On 11 Sep, HKEx announced a surprising potential acquisition of LSEG (LSE LN, NR) with a consideration of GBP 29.7bn (or HK$ 287.8bn), but the deal will move forward only if LSEG’s takeover of Refinitiv does not happen. We see the potential deal to extensively expand HKEx’s global presence, diversify its revenue streams, and connect China with the rest of the world on a broader scope, while uncertainties remain high and deal valuation seems not attractive.
- Deal valuation and structure: The consideration implies 42.5x FY19E P/E of LSEG, much higher than its current 36.5x and HKEx’s current 29.7x. HKEx will fund the deal by cash (both its own funds and new debt) and new share issuance to current LSEG shareholders (Figure 1), who will hold ~41% in HKEx’s enlarged share capital. The newly issued shares of HKEx will seek to float on LSE for secondary listing.
- Strategic synergies>financial benefits in short-run. If succeeded, the deal aims to form a world leading market infrastructure operator connecting the East (esp. China) and the West with diversified asset classes. HKEx’s revenue structure will be enhanced by LSEG’s information services (esp. FTSE Russell Indices) and FICC business, where HKEx currently lacks competitiveness (Figure 2). In addition, the Connect Scheme may further penetrate into the European market. Though the strategic prospects are promising, short-term financial synergies may be limited as 1) earnings will be diluted due to new share issuance, 2) LSEG has relatively lower operating efficiency than HKEx (Figure 4), and 3) HKEx will bear heavier debt burden whilst targeting to maintain a ~90% payout ratio after combination.
- Challenges ahead. 1) Uncertainties regarding the Refinitiv deal. It would not be easy to get LSEG to back down this transaction. LSEG stated it would remain “committed to and continue to make good progress” on takeover of Refinitiv. Its stock has also surged 27% since the Refinitiv deal was announced, showing investor’s welcome to the transaction. 2) Geopolitical and regulatory uncertainties. Whether the UK regulators will allow HKEx to acquire its key capital market operator considering national interest would be a big concern, especially amid rising geopolitical upheavals.
- Valuation. HKEx currently trades at 29.7x FY19E P/E, equivalent to its 5-yr avg. The market may not react so excitedly as long-term positives may be overshadowed by uncertainty regarding the completion of the transaction.
