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.'