Government just throwing good money after bad

Its latest strategic stake in Hong Kong Exchanges and Clearing is purely political and will not make a profit as past performance shows

PUBLISHED : Monday, 03 December, 2012, 12:00am
UPDATED : Monday, 03 December, 2012, 4:26am

On Thursday evening, after the market's close, Hong Kong Exchanges and Clearing snapped out a HK$7.75 billion share offering.

The proceeds will go towards funding HKEx's HK$17 billion acquisition of the London Metal Exchange, originally financed with bridging loans.

Among the offering's eager buyers was Hong Kong's financial secretary, who scooped up HK$450 million worth of the new shares.

His purchase maintains the government's status as HKEx's largest shareholder, a position it acquired back in 2007 when it bought a 5.8 per cent stake in the stock exchange operator for its strategic portfolio.

It's the word "strategic" that should sound the alarm bells.

It implies the government is investing the public's money not to generate a positive return, but to further its own narrow political aims. In short, "strategic" is just a euphemism for money-losing.

And the government's investment in HKEx has certainly lost money. The financial secretary acquired his stake back in 2007 at an average cost of HK$155.40 per share. Since then, HKEx's stock has slumped in value by 20 per cent.

Factor in dividend income, and the total return is a 7 per cent loss. That doesn't sound so bad, until you consider that if he had bought five-year US Treasury bonds instead, over the same period, the financial secretary would have earned a positive return of 41 per cent.

Admittedly past performance is no guarantee of future results. But there are plenty of reasons to worry about HKEx's future returns. Over the first nine months of this year, the stock exchange's turnover was down by 27 per cent compared with the same period in 2011. As a result, earnings slumped by 16 per cent. Granted, average daily trading volumes have picked up over the last couple of months following the US Federal Reserve's latest round of quantitative easing. But as the first chart shows, over the longer term, turnover on the exchange is no longer growing.

And companies are no longer jostling to list their shares. As the second chart shows, total equity capital raised on HKEx this year is even likely to fall short of the dismal figure recorded during the crisis year of 2008.

Nor are these trends likely to reverse any time soon. With both real interest rates and wages rising, and with economic growth softening, Chinese companies are facing a profit squeeze that looks set to depress interest in the market for a long while to come.

All this has prompted HKEx to look for another source of income, and in July it agreed to buy the LME. You can follow the thinking. China is the world's biggest metals buyer, and the LME is the world's most important market. Owning the LME should be a sure-fire way to boost long-term earnings.

Except there are problems. China's metals demand over recent years has been driven by sky-high levels of investment. If policy-makers now push through promised policies aimed at rebalancing the economy, mainland demand for metals will stall.

Credit Suisse, for example, expects China's copper demand to grow by just 1 per cent next year, down from 26 per cent growth at the height of China's stimulus effort in 2009.

With miners ramping up capacity, excess supplies mean metals prices could well fall. That would depress investor interest in the LME's contracts, leading to a decline in volumes.

Even so HKEx could still make the LME pay by closing down its picturesque though expensive trading floor and raising fees in line with those charged by other exchanges.

But in its eagerness to acquire the LME, HKEx promised it would do neither.

As a result, the exchange operator will struggle to generate earnings growth either from its existing operations or from its new purchase. By buying into Thursday's offering, investors, including the Hong Kong government, were throwing good money after bad.