In this interview, Gokul Laroia, head of global capital markets at Morgan Stanley, talks about the market trends that are underpinning this slew of equity activity as well as Morgan StanleyÆs improved position in the market. The bank has had a strong six months which has left it at the top of the league table for overall ECM ahead of UBS and Goldman Sachs. It also tops the rankings for issuance out of China/Hong Kong (ahead of the same banks) with an 18.4% market share.
If you were to highlight a few things that have defined the first six months of this year, what would they be?
One thing that we have seen in China this year is that many of the private sector companies that we have always spoken about as being small- and mid-caps are now large-cap companies. So when you think of Belle International or China Molybdenum or Country Garden, they are $10 billion or $12 billion market cap businesses, sometimes more. In Hong Kong, the private sector is going to generate several times the volume that is coming out of state-owned institutions this year.
WhatÆs also exciting is the scale of the private sector and the number of companies coming out of industries such as real estate, consumer and retail, metals and mining, and building materials. And we donÆt think that is going to change because with rising urbanisation and wealth levels, consumption (broadly defined) is going to be a big theme. You see that in terms of the multiples that the market is willing to pay for these deals.
In Singapore, an interesting development is that a lot of the capital raised there isnÆt necessarily for Singapore. People are choosing Singapore as an exchange because of a well-established Reit code û which has been a big success - or because of the new business trust legislation.
There has also been a resurgence in some of the smaller markets. The Philippines is one example. It wasnÆt long ago that the market traded around $20 million per day, yet now itÆs able to absorb deals of $300 million to $500 million.
Based on your pipeline and what you are hearing from your clients, what can we expect to see in the second half?
The first half obviously has been incredibly busy and the good thing is that this activity has been across sectors. In China we will see more FIG deals, both state-owned and non-state owned. In the first half there was only China Citic Bank but in the next six to nine months we expect there will be several more.
Real estate will be important again, with a number of Chinese real estate companies and some Indian players coming to market. I also think we will see Reit activity pick up with financings in the Reit and business trust space in Singapore. In addition, we expect metals and mining and consumer/retail to continue to be big themes.
India is important in terms of where a lot of capital raising is going to come from. To a smaller extent most of the themes that apply to China apply to India - it is a large market and growing rapidly and therefore there is a tremendous need for capital. Domestic consumption and resources are major themes. Banks are financing a large part of the economy and therefore recapitalisations will also generate activity.
Southeast Asia is becoming increasingly active. Indonesia is going to become a bigger piece of the puzzle after being remarkably quiet over the past few years given the scale of the country and its need for capital. Activity in Malaysia and Thailand is expected to be more sporadic. Vietnam is very interesting. Across the Street there are a few privatisations and some private companies in the medium term pipeline, but timing is somewhat uncertain.
How is Morgan Stanley positioning itself for these developments?
We are very focused on building a holistic platform across Asia. Obviously India and China are two key markets in this part of the world, but we are also investing further in our platforms across the whole region. Southeast Asia is certainly a focus, and that could include looking at markets like the Philippines.
During the second quarter it has sometimes felt like investors were happy to buy anything coming out of China and at any price, perhaps with the exception of the many property sector follow-ons. WhatÆs your view on this? Are investors becoming less selective?
There is still plenty of liquidity in these markets pursuing real growth, which is only available in a few places in the world. China is one of them, India another. Even though new issue valuations are high, if the 25%, 30%, or 35% growth rates pan out over the next year or two, deals like Belle or Anta which priced between 20 and 30 times 2008 earnings will be great long term investments. Global investors have been active in these markets for a number of years now and are seeing that this growth is for real and with so much liquidity in the system they are willing to pay for it.
With regard to the Chinese real estate companies, they now make up about $60 billion of market cap (in Hong Kong), so there is a lot of choice for investors. As new companies come to market, it is going to be very important that they are positioned in a manner that makes people want to own them, whether because the fundamental business proposition is slightly different or because they are attractive from a value perspective. I think there is going to be appetite, but itÆs going to be appetite for the right story.
What are the risks going into the second half, as you see it?
The risks are mainly global by nature. If the subprime issue worsens and the credit market is impacted then the equity market will also react. Another concern right now is the exact impact of the slowdown in the US housing sector and how that may affect the financial sector. In addition, continued increases in the oil prices create uncertainty and geopolitics are unpredictable.
If earnings are worse in this quarter than the markets are expecting, it will have an impact. A big momentum driver has also been the strong M&A activity weÆve seen, much of which is on the back of financial sponsor interest. If liquidity dries up or if interest rates go higher and their activity level drops that could be a catalyst.
Last year Morgan Stanley was a middle of the pack firm in terms of the equity league tables, but we have seen a Lazarus-type resurrection this year. What do you put this down to?
I wasnÆt concerned about our business last year because I knew what our pipeline was and if you exclude the ICBC and Bank of China deals, which we werenÆt in, we were doing well. And there is a lag effect, so a lot of the deals we have done in the first half were won in the second, third and fourth quarters of last year.
I think our strong momentum is the result of investing appropriately in certain sectors that we thought, and continue to believe, will have meaningful amounts of capital coming out of them. For instance we now have a team on the ground to focus on healthcare and twelve months ago we increased the size of our real estate and consumer and retail coverage teams. We have invested in metals and mining and that sector has seen a lot of issuance. Because we got into China real estate early with Shanghai Forte and have followed that up with Guangzhou R&F, Shimao, Agile, Country Garden and KWG which have all done well, we have built good momentum with issuers in this sector.
On consumer/retail, we identified quality businesses early. And having a couple of brand names out there that you sponsor, like Belle, Anta or Mengniu Dairy, is a great driver. People want to be associated with the firm that did the last big and successful deal. A lot of these businesses are also sponsor invested, so you also have to have good relationships with that community.
One thing that stands out about the first half is the dramatic increase in
A-share IPOs. What impact is this having on equity fund raisings in Hong Kong, in your view?
On primary issuance it has had a meaningful impact. We think there is going to be $30 billion of issuance volume in the A-share market this year and if the A-share market hadnÆt been there at least half of that would have happened in Hong Kong. But some of this is one-off issuance as a number of major Chinese companies seek to become listed domestically. Going forward we think there will be about $50 billion to $60 billion of capital raisings out of China every year and that business will be split between Hong Kong and Shanghai, whether that is 50-50 split or 60-40 or 70-30 is very difficult to judge right now.
Businesses that are incorporated outside of China will continue to be attracted to the institutional investor base, flexibility and consistency that Hong Kong offers. Hong Kong is also trying to work with Shanghai so that a lot of the new issuance is going to be concurrent A- and H-shares. And I think many of the large SOEs will do that û or do an A-share offering first and then an H-share deal thereafter.
Does this pickup in A-share activity increase the pressure on banks, including Morgan Stanley, to establish a business in the Mainland that can underwrite A-share offerings?
Having a platform to operate in ChinaÆs domestic capital markets is clearly a focus for all firms.
Like several other international investment banks, you exited your joint venture in India earlier this year. WhatÆs your plan on how to rebuild your franchise in this market?
Our equity sales and trading business is very established and is growing. The plan is to build out investment banking. By the end of this year we hope to have a full-fledged banking team on the ground and have so far hired about one third. In addition, we will need to obtain the appropriate licences.
The good thing about our business in India is that our brand is well known and our credentials sheet is very current. This year we have been involved in a number of major capital market deals in this market, including the $2 billion Sterlite transaction in June, HDFC Bank in July and Genpact, which is currently on the road.
So, will 2007 be another record year for equity issuance in the region?
It certainly appears so. Strong growth in the region is and will continue to be the biggest driver of volumes.