What is driving the growth of Asian M&A?
V Shankar: Global consolidation is driving M&A. Asian companies are getting the scale, scope and importantly, the confidence to pursue cross-border deals. Let me illustrate with one of our clients. We worked with Tata Steel on the acquisition of NatSteel, then Millenium Steel. Both these deals were medium sized but increased their confidence to pursue û and ultimately win û Corus.
I see this as an inevitable phase of globalisation. The first part was companies from the west buying companies from the east and perhaps companies from the northern hemisphere buying companies from the southern hemisphere. This is the other side of the coin.
Joe Stevens: I would add that companies are also being driven by the need to acquire resources. The oil and gas transactions we have seen in India and China fit this bill. In some cases, acquisitions are driven by the need to access markets and new technology.
Which countries and sectors will be active in the M&A market in 2007?
VS: This is a bit like crystal ball gazing. For example, in 2003 completed deals by volume in India were $3 billion while in China it was $33 billion. In 2006, India had grown to $32 billion while China was $52 billion. Who could have predicted India deals would multiply by that kind of number?
I expect both India and China to continue to be active this year, for both inbound and outbound M&A. There are still a few big-ticket deals to be done in Korea.
Industries like telecom and financial services will continue to see inbound activity. The manufacturing sector will continue to look outwards as it tries to harness its competitive and cost advantages. As Joe said, natural resources will look outwards.
How is this quantum of activity being financed?
VS: Post the 1997 crisis most Asian companies have maintained low leverage levels. They learnt the lessons regarding high debt levels and have been prudent since then. These companies have spontaneous cash flow and sufficient equity to finance the deals they are pursuing. Add to that the liquidity in the banking system and the avenues available for companies to tier their financing using, for example, mezzanine financing.
Banks have gotten more sophisticated. Look at our own team. We have added some very talented financiers who were not here 5 years ago. We have continued this trend by recently hiring Joe to upscale our private equity and alternative investment efforts as an integral part of our corporate finance effort.
JS: In addition to the quantum change in the capabilities and the level of sophistication of banks in Asia, we have seen the arrival en masse of other sophisticated providers of finance. Private equity and hedge funds are now providing new sources of finance, including to strategic acquirers. A high profile example was the Lenovo acquisition of IBM PC, where TPG and General Atlantic provided additional equity to Lenovo. There are many other non-public examples of such financings. What is not so well known is how many companies are tapping into this.
How has this translated into the metrics?
VS: In some industries the multiple expansion has been large but it is case-specific so itÆs difficult to generalise. We were advisors to the Ruias (Essar) on the Hutchison Essar transaction. The firm value Vodafone ultimately won at, $18.8 billion, represents an 18 times forward multiple. But mobile penetration in India can only grow from the current base of less then 15%. A number like half a billion subscribers is not inconceivable. So, the price cannot be based on asset values but must incorporate the huge potential for growth.
And India is not isolated in being in this high growth phase; the phenomenon is widespread in the region. EV to Ebitda multiples in China are far higher today than what they have been in the past. Ultimately, like everything else, value lies in the eye of the beholder.
JS: We believe, for the most part, that Asian buyers have generally maintained price discipline. Prices will generally reflect the strategic importance of markets.
In this environment how do you hedge the risk inherent in financing such transactions?
VS: The biggest immunisation technique is distribution û you donÆt hold the risk, you distribute it. It is possible to do this today when far more players are participating in the market and more tools are available û CLOs, credit derivatives.
Obviously, it is essential for the bank leading the financing to have a very well-refined understanding of the company, its management and its balance sheet. For example, non-spontaneous cash flows available to cover risks, non-core assets which can be sold or securitised. There must also be sufficient equity in the deal.
How is the leverage finance market evolving?
JS: Deals are getting financed at 3.5 to 4 times Ebitda with repayments over 5-7 years. In less cyclical industries this can go as high as 4.5-5.5 times Ebitda. The market is evolving from plain vanilla into one which has less cookie-cutter solutions. Mezzanine-type financing is becoming more common.
How much are local banks participating in the market? How will this influence dynamics?
VS: We expect the local banks to be a larger force going forward. This is partly because some of the local banks operating in the region are cutting edge û IÆd cite ICICI Bank as an example. ICICI Bank and SBI participated in the financing for the Tata Steel Corus acquisition alongside us and others. The other reason is that banks will have to go fishing where the fishes are if they want to continue to grow their balance sheets.
How are spreads looking?
VS: Although this is situation and sponsor specific, in general spreads are at an all time low. Having said that, we have not yet been driven into a situation where competitive pressures are forcing spreads to levels where return does not cover risk. This is also because the market has only a handful of players who are sophisticated enough to lead such financings. These players know how to price risk and reward.
How is the private equity market evolving?
JS: The evolution of the private equity market generally follows that of the M&A market. In the last decade, the M&A market in Asia has seen a change from being driven by distressed assets to being driven by strategic acquisitions.
In some markets LBOs are emerging, namely, Taiwan, Korea and Southeast Asia. I expect LBO opportunities to develop more rapidly in these markets and much more slowly in India and China.
In the region is there too much private equity money chasing too few deals?
JS: No doubt there are huge pools of money chasing opportunities in Asia. But as markets evolve, the number of opportunities grows and new players are helping to create some of these opportunities. Also, we are seeing a greater acceptance on the part of Asian businessmen to private equity as a legitimate source of capital. Fifteen years ago, Europe was at a similar stage and look at how broad and deep the private equity market is there today.
What are Asia specific factors that private equity funds are having to factor in when they pursue deals?
JS: There is still a resistance on the part of founders or controlling shareholders to sell control in most of Asia. This is changing albeit slowly û in some cases it may require generational change.
Taking companies private can be tricky in some markets because of very high shareholder acceptance requirements. The regulatory framework in parts of the region is still evolving û we believe it is evolving in the right way, but different geographies are at various points in the evolutionary curve.
Do you see rising nationalism as a concern for deals in the region?
JS: Nationalism is a factor world-wide when doing deals, not just in Asia. If we are advising on or investing in a politically or economically sensitive deal, we, in turn, will be sensitive to the situation.
This may be reflected in the structure of the transaction and in the time we spent educating regulators and other stakeholders as well as gaining their support.
VS: I would add it is important to remember that closing deals is not just about winning minds but also about winning hearts. Every Tata acquisition we have advised on we have been cognisant of this, hence their success rate.
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