Global companies seeking a foothold in fast-growing countries such as Turkey, China, Russia and Brazil have pushed deal-making in emerging markets above that of Europe for the first time. According to Dealogic, emerging market targeted M&A volume is up by more two-thirds to $575.7 billion, while European volume has increased by barely 20% to $550.2 billion in the first half of 2010.
Deals by companies in emerging markets now account for 30% of global M&A activity, while Europe’s share has fallen to 29% – the lowest level in 12 years.
China, with about $133 billion in deals, has attracted most interest this year from acquirers. Brazil, India and Russia follow, with the four BRIC countries together accounting for more than half of emerging markets activity. In Turkey, M&A volume is almost double of FY 2009 in the first half of 2010.
Most multinationals need to look beyond developing nations for sustainable growth, particularly inorganic to secure access to high-growth markets and customers. The race to secure global energy resources has seen some of these companies use increasingly aggressive bidding tactics. This summer, Korea National Oil Corp, the state-owned energy explorer, launched the country’s first cross-border hostile takeover to try to win control of UK oil group Dana.
According to McKinsey, the rapidly growing ranks of middle-class consumers span a dozen emerging nations ranging from Turkey to South Africa, not just the fast-growing BRIC countries and include almost two billion people, spending a total of $6.9 trillion annually. McKinsey research suggests that this figure will rise to $20 trillion during the next decade—about twice the current consumption in the United States.
US companies on the other companies have been more cautious in seeking growth in emerging economies. The largest such deal this year was Abbott Laboratories’s’ agreement to buy the healthcare solutions business of Piramal, the Indian conglomerate, for $3.8 billion.
Credit Suisse leads the announced emerging market advisor ranking with about $103 billion in deals so far this year, followed by Morgan Stanley and Bank of America Merrill Lynch.
Multinational companies planning M&A ventures in emerging countries will be breaking new ground. To succeed, they must be prepared to fundamentally adapt their deal-making mechanisms to the characteristics of the local market.
So what is different about deal making in - what I call - the New Silk Road? Aspiring buyers must consider the peculiar dynamics of the New Silk Road specifically, the fact that conventional approaches to M&A are inappropriate:
- Prepare to pay more but it may not be enough to close the deal: Valuation multiples tend to be relatively higher as there is more competition for increasingly smaller deals. You tend to price each deal based on growth potential driven off of some per capita basis penetration trajectory over the next decade, which can change drastically. Traditional valuation is often impossible, since benchmarks and reliable financial information are rare. Often, option value is everything.
- Look for sizeable target but be ready to settle for much smaller deal: Industries from which you will target your next emerging market M&A deal tend to be a lot more fragmented than developed economies. In a given industry, after only a few market leaders, you can easily end up with targets in the tens of million dollar range in size. Be ready to make smaller deals priced at large company multiples. For example in Turkey, billion-dollar size deals are limited to only a few industries such as energy and steel. State-owned enterprises are cleaning up their asset portfolios and improving standards of disclosure, making them attractive targets for foreign investors. A number of private companies better managed than their state-owned peers are also emerging as candidates.
- Every deal will be contested: Multinational companies face challenging competition in emerging markets, as these economies already boast aggressive local players that have captured a significant portion of spending. Each deal you would hope to seal will face stiff local competition with deep pockets.
- Local financing may require too much upfront work: Given the specific countries local regulations, complex financings tend to be more common. Dealing with targets existing local bankers would be a good starting position. Change of ownership would inevitably ignite such discussions anyway.
- Watch out for cultural nuances: There are plenty of cultural differences that can make or break a deal. In the end, it is people that do business with one another, not companies.
- What you see may not be what you buy in the end: The standards of corporate governance in these economies can be drastically different than the US for example. If they are listed, it might be a bit safer but still there are still no guarantees. The information needed for robust due diligence is elusive in China, where IT systems are generally weak, databases lack breadth and capacity, and legal systems and requirements remain opaque. Corporate governance standards in emerging markets still lag far behind those of developed markets.
- Complex local regulatory frameworks are most difficult to understand: One of the biggest hurdles in deal making in the new Silk Road has to do with the uncertain regulatory environment. For example, in Turkey it is still not legal to delist a public company. Many private equity firms or multinationals that are also public in their home markets are forced to leave their investment listed in a second stock market.
- Cross-border transactions are inherently more time consuming: A lack of experience in cross-border transactions can make the process more difficult. You need a dedicated team of experts that are heavily staffed locally and properly equipped on the local level to complete deals.
So what should your M&A teams do differently to make things work?
- Study the market closely, start early: Nothing can substitute a well-structured market assessment of your target geographies with a consulting company that preferably has a local branch and team.
- Commit to the market early for the long-term: as soon as you determine where you should invest, you need to recruit a small local team to build connections and learn. For example, Best Buy entered the Turkish market and studied it for 2 years prior to opening stores. Try to visit the country several times in person. Seeing is believing. Make new local friends that can take time and effort to cultivate. Build rapport with people and understand their value system: Talk to close friends and hire people who understand both cultures.
- Source a hybrid M&A team staffed mostly with locals and manage your team closely: Plan your team early. Source and contract the best local legal and transaction execution advisory you can afford. M&A in emerging markets is different. For example, forecasting methods used routinely in more mature markets do not apply to emerging markets. Local legal and tax regulations can be so different and complex that can kill a deal. You want to know about them as soon as possible.
- Use a wider range of valuations and let your local team be your guide: Relying heavily on a multiples-based valuation can almost automatically lead to highly distorted results, while these economies can be too dynamic for discounted-cash-flow analysis to be accurate; forecasting cash flows beyond three to five years is mere conjecture. In addition, local counterparties often use a statutory valuation, which is similar to valuing assets at book or asset value but does not take into account the level of cash flow the assets could generate. Past growth rates and margins do not provide an accurate guide on how an industry will develop in the New Silk Road economies. Yet the boards of multinational companies often insist that their valuation teams come up with a single, bottom-line number. As a result, deal teams frequently feel pressure to under- or overprice a purchase rather than explain why the value realized could be higher or lower, depending on the industry's evolution. Using a wider range of valuations would give a buyer leeway to assess the most likely outcomes and to base its decisions on the way emerging markets fit into the overall company and industry strategy.
- Be realistic about synergies: Buyers often look to the synergies of deals to justify investments. But capturing synergies in the New Silk Road is difficult. Cross-selling products, for example, is unrealistic if brands and products are positioned for different market segments: it is just not feasible to try to cross-sell, say, a premium brand of beer through a largely rural distribution network. Synergies in revenues and labor (through massive layoffs of workers) are also hard to achieve. In addition, buyers must be aware of potential post acquisition cost increases owing to the expense of an expatriate staff and spending on health and safety improvements. Savings in production and operations are easier to capture, although sometimes a deal's value resides not in its synergies but in its long-term option value: capturing the potential and growth of the sizable emerging markets.
- Share upside and downside risk: When differences over the valuation of a company cannot be bridged, buyers should seek to structure a deal so that it takes this uncertainty into account.You may for example in a joint-venture make an additional payment three years after the transaction date if the venture achieved an agreed-upon earnings target and if tax regulations changed. Such earn-out mechanisms can be useful when opinions vary over other external factors, such as industry growth and the cost of key inputs. The trick with earn-outs is to focus on matters that are generally beyond the influence of either negotiating party; otherwise, there is room for gamesmanship, which should be avoided.
- Work like a detective during due diligence: Due diligence is the core of acquisition procedures. In my experience, buyers tend to be either overly cautious (thus missing potentially attractive opportunities) or overly optimistic (and likely to find surprises later on). The information needed for robust due diligence is elusive in emerging markets, where IT systems are generally weak, databases lack breadth and capacity, and legal systems and requirements remain opaque. Furthermore, agreements are often oral, and the high proportion of cash deals makes it difficult to validate the true ownership of stated assets. Multinationals should expect a high level of liability and risk exposure and make sure that any team conducting due diligence on their behalf has enough time and people to dig for information. Accounting and legal advisers with local experience are absolute must haves. Wherever possible, teams should be based locally and have the insider knowledge and relationships needed to understand target companies fully.
- Deal structure should help you achieve your strategic goals: Be flexible to structure the deal other than M&A with full control if it can’t be achieved due to local regulations or deal specifics; there is the option of joint-ventures where you can share local market leaders economic network and accelerate your market penetration. Or you can go for a minority equity investment with limited control like in the media sector in Turkey for example as an option to step up deal after relaxation of regulation, to preempt competition and to accumulate learning. Another successful approach to structuring deals involves outlining important areas of decision making and establishing mechanisms to exercise control over them. If direct control of the board is impossible, a buyer might push decisions down to a level where it can exercise authority through day-to-day operational decisions. Often multinationals combine them with an agreement to increase ownership and control over time.
- Leave your usual M&A mind-set at headquarters: Look at an acquisition as a partnership rather than an outright acquisition. If a company is listed in the public markets, in form it will obviously be an acquisition, but in substance it could be a very good partnership if we align the objectives across the organizations as if it is a partnership. Don’t send plane loads of people into a new company. Instead, send in a few integrators. Make a concentrated effort to co-create a vision for the enlarged organization rather than just imposing your own from the headquarters. Ask key questions. What are our objectives? What are our strengths and our weaknesses? How do we leverage those strengths—such as people, R&D, access to new markets, and our organic-growth pipeline—to collectively achieve the vision? If the vision exercise isn’t shared or if the process isn’t participative, then the acquired organization’s willingness to be part of the future action plans and the consequent accountability will be much lower.
- Culture fit is still everything in emerging markets too: You have to accept that there will be differences in cultures; one cannot make a single-culture organization. But it is critical to build a uniform performance culture. By that, I mean how we think as one enterprise and set targets for the larger organization, how we go about realizing the group vision—including how we benchmark performance and identify sources of value—and how we measure less tangible actions and behavior. These things are especially relevant now because there are no standard operating procedures for overcoming a global financial crisis.
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