JPMorgan's Marin predicts mezzanine-type financing in M&A

What has been the trend in Asian M&A during the course of 2006?
At the beginning of this year many believed 2006 would be dominated by outbound M&A from China, given the publicity surrounding that activity in 2005. Early in the year, I observed that only a couple of transactions had closed and that I did not see an emerging trend - my view has not changed. To be sure, any given year could see one or two transactions - and when they happen they will attract attention as it will be the larger, more widely known companies that are involved.

The M&A activity in 2006, which in my view does constitute a trend, is private equity investment. As you know, in 2005 a number of global funds opened offices in Asia and raised large pools of capital. They have been quick to put this capital to work despite their limited experience in the region and in some cases very limited staff. I expect private equity investors will be even more active in 2007 as the recently arrived firms gain more experience in the market and the veterans labour to put capital to work. Looking beyond 2007, activity will include not only additional investments, but future asset sales as they look to monetise their holdings over time. In that way, every private equity transaction yields a second transaction when the investor chooses to exit û this tends to be three to five years later.

Activity has been much broader than in the past and we are seeing transactions across several industry sectors û this reflects the strength of the current M&A market. Telecommunications, technology, transportation, financial institutions, general industries have all been active. As well, driven by the private equity trend I mentioned earlier, we are also seeing activity in a host of sectors collectively dubbed ôinfrastructureö, which include toll roads, ports, power, cable networks, etc.

How has the changed landscape affected how deals are priced?
In general, prices are up in all M&A transactions and it has become much more of a sellerÆs market.

The increase in private equity activity both in the Asia market and globally has contributed to an increase in competition for assets and thus prices. I realise that the notion of private equity firms driving prices up, given their focus on returns, sounds counterintuitive. And, historically it was rare for a private equity firm to pay more for an asset that a strategic buyer would. That has changed for a couple of reasons. First, private equity return expectations have changed over time. Historically, private equity firms stated minimum return criteria of 30%. Today return requirements are closer to 20%, and for the right asset they are willing to entertain even lower returns. Second, the lower cost of debt has reduced their overall cost of capital thus allowing them to pay more. Finally, given the enormous amount of capital the private equity firms have raised they have to be more aggressive to put this capital to work.

Why have intra-Asia deals dominated?
The level of M&A activity in the US and Europe has sky rocketed in 2006 and this year those markets have actually seen greater growth in deals than has Asia. In most cases companies focus first on M&A opportunities and consolidation activity in their home market or nearby markets. As a result, Western companies have had less time this year to focus on Asia.

To be clear, the interest in Asia remains very high, but decision makers are just too busy looking at opportunities closer to home. As a result, if one looks around Asia, much of the activity in 2006 has been domestic or intra-Asia. Korea is a perfect example, where the three largest M&A transactions have all involved local buyers.

Stock markets in the region are trading at high P/E multiples. How does this impact transactions?
JPMorgan has researched M&A trends over the past several decades and there is a very strong correlation between the level of M&A activity and rising stock markets. One reason for this is that a major determinant of M&A activity is corporate confidence. When companies are doing well, they feel confident about pursuing acquisition opportunities. And, when companies are performing well their stock prices increase. This is the situation we are seeing now. There is a tremendous level of confidence among CEOs and their boards. Most companies are performing well; they have clean balance sheets and generally feel good about future prospects. So, despite the fact that stock markets are approaching all time highs, companies are confident and want to grow their businesses, oftentimes through strategic acquisitions.

So, yes prices are higher than they were, but buyers are feeling more confident than ever and are thus willing to pay higher prices to secure an acquisition.

What are the trends in financing M&A transactions?
As I mentioned, most companies have cleaned-up their balance sheets over the past few years and have significant debt capacity to facilitate an acquisition. As well, despite the recent increases in interest rates, rates are still relatively low when one compares them to average rates over time. Combine this with the fact that banks are very eager to extend financing and you have financing markets that are very willing to support the M&A activity.

In terms of trends, we are seeing an emerging high-yield market in Asia, as well as, the use of more creative mezzanine-type financing to support M&A transactions.

To your mind what are key differences in approach between buyers who are private equity and strategic buyers?
There are many. First, private equity firms do not have many of the market or investor issues that a public company does. They donÆt have to be concerned with accretion/dilution or the stock markets reaction to an acquisition. As well, they are much less concerned with the near term earnings prospects or the level of debt employed to consummate the deal.

Private equity firms also do not generally have to address issues of integration or synergy extraction that accompany an acquisition by a strategic buyer. As well, ôsocialö issues (e.g., company name, headquarters location, who is CEO and who is Chairman) are usually not an issue for a private equity firm.

What broad trends do you predict across geographies for 2007?
Korea has been very active this year so it will be difficult to duplicate in 2007. One could say the same for Australia, but both of these markets have had a habit of consistently delivering several large transactions. China has had a quiet year compared to 2005 and while we anticipate more activity in 2006, much of it may be domestic. We expect activity in Japan and India to increase as both of those economies are performing well and there has been less activity in recent years.

Consistent with a strong M&A market, we see activity being very broadly based across several industry sectors. And, you should watch the private equity firms, as we think they will drive much of the deal flow.