M&A in China may slow, says Banfield

Head of M&A at Credit Suisse, Colin Banfield, says China's new regulations could dampen activity in the short term. He also explains why it has been difficult to close announced M&A deals in Asia this year.
What have been the trends in Asia (ex-Japan) M&A during the course of 2006?
2006 has been a record year for M&A in the region with announced deals year-to-date already totalling $210 billion compared to 2005 full year values of $175 billion. The most active markets around the region have continued to be Korea, Singapore and China with India enjoying a breakthrough year off the back of a number of important deals such as Tata Steel's cross-border acquisition of Corus ($10.5 billion), Videocon's acquisition of Daewoo Electronics ($700 million) and Tata Tea's acquisitions of significant stakes in two US businesses, Energy Brands ($677 million) and of Eight O'Clock Coffee ($220 million). India's own cross-border M&A track record compares very favourably with that of its more high profile neighbour China, with two India affiliated entities, Tata Steel and Mittal, now controlling significant market positions in the global steel industry. The Indian buyers have typically been private sector entities utilising their own internal resources in addition to third party public market funding in contrast to the experience of Chinese buyers.

In China, the focus during 2006 has continued to be the global quest for energy-related assets with deals done earlier in the year by CNOOC in Nigeria and Sinopec in Russia and most recently with CITIC Group's acquisition of Nations Energy's Kazakhstan oilfields ($1.96 billion). In addition, the financial services sector in China has continued to attract significant inbound investment into pre-IPO candidates such as ICBC as well as in competitive auction situations such as Guangdong Development Bank.

In Korea, the M&A market has remained vibrant throughout 2006 with several large and high-profile transactions including the auctions of Korea Exchange Bank, LG Card, Daewoo Construction, Daewoo Electronics and the divestments of the local retailing businesses of Walmart and Carrefour to Korean buyers.

In Singapore, the standout deals this year have been Temasek's acquisition of Shin Corp ($2.4 billion) and PSA's acquisition of a substantial position in Hutchison Port Holdings ($4.4 billion).

What challenges has 2006 presented?
Even more so than in previous years, one of the major challenges across the region during 2006 has been getting announced deals closed, with long delays being experienced in several high profile deals such as Lonestar's acquisition of Korea Exchange Bank, Francis Leung's acquisition of PCRD's stake in PCCW and Carlyle's acquisition of Xugong.

In China, an additional challenge has been thrown up with the introduction of new M&A regulations in Q3 2006 which allow for considerable subjectivity when it comes to defining terms such as "key industries" and "state economic security" in assessing whether foreign parties are able to acquire control of Chinese companies. The true impact of these new M&A regulations will become clearer in 2007 and may, in a worst case scenario, potentially result in a temporary slowdown to inbound investment into China.

Stock markets in many countries have done well. How has this played into M&A deals?
Strong market conditions across most of the regional economies have generally helped to bolster CEO sentiment towards undertaking M&A deals however, the overall correlation between strong markets and high levels of M&A activity is less obvious then in the more established markets of North America and Europe. In Asian (ex-Japan) deals, consideration is typically paid in the form of cash and there are far fewer share-for-share exchanges or partial cash/stock considerations than in the more developed M&A markets. Buoyant stock markets have, in certain instances, encouraged lenders to provide short term or bridge financing to buyers who are then looking to refinance the acquisition through some form of public market takeout. Conversely, very weak stock market conditions have also proved to be highly attractive for M&A with one of the busiest periods for M&A practitioners being immediately after the Asian/IMF Crisis in 1998-2000

How is financing for M&A deals developing? Do you believe the cost of capital i.e. both the cost of equity and debt for Asian companies has changed over the recent past?
There is currently plenty of financing available from multiple sources for those wishing to undertake M&A in the region. The providers of financing have widened their pools of funding and developed new instruments and there is undoubtedly a greater level of sophistication in the regional market than at any other time previously. In fact, financing deals is no longer the biggest constraint, sourcing the deals is often much more challenging.

Yes, we agree that the cost of capital has come down over the past few years with the main reason being the reduction in the risk free rate. If we look at the typical 10 year risk free rate in Korea, this is currently around 4.9% compared to around 7% in 2001, in Taiwan this was around 4% in 2001 and has halved to around the 2% level and in Hong Kong it used to be at the 6% level and is currently only 4%

What key differences have you noted in the approach of financial sponsors to M&A transactions as opposed to strategic buyers?
Both strategic and sponsor buyers are highly focused on valuation and in theory strategic buyers should enjoy greater pricing power because of the potential for synergies that they can enjoy and their longer term time horizon for the investment. In reality, we have seen on numerous deals across the region that sponsors typically submit more competitive bids and win out in auctions where there is a "true" level playing field between sponsors and strategics.

Decision making is often much quicker at the sponsor firms with critical decisions being taken regionally rather than by someone at the head office of a strategic in another region. Also, sponsors have been able to react more quickly to changing market and regulatory conditions in the countries that they operate in and have proved to be pragmatic in seeking minority stakes or venture capital opportunities over the short term whilst awaiting regional markets to mature sufficiently to deliver their preferred LBO opportunities.

What are your broad predictions for 2007?
I think you will see increased levels of M&A activity in the financial services sector in Taiwan during 2007. Standard Chartered's recent acquisition of Hsinchu International Bank ($1.2 billion) will likely act as a catalyst for further M&A as domestic players push for consolidation and as foreign players use the Hsinchu deal as a blueprint for their own entry or expansion plans.

For some time now, observers have been forecasting a wave of consolidation activity in the China technology sector as operators struggle to maintain margins and as bottom line profitability comes under pressure and I think 2007 will see a number of deals happening across the WVAS (wireless value added services), portal, gaming and search verticals in order to eliminate competition and to achieve cost savings.
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