Is The Offer By Hong Stock Exchange For LSE Destined To Fail?

The city of London and the financial world was taken by surprise on 11 September when Hong Kong Exchanges and Clearing Limited announced that it had made an unsolicited, preliminary and highly conditional proposal to the Board of London Stock Exchange Group PLC to merge the two businesses for a total consideration of about GBP 31.6 billion (USD 57 billion). According to market sources, if the deal goes ahead, the merger would unite two of the major trading hubs in the world at a time when both are under severe political pressure and would create the third biggest stock exchange group in terms of the value of companies listed on those markets. However, the potential deal is fraught with regulatory and other challenges, with many experts doubting that it would not go ahead.

The proposal by the Hong Kong Stock Exchange came just weeks after the London bourse agreed to buy financial information firm Refinitiv for USD 27 billion in a bid to rival the financial data empire of Bloomberg and other large US exchange operators and transform the British company into a market data and analytics giant. This acquisition would help the London Stock Exchange Group scale up its business into the emerging sector of data and reduce its reliance on its UK and European business further to become less dependent on transaction-based revenues. However, the new bid from the Hong Kong Exchanges and Clearing Limited can sabotage the acquisition of Refinitiv as the proposal is conditional on the acceptance of the London exchange to shelve the deal. But the group in its statement said that while it would review the proposed offer, it continues to make good progress on its earlier offer to acquire Refinitiv, suggesting a cold response to the proposed offer.

Implying an enterprise value of around GBP 31.6 billion, the value for the entire ordinary share capital of the London Stock Exchange has been pegged at approximately GBP 29.6 billion under the terms of the proposal, representing a premium of 22.9 per cent to the closing share price of 6,804 pence per share on 10 September 2019. The shareholders of the London exchange have been offered 2.495 newly issued Hong Kong Stock Exchange shares and 2,045 pence in cash, which would be financed through a combination of existing cash resources and new credit facilities. Reflecting its continued commitment to the UK, in addition to already owning and managing the London Metal Exchange, the group also intends to apply for a secondary listing of its shares on the London Stock Exchange.

The Hong Kong-based financial group said that the potential deal represents a highly compelling strategic opportunity for both the firms to create a global market infrastructure leader and benefit from the dynamic and evolving macroeconomic and political landscape in both the regions. The merged entity would offer market participants and investors unprecedented global market connectivity and will better position them to innovate across markets and geographies to help in strengthening the businesses. The emerging financial markets in the East, particularly in China, would be able to connect with the established financial markets in the West and offer diversified assets. The group also believes that the deal presents strong synergy opportunities as the superior technology of the London-based bourse would highly complement the trading and clearing platforms of the Hong Kong Stock Exchange.

However, market experts believe that there are other reasons as well behind the potential offer, not least the domestic political turmoil currently being witnessed in Hong Kong. The executives at the company have realised the need to diversify their income source as the latest protests in Hong Kong shows that interference by the Chinese authorities can create trouble for businesses based on the island. As the business in Hong Kong has come to a standstill in recent weeks and uncertainty about future conditions rose, companies have started to prepare alternative arrangements to ensure sustainable continuity of their business. This partly helps to explain the rationale and timing of the surprise offer, as it will help the group to overcome uncertainty at home.

Market experts also believe that weak pound due to domestic troubles in the UK because of Brexit also makes the price attractive, as it reduces the effective cost of transaction in local currency for the Hong Kong Stock Exchange. Amid the increased focus on milking data and seeking global scale, the proposal is the latest attempt to consolidate the exchange industry, and the group hopes the merged company would be better able to compete with US rivals such as Intercontinental Exchange and CME Group.

However, the deal may get rejected in the face of resistance from investors and regulators, as experts believe that markets would question the structure of the deal and reckon the significant political hurdles it will have to face. As investors were caught off guard, this pessimism about the deal became clear as the shares of the Hong Kong Stock Exchange fell by 3.4 per cent by early afternoon in Hong Kong (as on 12 September 2019), wiping more than USD 1 billion in value. Moreover, people close to the London Stock Exchange reported that the group was leaning towards rejecting the bid as the company was committed to its own deal of acquiring data and trading group Refinitiv, which is particularly well-perceived by its investors for its potential to transform the business and add value over the long-term.

Analysts have also drawn attention to political considerations of such deal, as the London bourse is considered a crucial part of the financial system of the country and Europe, and any such agreement can make concerned authorities sceptical. It is common knowledge, and now Carrie Lam – chief executive of Hong Kong – has accepted, that the city is unable to take any significant actions without the support of Chinese authorities, which has spooked investors in recent times. To worsen the case, the beleaguered Hong Kong government, which directly reports to the Communist Party in China, is the largest shareholder of the Hong Kong Exchanges and Clearing Limited and appoints six of its 13 board members, further questions the intentions of the surprise takeover bid. Along with key infrastructure for European debt markets, the Italian stock exchange is also owned by the London Stock Exchange, and the Milan-based bourse controls the platform behind the government bonds trade, which can raise the question about the potential deal beyond the borders of the UK.

When asked about the proposed deal, Andrea Leadsom, the UK business secretary, said that her office would scrutinise anything that had security implications for the country, raising the prospect that the group would find it difficult to secure the support of the British government. The UK Treasury described the bourse as a critically important part of the financial system of the country and signalled wariness over giving reigns of its stock exchange to a foreign acquirer with close links to the Chinese authorities. Moreover, as the UK is poised to leave the European Union, an attempt to buy the exchange is viewed from the lens of suspicion by many, with some analysing the deal in light of escalating trade tensions with China. The lack of democracy and transparency is going to be a significant hurdle for the group, even if the shareholders of the London Stock Exchange approve the deal, which is itself a big ask.

The Chief Executive Officer of Hong Kong Exchanges and Clearing Limited, Charles Li said that the deal would redefine global capital markets for decades to come and stressed that the LSE offer was not hostile, and investors would be given an opportunity to evaluate the bid. However, local strategists find that the deal would be potentially unaffordable for the exchange as the final price could go up as negotiation progresses. But experts seem to agree that both sides have a lot to offer as it would allow for 18 continuous hours of trading, and while Hong Kong is one of the biggest IPO markets in the world, London exchange is very strong at fixed income, currencies and commodities.

The deal comes at a time when the status as regional financial hubs of both the exchanges has been jeopardised by social, political and economic turmoil at home, and centuries-long position of London as a leading financial capital of the world is already in doubt because of Brexit. Traditional market exchanges are being threatened with obsolescence as they try to fend off both upstart competitors and new technology, increasing the need for consolidation and continuous evolution. While a cross-border exchange seems to be an attractive proposition, political considerations would be playing a major role in this transaction, and hence it may not see the light of day.