Grasping for the shiny metal object
Warning bells should have started pealing the moment that Charles Li Xiaojia, the chief executive of Hong Kong Exchanges & Clearing (HKEx), tried to justify the highly demanding amount he plans to pay for the London Metal Exchange by saying: 'We should not look at the acquisition price based on the past record of the LME right now.'
So, does Li believe that past earnings and performance are not prime indicators of fair valuation for an acquisition? Maybe this is why he is so relaxed over the HK$16.6 billion price tag for the LME, representing more than 180 times its profits last year and 22 times its share price before the takeover announcement.
If this casual attitude to earnings were not sufficient to raise eyebrows, Li's careful insistence on the deal's political economics should also be cause for concern. HKEx is apparently keen to play its role in China's 12th five-year plan by developing the nation's commodities industry. We can set aside the broader discussion of whether five-year economic plans are all they're cracked up to be, to focus on the simple question of whether a public company, albeit with a majority Hong Kong taxpayer shareholding, should involve itself in trying to achieve political objectives.
If it were possible to ignore all these misgivings, it would still be necessary to examine the rather bewildering concessions made by the HKEx to secure the deal. It had to agree to keep the exchange based in London and regulated by the British authorities and it has basically agreed to preserve its member-owned business structure, which is not designed for profit. And even if this acquisition is being partly made to satisfy the demands of policymakers in Beijing, in both a physical and regulatory sense, the LME will remain well outside China.
It is a widely known fact that most mergers and acquisitions fail; indeed, a recent Harvard Business School study put the failure rate as high as 70 to 90 per cent.
An article in The Harvard Business Review by one of the study's authors explained the core reason for failure: 'So many acquisitions fall short of expectations because executives incorrectly match candidates to the strategic purpose of the deal, failing to distinguish between deals that might improve current operations and those that could dramatically transform the company's growth prospects. As a result, companies too often pay the wrong price and integrate the acquisition in the wrong way.'
In his more folksy style, Warren Buffett said: 'Sometimes the thrill of the chase blinds us to the realities of the catch.' Maybe that's what happened here, as the HKEx is acting mighty pleased with itself for having won the chase, albeit subject to regulatory approval.
Yet the elements discovered in the Harvard study of acquisition failures seem to be evident here. The acquiring party has yet to explain how ownership of the LME will improve operations. And, by blithely ignoring the high price of acquisition, the HKEx seems to be saying that it is basically buying an expensive brand into which it will invest heavily.
It could have taken a different strategy and, indeed, the Hong Kong exchange's own history provides a better guide to how this could have been handled.
HKEx has become a global equities player entirely through organic growth after it was formed by the amalgamation of smaller local exchanges. It used its established presence in the equity market to develop business in other financial markets, but has been a laggard in the area of commodities.
The LME acquisition may solve this problem, but it could have built its own Asian commodities platform at half the price it intends to pay for the LME, with largely the same results.
It was, after all, the listing of mainland entities that catapulted the exchange into the big league, and it is the integrity of the exchange that continues to make it attractive for investors interested in Chinese equities. Why, then, will this same logic not apply to commodities trading? So, does Hong Kong need to own an exchange in London to do a job that could be done here?