Cross-Border Asian M&A, published in Financier Worldwide

Published in Financier Worldwide
The economic map of the Asia-Pacific region is rapidly being redrawn. In line with the rise of China and India as trading powerhouses, cross-border M&A activity has been soaring in both countries, as it has been in Australia, Singapore, South Korea and Thailand. In the first six months of this year, cross-border dealmaking ran at more than double the total for the same period in 2006, according to figures from Thomson Financial.

It is too soon to judge how far the turbulence on the world's stock markets will affect the situation during the second half of the year, but the flurry of acquisitions that have already taken place have already marked 2007 as a watershed year, with a series of record-breaking deals completed across several different sectors and countries.

A total of 3,123 deals were announced in the first half of the year, worth a combined $254.6bn, 101 percent higher than for the same period last year. This figure comprised $129.6bn in inbound deals and $125bn of outbound deals.

Vodafone's $11bn takeover of Indian mobile phone carrier Hutchison Essar stands out as a highlight, a rare major corporate deal conducted in India, where regulation and cultural differences can deter acquirers. Singapore Power and Australian bank Babcock & Brown jointly acquired energy utility Alinta for $11.5bn and India's Tata Steel acquired Anglo-Dutch firm Corus for $12.2bn.

Indian firms in particular have contributed greatly to the rising outbound M&A figures, with $27.9bn worth of deals announced in the first half of this year, compared with just $9.9bn for the whole of 2006. Sharing a common language and an intermixed history, India and the UK have plenty in common, helping to explain why many Indian companies have begun acquiring British ones, and vice versa. Indian companies spent $1.2bn on UK businesses in the first half of 2007, three times the amount spent on any other market, according to Grant Thornton. Last year the US was the top M&A location for Indian acquirers, but this appears to have changed, perhaps in response to weakening economic conditions in the States, together with relative buoyancy in the UK market.

While UK acquisitions of Indian businesses have totalled $12bn, the great majority of this is down to the Vodafone/Essar deal. "These numbers are strong, but based largely on a few mega-deals," says Anuj Chande, head of Grant Thornton's South Asia Group. "It seems particularly mid-market corporates have not made the most of the potential this rapidly growing market offers. As anyone who has visited India recently will attest, the opportunities for investment are almost unlimited."

Growth in the country has begun to spread from the few very large cities that saw most growth in the 1990s, following deregulation of industry, to a series of smaller cities that are now experiencing massive expansion. Pune, two hour's drive from Mumbai, is a case in point, with exponential growth from IT companies and industrial firms. A new motorway has recently been built between the two cities. Similar stories are coming out of Gurgoan, a rapidly growing town close to Delhi, with a high concentration of IT campuses.

The IT sector has led the Indian M&A boom, with companies such as Infosys capitalising on the trend for US and European firms outsourcing IT functions to emerging economies. The automotive sector is now on the verge of competing for international prominence, as Vivek Gupta, managing director of AT Kearney India points out: "The Indian and US economies in the automotive sector are at other ends of the spectrum. So it makes it very conducive for Indian companies, which are on a high, to go after the North American auto clients that are on the reverse state of the cycle. So, where earlier companies were targeting niche technologies, now people are talking about large, tier-one companies."

He believes that the size of acquisition that Indian companies are willing to take on will only increase. "The Indian company is still learning and feeling its way," he says. "I am hopeful that in three-to-four years from now, as the speed and size of the acquisition train moved on, there is a larger sense of what an India-centric MNC looks like." Conversely, the power of the Indian IT industry will mean overseas companies become compelled to make acquisitions inside the country, in order to compete. "If you want to be in this sector, you will have to buy Indian companies," says Gupta.

A series of studies of the Asian M&A market have appeared in recent weeks, each of them finding that executives believe the very high levels of activity of the first half of the year will continue. They may be wrong, or may have changed their minds in the light of financial events, but there is an extreme degree of optimism among respondents. Law firm Simmons & Simmons asked 200 corporate CEOs and CFOs in the Asia-Pacific region what they felt about M&A conditions: 60 percent of them were planning joint ventures or strategic alliances, with 58 percent planning M&A deals within the next 12 months. By country, China emerged as the most attractive M&A destination, chosen by 84 percent of respondents, followed by India at 59 percent, while a majority believed that outgoing cross-border M&A will increase over the coming year.

"It is clear that there will be a growing trend for outbound investments," says Jane Newman, head of the Shanghai office at Simmons & Simmons. "We have seen the same thing happening with the cash rich Oil States in the Middle East starting to invest heavily outside that region. As the Asia-Pacific economy develops private and state-owned enterprises, in particular China, will look to spend their country's foreign reserves and increase their geographic coverage."

Three-quarters of respondents expect that there will be increased M&A activity in the financial services sector, with a similar number also expecting rises in life science company deals.

PricewaterhouseCoopers also found that financial services are expected to continue showing high levels of M&A activity, indeed carrying on at their present high levels for the next five years. This may now seem an irrational view, arrived at through simply extrapolating recent conditions into the future, but once again almost three-quarters of the survey's respondents predicted that M&A would race ahead. Financial services M&A had already reached record levels in 2006, rising 66 percent over 2005 to $64bn.

The survey found that protectionism and high prices were significant barriers to M&A dealmaking, but that the drive to conduct acquisitions was so high that "Asia's financial services industry is learning to live with the underlying implications of the regulatory environment, or at the least to prioritise growth."

Almost half (47 percent) of respondents described the need to increase market share as a motivation to merge, with 46 percent saying that entering new geographical markets was top of their agenda.

The opportunity to get into new sectors such as insurance and trust companies has recently emerged in China, PwC has found, while the prospects of doing M&A deals in Taiwan, Pakistan and Vietnam are much brighter than in previous years, as regulations have eased and vendors are more plentiful. "The outlook for deals in the insurance sector remains strong as global players seek to catch up with the market leaders and regional players begin to emerge, particularly from Japan," says Matthew Phillips, a partner at PwC China. "The survey has confirmed that Asia is still the 'home of growth'," says Phillips. "When compared to Europe, entry into the Asian market presents more of a challenge as the environment is less conducive to control deals, which in turn increases the risks if you are not able to find the right partner. Although this risk in Asia remains high, the growth potential will continue to present compelling opportunities."

With companies and financial institutions becoming increasingly risk-averse, this issue may come to dog cross-border M&A in the coming years. But for now, analysts are waiting to see whether the series of record-breaking M&A results that have contributed to the region's rising economic profile will continue. Chinese M&A last year totalled $99bn, boosting the value of transactions in Asia-Pacific to a new high of $385.4bn, 50 percent higher than in 2005. Standard & Poor's singled out banks, metals, oil and gas, medical and technology companies are the most active, with financial services registering the most surprising growth, since China's authorities have been strongly protective of overseas acquisitions here in the past. Banco Bilbao Vizcaya Argentaria, the second-largest financial group in Spain, paid $650m for a 5 percent stake in China Citic Bank. Going in the opposite direction, China Development Bank recently bought an $11.8bn stake in UK bank Barclays. So you might imagine that the Chinese authorities feel the need for some reciprocal loosening of the restrictive attitude here.

Standard & Poor's predicts that there will be a continued surge in M&A in China, particularly in retail, service and consumer-goods markets. "Some of these sectors are viewed as less strategic to China and are therefore less protected, with foreign investors able to buy a large or controlling shareholding," states the report.

Law firm Norton Rose conducted its own survey into Asian M&A attitudes and expectations, finding that financial services was the sector most likely to see high levels of dealmaking in the coming year, followed by telecoms, then manufacturing, infrastructure, energy and utilities, real estate and then pharmaceuticals. And among the countries expected to see most activity, the list reads China (41 percent), India (32 percent), then Singapore (6 percent). Financial services companies based in Asia seem reluctant to go after Western targets. "This may reflect the fact that most targets in the West are too big, richly valued and fought over by global leaders (who are themselves hunting for deals in Asia," says the report. "On the other hand, respondents from Asia's IT and technology sector are more confident about doing deals with firms in Europe or North America (32 percent) than in Asia (26 percent), presumably because the West has more to offer in terms of cutting-edge technologies, global marketing and branding know-how."

Financial services and telecoms are in fact among the most regulated of sectors in Asia, but as Norton Rose points out, the eagerness of foreign companies to get into these areas indicates their faith in the growth of Asia's economies, "Financial services and telecoms are two of the most direct ways to participate in an economy's growth, particularly in huge consumer markets like China and India, which have a combined population of 2.5bn people." Motivation for conducting M&A is primarily to consolidate market position, Norton Rose found, followed by expansion into a new market or to establish a presence in a new sector. In China, 92 percent of respondents said they expected to be involved in an M&A deal in the next 12 months, compared with 80 percent in India, 71 percent in Singapore and 58 percent in Hong Kong. Thai executives (14 percent) and those in Indonesia (5 percent) were the least interested in M&A activity.

South Korea, with little track record of major cross-border acquisitions, surprised market observers in late July when Doosan Infracore (formerly known as Daewoo Heavy Industries and Machinery) announced a $4.9bn bid for the construction business of Ingersoll Rand, the US conglomerate. If completed, this will be the single biggest foreign takeover by a Korean company.

Being in the World Trade Organisation has obliged India and China to deregulate many areas of their economies, something that is happening at varying speed between the two countries. In telecoms for example, "a phone operator can apply for a license if its level of foreign ownership is 74 percent or less," says Allen Ma, president of BT Asia Pacific (a subsidiary of British Telecom), which recently acquired an Indian telecoms company. "China doesn't have the kind of licensing regime that is as open as India," he adds.

By contrast, Australia has a western style of business regulation that allows private equity firms, for example, to operate much as they do in Europe or the US. Large buyout targets are commonly approached by private equity firms, but with prices getting over-heated and shareholder activism rising, there have been a couple of high profile lost deals in recent months. A Macquarie-led group of investors wanted to take over national airline Quantas for $9bn, but shareholders rebuffed the approach. US private equity firm TPG also withdrew from a bid for Coles Group, Australia's second largest retailer.

For some financial experts, there is no question that Asia - particularly India and China - will continue to make inroads into international M&A. "I'm a firm believer in China and India's future development," says Ed King, head of Asia Pacific M&A for Morgan Stanley. "With rapid economic growth, it is inevitable for Chinese and Indian companies to seek expansion globally."

As a longer-term prediction, this is most likely to be true. But with jitters, if not outright panic characterising the international markets this summer and threatening to derail any number of deals, dampening growth across most sectors and geographies, the near-term health of the 'risky' Asian markets cannot be guaranteed.