Sunday, October 03, 2010

Emerging Markets Point the Way Forward

By Lina Saigol
Financial Times, September 27 2010

New direction: companies in emerging markets are increasingly looking to international acquisitions

For the past three years, the mantra among global dealmakers was that emerging markets would pick up the slack as their US and European counterparts hunkered down. This now appears to have come true as companies in developing countries cement their position as a new breed of global dealmakers. Although Asian economies have not been immune to the global financial crisis, the region’s capacity to overcome the downturn, while western economies are still suffering, has confirmed the notion that the balance of commercial power is shifting from west to east. 

Chinese investment is surging in Africa, Latin America and south-east Asia, while Russian and central Asian natural resources companies are looking to list shares in Hong Kong. This has resulted in companies in emerging economies recording a 25 per cent increase in cross-border deal activity in the first six months of the year, according to KPMG’s latest annual Emerging Markets International Acquisition Tracker. 

“Emerging-market companies have become acutely aware of the global dimension in which they operate. They are fast learners and will be after intellectual capital, access to developed markets and, inevitably, commodities,” says Carlo Calabria, vice-chairman at Bank of America Merrill Lynch. South-east Asia has been the most popular destination for inbound deals, with China ahead of India as the next most popular market, KPMG’s analysis found. Jeremy Fearnley, head of M&A at KPMG Corporate Finance in Hong Kong, notes that dealmaking confidence is returning far more quickly for emerging economies than for their developed-market counterparts.

 “One reason for this trend is that emerging economies are capital rich,” he says. “In the case of China, for example, there is increasing demand for commodities in this market as it continues to industrialise and invest heavily in infrastructure.” 

The race to acquire natural resources is fierce, with Chinese, Indian and Brazilian companies all competing for assets. As a result, the tactics of acquisitive companies are starting to mirror those of their western counterparts. Korea National Oil’s $1.87bn cash bid for Dana Petroleum, the UK oil explorer, shows just how aggressive some companies are prepared to be to secure their targets. The bid is the first of its kind launched by a state-backed Asian company that may have seen similar deals slip away because it was too timid in its pursuits. The South Korean group wants to double its production to 300,000 barrels a day, and buying Dana is central to achieving this goal, especially at a time when global oil assets are not getting any cheaper.

“The other side of the coin is the emerging-market domestic consumption story, where we continue to see increased demand for western products and brands,” says Mr Fearnley. “The focus of Chinese outbound acquisition activity is therefore introspective as buyers seek to acquire more established western brands to sell into their domestic market.” The services industry in China accounts for roughly 40 per cent of China’s gross domestic product in 2009, compared with roughly 75 per cent in the US, suggesting there is considerable room for growth.
But mergers and acquisitions activity is not flowing only one way.

On the hunt for growth, companies in Europe and the US are taking advantage of good valuations to position themselves for the new world economy. Having spent the past two years cost-cutting and repairing their balance sheets, S&P 500 companies are flush with cash that they are keen to put to use via M&A. “US corporates are clearly interested in strategic emerging-market opportunities. Equally, some of the emerging-market leaders are looking cross-border and taking advantage of significant liquidity, strengthening exchange rates and a more positive local economic climate,” says Glenn Schiffman, head of investment banking for the Americas at Nomura.Wilhelm Schulz, head of European M&A at Citigroup, says that with the likelihood of another macroeconomic shock receding, European corporate boards have also started to execute their long-planned M&A strategies. “This – across most industries – involves geographic diversification and gaining scale to combat muted organic growth prospects at home,” he says. 

BHP Billiton’s recent hostile $39bn bid for PotashCorp, the world’s biggest fertiliser maker, comes at a time when global demand and output for the potash business are expected to increase dramatically. The Paris-based International Fertilizer Industry Association estimates that potash demand could rise by almost 20 per cent this year, from an estimated 49m tonnes of potassium chloride to 58.7m tonnes in 2014 – and BHP wants a large slice of that. Financial services companies are also looking to emerging markets for expansion.

 Santander, the highly acquisitive Spanish bank, recently won an auction for a controlling stake in one of Poland’s largest banks. It fought off stiff competition from European rivals to purchase the 70 per cent stake of Bank Zachodni WBK that Allied Irish Banks has been forced to sell as a condition of the state aid it has received from the Irish government. HSBC, meanwhile, is in exclusive talks to buy 70 per cent of South Africa’s Nedbank, giving the world’s biggest bank outside China a significant foothold in Africa. 

With dealmaking in emerging markets outpacing the US and Europe for the first time in years, many of the new merger arbitrage funds have shifted their focus to Latin America and Asia. These funds aim to profit from the difference between a target’s share price after a takeover announcement and the closing price at completion. There is roughly $15bn in funds specifically focused on merger arbitrage worldwide, estimates Hedge Fund Research, although other event-driven funds also invest around deals. 

One of the biggest trades for merger arbitrage funds at the moment is BHP’s bid for Potash. Since going public with its offer, more than 145m shares in the Canadian fertiliser company have been traded, and BHP is hoping these will help influence the outcome of the deal. Likewise, hedge funds including Jabre Capital have taken positions in Dana Petroleum following Korea National Oil’s offer. The Korean group needs acceptances from 75 per cent of shareholders before it can delist Dana from the London Stock Exchange, and 90 per cent before it can begin a squeeze-out process. If it succeeds in reaching its target, it may provide peers in the region with the impetus to become more aggressive when pursuing western targets. But while investors may welcome more emerging-market activity, they will not approve any deal at any price.

Prudential was one of the first companies to discover this after shareholders forced the UK life assurer to abandon its $35.5bn attempted takeover of the Asian assets of AIG, the US insurance group. Investors holding more than 20 per cent of the Pru were concerned that the economics of the deal left virtually no margin for error in delivering the promised returns and cost synergies. But while it is inevitable that some of these deals will fail to succeed, the impetus to keep trying is unlikely to wane. International companies that in the past have dismissed emerging-market M&A as nothing but a passing phase have taken stock of reality: the new breed of dealmakers is here to stay.
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