HKEx preps for placing
15 March 2012
Beware the Ides of March!
Hong Kong Exchanges and Clearing Ltd (HKEx, 0388) has today published its AGM circular for the meeting on 23-Apr-2012. Apart from seeking a stiff pay hike for the directors, which may grab some headlines in itself, the deeper but more important message is in the request for shareholders to grant the board permission to do a larger cash placing at its discretion, at double last year's limits, without offering the shares to existing shareholders. Couple that with the recently-leaked news of HKEx's bid for the London Metal Exchange, which could cost north of GBP1bn (HK$12.2bn), and you can see where this is going.
Last year, we gave credit to HKEx for adopting a Vampire-compliant mandate, in line with best practice from the UK, seeking a general mandate to issue new shares equal to not more than 5% of its existing shares, at a discount of not more than 5%. Project VAMPIRE stands for Vote Against Mandate for Placings, Issues by Rights Excepted, and is the long-running and on-going battle for HK to adopt pre-emptive rights in line with the UK's Pre-Emption Group guidelines, which limit companies to 5% per year at a discount limit of 5%. The UK has an additional limit of 7.5% in a 3-year period, or an average of 2.5% dilution per year, but let's learn to walk first. The UK guidelines have been in effect for a quarter of a century since 1987 and there is no evidence that this has stymied the capital-raising abilities of its leading companies.
HKEx is now asking permission to issue new shares up to 10% of its existing shares, at up to a 10% discount. Based on the current outstanding shares, that would be 107.99m shares. Based on yesterday's closing price of HK$139, at a discount of 10% this would raise about HK$13.51bn (US$1.74bn).
HKEx currently operates a set of statutory or de facto monopolies with equity of just HK$9.16bn, so a full-sized issue would expand the equity by 147%, and that would only be necessary if it were to take on a substantial acquisition or if a massive market default wiped out its prudential reserves, which buttress the clearing houses for the stock and futures exchanges. In 2011 its pre-tax profit of $6.03bn represented a margin of 82.0% on revenue and turnover of $7.36bn. Net profit of $5.09bn represented return on equity of about 55.6%. The market prices HKEx as if it will always be a monopoly. We disagree with that assumption, but that's beyond the scope of this article.
The rumour of HKEx's bid for LME came from Enoch Yiu's article in the SCMP on 18-Feb-2012, citing two people familiar with the situation. Her sources are usually pretty accurate and at least one of them is believed to be on the board, so we take it to be true. HKEx is a HK-Government-controlled entity (shareholders can only elect 6 of its 13 directors) and the Government's permission (via the SFC, after consulting the Financial Secretary) is needed for anyone to own more than 5% of it. The Chief Executive of HK (whoever that is) also has to approve the Chairman. Apart from the difficulties for HKEx of operating an alien business 10,000 km away from the cosy, competition-free environment of HK, we wonder whether the UK authorities would be quite so welcoming of the purchase of LME as they would be if the buyer was not controlled by a foreign government.
Of course, HKEx may not be the highest or successful bidder when bids close on 7-May-2012, but if it does decide to buy LME, then shareholders of HKEx can expect it to make a substantial cash call. It would be far better to do this by way of a rights issue than to place shares at a discount with friendly parties or governments; keep in mind that the HKSAR Exchange Fund, HK's sovereign wealth fund, owns 5.8%. Would they get their share in a placing? Without pre-emption rights, some shareholders are more equal than others.
HKEx has sufficient authorised share capital to do a 1 for 2 rights issue at a deep discount, without an EGM. A 1:5 rights issue at a 55% discount would be certain enough that it wouldn't even need underwriting, and it would raise the same amount as a 10% placing at a 10% discount. So we urge shareholders to protect their interests by voting against the expanded general mandate (Resolution 6) on 23-Apr-2012. That is the only way to be confident that you would be offered your fair share, and receive the benefit of the discount.
Leading primary-listed companies in HK which have a 5% limit on cash placings include HSBC Holdings plc (0005), Standard Chartered plc (2888), Hang Seng Bank, Ltd (0011), CLP Holdings Ltd (0002), Swire Pacific Ltd (19/87), Swire Properties Ltd (1972), Cathay Pacific Airways Ltd (0293) as well as several well-managed small caps. Several H-share companies have no general mandate at all, including China Construction Bank Corp (0939), Bank of China Ltd (3988), China Life Insurance Co Ltd (2628), Bank of Communications Co Ltd (3328) and China CITIC Bank Corp Ltd (0998). When they need to issue equity for cash, they can do rights issues.
Oh, and that HKEx pay hike - 66% for the Chairman, 56% for the other directors - did their job suddenly get that much harder?
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