London, 27 September 2011: Reuters

It's a question that has hovered over the London Metal Exchange ( LME) ever since 2000, when the exchange moved from its  original mutual not-for-profit status to a shareholder structure. It's also been largely an academic question since LME officials, most recently chief executive Martin Abbott, maintained a steadfast position that the LME simply wasn't for sale. Until now.

The LME last Friday confirmed that it has "received several expressions of interest with regard to strategic transactions" and has appointed mergers and acquisitions specialist Moelis and Company as adviser. The LME also said it will "begin a formal process which may or may not lead to an acceptable offer for the company being received."

The starting-gun for a sale has evidently been fired, implying that at least one potential suitor has already expressed concrete bidding interest. That in turn seems to have drawn in other potential bidders, hence the word "several" in the LME's press statement.

THE PRICE IS RIGHT?

Any sale will ultimately depend on the approval of the LME shareholders, a group that largely but not wholly overlaps with the exchange's membership. As such it is a unique and potentially fractious grouping of banks, brokers and industrial users of the exchange. Some will be automatically hostile to any sort of bid, one lamenting this morning that a sale "will be the beginning of the end of the LME as we know it."

Set against such ingrained independence will be the resulting windfall likely from a bidding battle. The face value of the LME "A" shares, which come with voting and dividend rights, is currently 492.50 pence per share, based on the most recent transaction recorded by market-maker J.P.Morgan Cazenove. That was in July of this year. Not entirely surprisingly the latest bid stands higher than that at 550.00 pence per share.

A more useful indicator of eventual valuation, however, comes from the "B" shares, which do not have either voting or dividend rights but which are required for any member to actually trade on the exchange. The most recent transaction listed by Cazenove was at 70.00 pounds per share, also in July this year.

The 1-billion pound ($1.5 billion) price tag that is being bandied around is coincidentally close to the value implied by the "B" share price. The gap between the prices of the two types of shares is indicative of what shareholders can expect in terms of payout windfall.

THE BUSINESS (VERSION 1)

What would 1 billion pounds, a nice round figure we'll use for the sake of simplicity, actually buy? In essence it's the LME's franchise as near-monopoly provider of exchange-trading in nonferrous metals, at least in the world outside of China, an important caveat on which more later.

It's a franchise that has been doing extremely well thanks to the evolution of commodities from exotic backwater to the mainstream of the financial universe. The trend is long-running but it has dramatically accelerated in the extraordinary investment climate ensuing from the Lehman Moment in September 2008.

That's why the LME can boast that its average daily volume so far this year is up 19 percent on 2010. Such success, though, is still primarily grounded on the LME's core basket of base metals contracts. The exchange has struggled to broaden its portfolio. Forays into precious metals, in the form of a silver contract, and industrial plastics proved ill-judged flops.

More recently, the LME has taken tentative steps into both the world of minor metals, in the form of molybdenum and cobalt contracts, and the fast-growing ferrous sector, in the form of a steel billet contract.

To put those into context, though, steel billet volumes in the first eight months of this year totalled just 158,018 lots out of total exchange volume of almost 93 million lots. Cobalt and moly volumes were much smaller still at 3,781 lots and 331 lots respectively.

The core of the LME business was and remains its traditional suite of contracts, namely aluminium, copper, zinc, nickel, lead and tin.

THE BUSINESS (VERSION 2)

Struggling to find new products that can be dovetailed into its traditional physical deliverability criteria, the LME has therefore started to reinvent itself, particularly in the posttrade clearing space. Together with LCH.Clearnet the exchange introduced clearing for the London bullion market at the end of last year, an initiative that seems to have been more popular with the London Bullion Market Association than with the LBMA's members despite the fact that many of them are also members of the LME. It was, though, just a sign of things to come.

In May this year the LME announced it was "giving serious consideration to the possibility of building its own clearing service." It has just appointed Trevor Spanner as a new director of post-trade services. Spanner, with an extensive track record in the field, will take charge of the formal feasibility study into self-clearing.

The LME has stated that moving away from its traditional clearing relationship with LCH.Clearnet will be "accretive to earnings at the LME." And presumably "accretive" to its shareholders as well.

THE BIDDERS

So who's in the frame for a 134-old London exchange that still trades at least partly via open outcry, has an archaic daily prompt system and a highly problematic relationship with the warehousing companies that sit between it and the physical metals markets?

So far, the list is no more than one of the "usual suspects", led by the CME Group and IntercontinentalExchange and stretching to the likes of the Singapore Exchange and the Hong Kong Mercantile Exchange. CME Group is probably the only true Western World competitor to the LME and even then only in the copper sector. An attempt to launch an aluminium futures contract in competition with the LME came to nought.

The true long-term competitor to the LME is the Shanghai Futures Exchange ( SHFE). It offers copper, aluminium, lead and zinc contracts as well as steel rebar, an offering that has comfortably outperformed the LME's billet contract in terms of volumes.

Just as London was the pivotal point of arrival for industrial metal cargoes in the 19th century, so is China now the physical driver of the global metal markets. The influence of SHFE pricing has been steadily rising, a phenomenon that has caused the LME to fight back in the form of new "Asian" benchmark prices and a tie-up with SGX for mini contracts.

The LME and the SHFE have been engaged in a cat-and-mouse phoney war since Beijing vetoed a proposal to allow the LME to open warehouses in China. The LME is inching closer to mainland China, working on a proposal to add Taiwan to its good delivery location network.

Shanghai, meanwhile, is building out its bonded warehouse system, a staging post for metal travelling between international and domestic markets. Beijing has long talked about allowing the SHFE to break out of its domestic market shackles and enter the international trading arena.

There is, though, no suggestion that it will happen any time soon, or at least not soon enough for the SHFE to be a serious bidder for the London exchange. Shanghai's status as gateway to the metals business in the world's largest consumer ensures its standing will only grow over time. At some stage that will mean a serious challenge to the LME and its owners, whoever they might be.

Before then, though, there is the more pressing matter of who can find the right price to persuade the LME membership it is time to sell up.

Ends --

By Andy Home, Reuters market analyst – for Commodities Now.

The views expressed here are his own.