Asian M&A: A bright spot on the horizon

Results of a recent survey conducted by Clifford Chance and FinanceAsia suggest guarded optimism prevails with respect to M&A across the region.
Uncertainty has continued to plague financial markets across the world this year and both equity and fixed-income deals have been difficult to execute. M&A seemed to be the bright spot on the horizon for the first half of the year as a number of Asia outbound deals were announced. In some cases it seemed that depressed valuations in subprime-affected markets coupled with private equity firms becoming less active as leverage dried up, was playing to the advantage of Asian acquirers. Targets were becoming cheaper and the competition was diminishing.

But by the second half of the year, the subprime crisis caused AsiaÆs equity markets to correct, short-term credit to dry up and the bank financing market to tighten. Acquirers dependent on external financing found the cost of raising capital prohibitive and investors less receptive to financing their growth ambitions.

Clifford Chance and FinanceAsia decided to survey those in the know about their prognosis for 2009 and beyond. Our survey was conducted in October and received 250 responses. Our respondents are well-placed to comment on M&A markets: 150 of them, representing 60% of the sample in aggregate, work directly in financial services. The largest category of our respondents, 28%, work in investment banking, while another 19% work in asset management (including private equity and alternative assets) and 13% in commercial banking. The overwhelming majority of our respondents, 82%, are based either in Greater China or in Southeast Asia, including India.

Corroborating the frequently expressed view that Asia will not be as badly affected by the meltdown as Western markets, 68% of our respondents expect cross-border outbound M&A from Asia-Pacific strategic acquirers during the next 12 to 18 months to either increase over the previous year or stay at similar levels. Another 72% expect intra-Asia-Pacific M&A to increase or stay at similar levels.

ôA clear majority [of respondents] see the mid-sized range of between $100 million and $1 billion, as the most active sector of the M&A market," says Jamie Paton, the head of private equity firm Candover in Asia, commenting on the survey results. After all, uncertain environments donÆt create the confidence needed for mega-deals.

At the same time, a majority of respondents, around 60%, expect cross-border inbound M&A from non-Asia-Pacific strategic acquirers to decrease over the previous year. We canÆt say weÆre surprised û companies in Western markets currently have their hands full assessing the impact on their businesses from the recessionary conditions. Looking eastwards for acquisitions is not something we expect them to have too much time for.

ôWe still continue to see inbound activity,ö says Roger Denny, head of M&A Asia at Clifford Chance. ôHowever, with recession looming û if not already underway û in many Western economies and bailouts in the financial services sector, we may actually see an increase in the number of disposals of Asian businesses by Western companies.ö

Mainland China is the country that our respondents expect to be home to the most investors and acquirers next year. This was a dominant theme of Asia-outbound M&A in 2008 as well. Whether Chinese companies continue to be acquisitive in 2009 will depend on a number of things, including how much the economy is impacted by the export slowdown.

ôThis year, we have seen strong strategic cases for China outbound investment, including some of the transactions on which we have advised û the China Oilfield Services acquisition of Oslo-listed Awilco Offshore for $2.5 billion; ChinalcoÆs acquisition of a stake in Rio Tinto; and China Merchants BankÆs takeover of Wing Lung Bank," adds Denny of Clifford Chance.

ôIrrespective of any slowdown in growth in China, I believe the longer term rationale for these types of acquisitions remains, and the correction in the markets could well provide better opportunities for Chinese strategic acquirers,ö he says.

Following China are the Middle East and Japan. Outbound activity from the Middle East went quiet in 2008 following a number of deals in 2007. Some market observers suggest that the sovereign wealth funds (SWFs) based in the region were daunted by the performance of their investments in banks. Among others, the investments by Abu Dhabi Investment Authority in Citi and by Kuwait Investment Authority in Merrill Lynch have not yielded the returns the SWFs may have anticipated.

Other reasons for the slowdown in activity could include the impact of the drop in oil prices on all oil-driven economies. Middle Eastern investors could also be waiting for markets to bottom out further. But our respondents seem confident they will be back in the game soon. Indeed, in October SWFs from Abu Dhabi and Qatar agreed to invest ú5.8 billion ($9.1 billion) in British bank Barclays, which suggests that for the right investments, the appetite is still there.

JapanÆs ascendancy to a top three position is not surprising. Japanese companies have used the last few years to create healthy cash reserves and are backed by a strong banking system. The need to secure future growth has already driven a number of Japanese firms to pursue cross-border deals this year. Japanese liquor majors Suntory and Kirin emerged winners in competitive auctions for Australasian food and beverage businesses this year, driven by precisely these factors.

ôWhile the majority of respondents note that M&A activity will be tougher to execute, many still see Asian companies seeking to adopt a global strategy,ö sums up Paton of Candover.Our respondents also expect the Greater China region to be the most popular target location for inbound M&A investment with 79% choosing it as one of the three destinations likely to see deal flow over the next 18 months, followed by India.

Financial services emerges as the industry 53% of our respondents cited as a priority sector for M&A investment. We reckon that the takeovers and recapitalisation that a number of global banks have already been party to are expected to gain momentum in Asia well. Regional banks whose balance sheets are not significantly impacted by subprime could see an adverse impact on their performance because of an earnings slowdown at the companies they do business with. It seems indisputable that banking, the world over, is becoming a big boyÆs game.

ôRegional financial institutions may look to merge with global institutions; alternatively, they may seek to grow their businesses through acquisitions, as the markets throw up opportunities,ö says Denny. ôWith challenges in the US and European markets, I expect to see some western financial institutions consider disposing of Asian assets in order to raise funds.ö

Following financial services among the industry groups most likely to see M&A activity are energy and natural resources. Indeed, in 2008 a number of Asian M&A deals were driven by the need to secure supplies of natural resources for growing populations. This need will continue.

Bringing up the rear is technology, media and telecommunications. In October, Norwegian telecom firm Telenor agreed to pay $1.07 billion for 60% of Indian firm Unitech Wireless. A key factor behind the deal for the Oslo-listed firm was diversifying into a high-growth market - a trend which is also expected to continue.

Our respondents are almost unanimous in agreeing that M&A deals will become more difficult to finance: 77% of those polled expect the financing environment to become slightly or much more difficult over the next 18 months. Corroborating this finding, an overwhelming 89% of respondents, who expect M&A deals will be more difficult to close, cited funding issues as the primary reason. SWFs and governments are expected to be the most important and available source of capital for M&A activity, followed by private equity funds and corporate reserves/fundraising in that order.

ôWe have seen a number of significant private equity fund raisings completed and major new private equity houses setting up in Asia and allocating resources to the region from global funds,ö says Denny. ôWhilst the high levels of leverage that were available during the credit boom are no longer available, we are still seeing considerable activity by private equity funds. To some degree, they may benefit from the rebalance of power in favour of the buy-side which we see in the survey and a resetting of prices, particularly in relation to public-to-private transactions.ö

Our respondents agreed that there are a number of factors driving Asia outbound M&A. But there are also some concerns: global economic conditions, lack of liquidity in international markets and lower growth prospects in western markets could be constraining factors.

Two thirds of our respondents expect M&A deals to become more complex to structure in the current uncertain market environment. More than three-quarters of our respondents expect the balance of power in M&A deals to be with the buy-side because there will be less competitors in the fray. A similar number expect that the current environment is more conducive to negotiated M&A deals. Despite that fact that price discovery for the sell-side becomes more challenging in uncertain debt and equity markets, our respondents suggest sellers will choose to be selective in engaging with counterparties who they have confidence in, rather than running broad-based auctions.

However, only less than half of our respondents expect it to be more difficult to reach an agreement on the pricing of M&A deals over the next 12 to 18 months with 32% expecting it to be easier and 22% expecting it to remain the same.

ôThe market has, to a large degree, already reset pricing levels for publicly listed assets. We are seeing increasing interest in public-to-private transactions as a result,ö says Denny. ôIn this environment though, it may be necessary to structure mechanisms which bridge the gap between the pricing expectations of the seller and buyer. This is something we have seen before, especially during the 1997-98 financial crisis.ö

WeÆd surmise that the outlook for M&A advisers in Asia continues to be bright - maybe not as bright as it was a year ago, but certainly not as dim as in some of the worst subprime-affected markets. Financing will be the biggest challenge and banks with relatively stronger balance sheets could use this time to consolidate their position with clients. And it will be a buyerÆs market û after all, whatever the currency, money talks.
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