Don't buy a bank in Hong Kong

Salomon Smith Barney''s M&A head, Steve Schiller has some thoughtful things to say about where M&A is going.

We've had a couple of big China M&A deals recently. Do you see that as one of the defining trends this year?

Chinese M&A is not going to see a geometric growth. It will be a linear growth over a period of time. We are going to see occasional very large asset injections - for example, the China Mobile trades - but in terms of real, arms length M&A, that's going to be slow and steady. We will see nice growth, and especially in areas that are more international like oil & gas, and where they have dollars. But we don't think M&A is going to explode overnight.

It will happen in a steady way. There are a lot of reasons for that. One is, these Chinese companies have a lot of other things on their plate. They are sorting out their accounting situations, they're trying to build infrastructures. The other portion is that they don't have the authority to spend - there are several levels of approvals to get the foreign currency to buy things. That's hard for them to get by. We have had properties which we talked to Chinese parties about and which they were interested in, but then couldn't bring cash to the party.

The third element is that you will see a lot of interest from foreign parties buying a stake in Chinese parties and doing joint ventures. But those deals take a while to get done, so you're not going to see an explosion there.

But M&A will be a big product in China. Do I expect major fees this year? I don't. But next year perhaps. And we've started to spend a bit of time working in this area. Some of our competitors may be a bit ahead of us in this regard. But we're catching up.

Do you have a sense that China is on the verge of adopting a takeover code?

They are a long way from having a market that is rule-based, transparent. There is still a very substantial element of negotiation among various state bodies to get transactions done. So I don't think we'll see a rule-based, transparent, free market for quite a while. The structures aren't just there, the companies are not mature enough and the state still has a large amount of control. There's a whole lot of sorting-out going on.

Then again, there are companies like CNOOC which have an international listing, an international board of directors, their own capital, a lot of cash. And big oil companies are more global. So those guys are ready. The likes of Legend too. They can do things on the outbound level.

And with the inward cross-border, you've got to believe that all this courting going to give rise to some marriages. But it's going to take a while.

Do you see a big emerging trend this year?

I would keep my eye on the tech space. I think we are going to see a lot of consolidation in that space. Micron/ Hynix might be an example. Bear in mind there is a tremendous shift in comparative advantage from the US to Asia and from Japan to other parts of Asia. We have found there has been a real pick up of interest in Western companies about Asia. They realize that to stay active in hardware manufacturing they have to find an Asian partner or buy an Asian company or somehow form a connection with Asia. Increasingly, Asia has the expertise and skillsets that they don't have. And sometimes Asians don't have what the Western companies have which is branding and design capabilities. So there is a natural communion of interests.

The other issue is that Japan has got to deal with some of its problems. They have technology and great brands, but their manufacturing costs are out of control. And they cannot stay in all the games. They have to exit. The question is will they do a trade with the Koreans, with the Taiwanese, within Asia. We see roughly as much interest within Asia as we do from the outside into Asia, or Asia to the outside.

And then there's banking.  There will be more consolidation in Korea, Hong Kong and Taiwan. The Hong Kong banking market is a tough market. Standard Chartered did, in retrospect, overpay for the Chase credit card business. They bid a full price and the card business in Hong Kong has gone into a bit of a downturn. Hong Kong is a tough market. Loan growth is down; margins are being squeezed.

Do you see a Singapore bank buying another bank in Hong Kong?

The Singaporean banks have got a lot of swallowing to do this year. They may, but bear in mind that Hong Kong is not a hugely attractive market. It's tough to make money in this town. The mortgage business in Hong Kong has very thin rates and that's assuming low credit losses. And by the way, credit losses are coming. At some point, people will stop paying their mortgages and the credit loss will creep up. And the mortgage book is a big one in Hong Kong. Would I pay a controlling family's value expectations to buy a bank in Hong Kong? Hard to say. There may be in-market consolidation but I'm not sure outsiders will come in.

Talking about in-market, should there be consolidation in the Hong Kong mobile phone scene?

No question, but sometimes things, which should happen, take a long time to happen. This is more likely to be the year it happens instead of two years ago, but it still may not happen.
You don't have the advent next week of 3G like you do in Europe, and so the pressures to merge are less. Don't underestimate the willingness of people to put things off. We're involved in this area, but we're not banking on it coming off.

Do you think this is going to be the year in which we see real consolidation in the Taiwanese banking sector?

I think you will. A number of those banks have some issues, but our conversations with a number of banks tell us there is more coming.

Is there scope for consolidation in the airline industry?

Obviously there's a huge reorganization going on in China, but airlines are tough. If there's anything that's wed to people's nationalistic feelings it's the airlines. Sabena should have been put out of business a long time ago, but the Belgians wouldn't allow it.
What you might see - if the business recovers - is companies like Cathay and Singapore Airlines take strategic stakes in other airlines.

Do you think this year's M&A volumes will be higher than 2001?

They will be comparable. I don't think they will be much higher. I don't see one area having big numbers. I see a steady stream of trades of various types. We see a lot of activity in a lot of spaces, but I don't see really blockbusters deals like the SingTel Optus transaction.

One positive is that I see a number of companies being treated more honestly by their governments. Malaysia is a good example. And in Korea the emphasis has moved away from distressed trades towards the more strategic.

And for those outside Asia, I think they are realizing you've got to have a coherent strategy for Asia. If you're a carmaker, you can't ignore Hyundai Motor. If you're in PCs you've got to have something in Asia.

Asia is extraordinarily efficient but it's not just about manufacturing. Places like China are now turning out engineers. Do you know how much it costs to have a bunch of engineers in Detroit make a change to a car model? If you go to Hyundai Motor they can make the same change much cheaper.

These engineers are getting better fast. These Chinese graduates may not be as good as the people Intel hires from the University of Texas, but they're getting better, and getting better fast.

And India?

We're seeing more activity out of India. It is not as far along as China in some areas. They haven't made the same investment in infrastructure. They haven't attracted as much outside capital. So they're behind and they probably need to focus on the China model and getting their act together.