The growing sophistication of Asian M&A

In the first in a series of interviews with M&A bankers, Citigroup's head of regional M&A, Gordon Paterson, says domestic companies now compete head-to-head with foreign buyers for Asian assets.
What have been some of the key trends in Asian M&A during the course of 2006?

To my mind, 2006 was a continuation on the right path. I've been in the region for seven years and have seen M&A activity developing in, what I believe, is the right way. Some notable trends include the emergence of domestic champions: in-country and in-region consolidation has continued to create companies with critical mass and higher credibility. Secondly, cross-border outbound M&A has been on the rise as opposed to the cross-border inbound which had prevailed for a number of years. Finally, financial sponsors are playing an ever more important role in the region's M&A. Funds are demonstrating a willingness to be more flexible. It used to be the case if they could not own outright then they were often not interested. Today they are more willing to be minority partners, providing capital to domestic players and exploring new structuring options to marry their objectives with those of the companies they partner.

Are we seeing mostly intra-Asian deals?

Transactions have been mostly intra-Asia, partly because the competitive landscape has changed. In the past strong domestic companies competing for assets were the exception, now this is the norm. Although there will always be an element of cross-border inbound from Europe and the US, it will be more selective. It is no longer an option for European and American companies to venture into Asia without a well-defined plan for the future. The "I need to be in China" type mantra is not driving activity as much as before. You need to have a strategy.

Do you believe the cost of capital for Asian companies has changed over the recent past?

As an advisor on deals, it is part of our job to assess how competitors bidding for the assets will value the deal. I'd say that today the cost of capital for emerging market companies is very competitive compared to developed market counterparts and this is fuelling transactions. This is across the board and not just related to the fact that the cost of debt has gone down. In many cases, especially across emerging markets, Asian companies view risk profiles of the countries more favourably than their European and North American counterparts and we have seen this especially with the major oil companies in Asia.

For certain deals in Asia it is about massive potential growth in a particular industry and forecasting may not be easy.áWhat complexities do these factors add to valuation?

Acquisitions in emerging markets are challenging and complex. A great deal of our time goes into exactly the scenarios you are describing. For example, in Taiwan there are a large number of banks offering a portfolio of products across market segments. It is difficult to assess how consolidation will play out across the industry and across products. We assess risks relative to rewards and timing. Simply put, we try to determine what is a reasonable price vis-a-vis expected floor level of returns. Where growth potential is very high we build extra scenarios in our forecasts.

What are the trends in financing M&A transactions?

Over the years the very limited avenues of financing have given way to local markets with depth and experience to finance deals. The high yield market may not yet be developed to the stage of the US market but it is certainly developing quickly and in the right direction. Liquidity in the market is high hence alternatives and sophistication are increasing. Convertibles, for example, even in sponsor-led deals are playing a bigger role.

To your mind what is driving financial sponsors to, in some situations, bid more aggressively than strategic buyers?

I think the differences are situation specific. As sponsors gain more experience and achieve higher familiarity with geographies and markets their willingness to bid aggressively is increasing. But situations are dynamic. For example, Korea was historically a sponsors' market. This has changed completely. Korean companies have access to liquidity and have an increased willingness to take on high leverage and they have strong views on their own domestic market; these factors combined are making them some of the most aggressive bidders for assets.
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