We're looking for it potentially going to an 18 percent payout.

“Financially we think it’s a potential disaster for Hong Kong exchange,” he added.

At the same time, HKEx may not be able to raise the equity it needs to pay for the acquisition if capital markets deteriorate further, Monaco said. He has a 12-month price target of HK$60 ($7.73) for the stock, representing a downside of 40-41 per cent from the current HK$101.30 ($13.06).

Shares of HKEx have fallen more than 19 percent since April 30, when it said it is among the bidders for the 135-year-old London Metal Exchange. Some analysts have voiced concern HKEx may be over-paying for the LME, which handles more than 80 percent of world trade in industrial-metal futures but made a net profit of just 7.7 million pounds ($11.9 million) last year.

HKEx will finance the acquisition of the exchange, where total traded value was $15.4 trillion last year, through its existing funds and with a 1.1 billion pound ($1.7 billion) bank loan and possibly issue new equity.

“The plan for equity issuance is what makes it dilutive to HKEx,” Sam Hilton, Analyst at Keefe Bruyette & Woods in Hong Kong told CNBC. “It might have been neutral or even slightly accretive to EPS if it was 100 percent debt financed.”

Hilton downgraded HKEx to “Underperform” in June after HKEx was announced as the winner of the bid.

Arjan Van Veen, Analyst with Credit Suisse in Hong Kong, who revised down his target price for the stock by 5 percent in June, says the deal is "strategically sensible," even if it’s dilutive to earnings in the short-term.

There will be additional costs in developing the London Metal Exchange’s Asian platform and it may take a while before revenue is generated, Van Veen added. HKEx has said the acquisition will add to its earnings from the third year after completion of the deal, which is expected in the fourth quarter of 2012.

“The key investment case for HKEx is longer term growth as the China-listed market continues to evolve, with HKEx being the key global gateway,” Van Veen said. “Further expansion into commodities trading in our view helps cement this role.”

The deal still needs approval of Britain's Financial Services Authority.

- By CNBC's Jean Chua.