Goldman's Leven discusses private equity and Asian M&A

In the second of our M&A interviews, Johan Leven who runs M&A for Goldman Sachs in Asia, discusses why financial sponsors are better positioned in Asia than in the rest of the world.
What have been some of the broad themes driving M&A activity in Asia during the course of 2006?
We have seen continued consolidation activity in the region, both cross-border and domestic. Consolidation activity now forms the base of the Asian M&A market. For example, MMC CorpÆs $4.7 billion acquisition of Malakoff falls into this category as a domestic transaction in Malaysia. In outbound cross-border deals, weÆve seen CNOOCÆs $2.7 billion acquisition of a stake in energy assets in Nigeria. Outbound cross-border activity by Indian pharma companies is also increasing. This is new but not unexpected û we view this as a logical next step.

Another key trend this year has been financial sponsors bidding for assets. Although transaction volumes thus far have been modest, this has been the year when a number of firms moved from merely having a foothold in Asia to really getting traction on deals. Given that the closure of a transaction often takes six to nine months, we expect that 2007 will see a number of sponsor-driven deals come to fruition.

Elsewhere, we are seeing increased shareholder activism requiring Asian companies to increase their use of shareholder value-oriented defence measures. This year we advised KT&G to mount a successful defence against unwelcome advances and reduce the threat of a hostile takeover. We were also defence adviser to Giordano in connection with an unsolicited takeover approach by JapanÆs Fast Retailing.

What have been some of the trends across geographies?
One is clearly the ôIndiaö trend. However, although volumes in India this year seem high, a great deal of this activity can be attributed to the internal family restructuring of the Reliance Group. The overall volume of India M&A would have been considerably lower without transactions associated with this division of family assets. Having said that, and notwithstanding this one-time event, we expect India to take off in 2007 and 2008, building on the pharmaceuticals deals announced this year and others such as Videocon Industries pursuing Daewoo ElectronicsÆ business.

Another trend of note has been the robustness of the Southeast Asian economies, with strong activity in Thailand, Malaysia and the Philippines. ItÆs unusual to see these three markets very active at the same time.

M&A markets the world over tend to exhibit a majority of activity that is domestic and geographically adjacent. We expect the same trend to persist - even more strongly than in the past - in Asia. Over time, inbound M&A into Asia will become relatively less important, although outbound activity from Asia will continue to grow. The earlier paradigm of Asian M&A being highly dependent on foreign investment inflows is squarely behind us. The Asian M&A market is now mature enough to sustain its own activity.

How do you expect transactions to play out across industries?
Over the last 24 months a distinguishing feature of Asian M&A activity has been the breadth of activity across industries. Historically, every few years would throw up a ôhotö industry, for example telecommunications or banking. This year no one sector has dominated. Assuming a continued benign environment, this should continue. Asian M&A has moved out of Base Camp to Camp Two and is currently probably at Camp Three. Although it is not yet at Camp Four, ready to ascend to the peak, the breadth of M&A thus far has been a very healthy development, boding well for future deal activity.

Stock markets in some parts of the region are trading at high PE multiples. How does this affect M&A transactions?
Higher share prices result in higher valuations and hence reported numbers and deal volumes tend to be bigger. This enhances the ability and willingness of companies to use shares as currency. An example would be Gome looking to acquire China Paradise in a share exchange offer. Generally, CEO and Board confidence is higher when stock markets are doing well. Management is able to spend more time thinking strategically about growth rather than operationally about costs.

What are the trends in financing M&A transactions?
The most important phenomena in this regard have been credit spreads and leverage multiples. Globally, including Asia, credit spreads are at historic lows and have been for a long period of time. Equally importantly, default rates in the region have been low. Based on this, we see two distinct scenarios going forward. In the first, the economic environment remains benign and spreads continue to be low. Then, the strong environment for financing will not only continue unabated, but will strengthen due to high bank liquidity, coupled with the continued development of the high yield bond market and an internationally traded bank loan market.

The other scenario is related to a downturn, likely driven by a sharper than expected slow-down in the US economy. This would adversely affect Asian exporters and lead to higher default rates. In this case, there will likely be a pullback, spreads will widen and the financing environment will become more difficult. On balance however, we see a ôhappy landingö, meaning the first scenario, where the US will successfully manage the interest rate environment and Asian economies will also see a soft landing.

Most likely, leverage multiples will continue to increase in Asia. Four years ago, levels around four times Ebitda were the norm. This has increased to six to seven times Ebitda and, if the benign environment continues, we expect Asia to soon fall in line with the eight to 10 times Ebitda now seen in the US and Europe.

To your mind, what are key differences between financial sponsors and strategic buyers?
I believe that, on a relative basis, sponsors are better positioned in Asia than in the rest of the world as they are able to be more aggressive on price in many of the regionÆs still emerging M&A markets. Strategic buyers in Asia are often family-owned companies which have built their businesses very prudently and may be less comfortable paying a full price for an acquisition û even if synergies are available. However, it is difficult to generalise this across the region. For example, in Korea this year, the sponsor interest in assets such as KEB and LG Card was very high, but ultimately - due to the strategic importance they attached to owning those assets - the winners were the strategics.
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