LME bid would test Hong Kong Exchanges Li's M&A mettle
* Final bids for LME due on Monday
* HKEx among four bidders short-listed - sources
* HKEx's Q1 net profit seen down 9 pct to HK$1.12 bln
By Denny Thomas and Lawrence White
HONG KONG, May 7 (Reuters) - Monday promises to be a big day for Charles Li.
The 50-year-old former journalist and investment banker is likely to report lower quarterly earnings at Hong Kong Exchanges and Clearing Ltd (HKEx), where he is CEO, and faces a deadline to bid for the world's largest commodities exchange.
The two are not unrelated.
A successful bid for the 135-year-old London Metal Exchange (LME), which handles about 80 percent of global futures trading in industrial metals and carries an estimated $1.6 billion price tag, could reduce HKEx's reliance on cash trading, one of the main factors dragging on earnings.
HKEx, the world's No.2 stock exchange with a market value of $17.5 billion, confirmed on April 30 its interest in an auction for the LME, where it's likely to face competition from CME Group, the world's biggest exchange operator, NYSE Euronext and InterContinental Exchange Inc (ICE) , sources close to the bidding process have said.
The Hong Kong exchange's push into commodities trading is led by Li and his head of market development, Romnesh Lamba, another former investment banker.
HKEx ownership would bring the LME closer to China, the world's biggest consumer of commodities such as copper, and which accounts for around 60 percent of LME trading volume, according to media reports. LME Chief Executive Martin Abbott said on Friday the exchange plans to invest heavily in Asia, drawn by China's industrialisation and urbanisation.
Li, who is in his third year as CEO, has previously been China head for both Merrill Lynch and JP Morgan. An English literature graduate from Xiamen University in southeast China and a former reporter with the government-aligned China Daily, Li was an offshore oil worker in the North China sea before college, according to online biographies, and is known for his interest in commodities.
"We are coming to a moment when China will become so international ... but frustrated they can't manage the commodities sector on their terms," Li told reporters in Hong Kong in January. "If we can tap into this, we can grow into it."
A HKEx/LME tie-up would maximise opportunities across commodity-consuming giant Asia, and the runaway success of Shanghai's copper futures contract shows the region's increasingly muscular role in driving demand.
"It's very natural for them to think a little bit forward, to bring more contracts that are China-related on to the exchange. That would be a very good marriage from my view," Janet Kong, head of commodities research at China International Capital Corp Ltd (CICC) told Reuters last month.
While funding an LME bid should pose little problem to the HKEx - shareholders have approved the issue of new shares, if needed - it may struggle to realise shareholder value from the deal, analysts said.
Ivan Li, an analyst at Kim Eng Securities, downgraded HKEx shares to a 'sell' rating late last month, citing likely weak earnings and concerns over an LME deal. "We believe the potential winning bidder is likely to overpay for LME, and a potential takeover is unlikely to create any synergy or bring any substantial profit to HKEx in the short term," he wrote.
Concern that HKEx may overpay for LME, if it goes ahead with an offer, has contributed to a 17 percent drop in HKEx's share price in the past 10 weeks, while the benchmark Hang Seng Index is down just 3 percent.
"The LME bid is weighing on the shares, with the market assumption being that HKEx will bid high to overcome its lack of experience on the commodities side," said Sam Hilton, an analyst at investment bank Keefe, Bruyette & Woods.
Buying the LME would be a potentially transformative deal and HKEx's first major M&A activity. The bourse operator sat out last year's wave of stock exchange consolidation, most of which failed, focusing instead on forming non-equity alliances with its neighbouring Shanghai and Shenzhen stock exchanges.
HKEx has held talks with banks to take out a bank loan of up to $3 billion to part-fund any takeover, sources have told Reuters, and could easily use its share price as an acquisition currency, without over-worrying about dilution. The shares trade at about 25 times forecast 2013 earnings - the most expensive among large publicly-listed exchange operators.
In a recent report, Credit Suisse said a HKEx bid for LME would make strategic sense. "However, such an acquisition is not without its challenges and brings further near-term earnings headwinds for the stock," wrote Arjan van Veen, predicting the HKEx would fund half of any deal with debt or equity.
First-quarter net profit is forecast to drop about 9 percent to HK$1.12 billion ($144.4 million), according to the average estimate of six analysts polled by Reuters, dented by disappointing equity market turnover, which is encouraging HKEx to look for other sustainable sources of revenue.
LME, the world's biggest market for industrial metals, is being advised by Moelis & Co, while HKEx has hired Rothschild to advise on any transaction. LME had a 2010 pre-tax profit of 12.5 million pounds ($20.25 million), a fall of 28 percent.
The LME, which is owned by its members and has Europe's last trading pit where orders are shouted out between traders, last year had record volumes with 146.6 million lots, equivalent to $15.4 trillion annually and $61 billion on an average business day, according to its website.
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