Asian companies will need to be nimble in 2015 and time volatile markets well, in order to help them raise capital in the run up to a likely US interest rate hike by the summer.
There are reasons to be optimistic. Asian loan markets remain liquid and debt capital markets are poised to expand further. After being shut for the last couple of years, the US market for initial public offerings has re-opened for Chinese technology companies.
Many Asian companies also still have large piles of cash and, assuming no major economic tailwinds, are expected to continue deploying that money.
As the Chinese government looks to root out corporate malfeasance and make its lumbering state-owned giants more efficient, this is expected to generate deals. Privately owned Chinese companies too are stepping up their global ambitions, encouraged by recent regulatory changes to seek out more mergers and acquisitions.
A key threat to this rosy outlook is the possibility of a sudden economic slowdown in China.
“What happens to the Chinese economy and the state of its overall banking system has an impact on our clients in the rest of region,” said Atul Sodhi, managing director and head of loan syndication at Credit Agricole.
Growth in China is gradually slowing as the economy matures but also because of measures taken to rein in a debt-fuelled housing binge. HSBC data shows manufacturing activity slipped in November to its lowest level in six months and the People’s Bank of China, keen to avoid too sharp a slowdown, cut benchmark interest rates last month for the first since July 2012.
Fosun, China’s biggest privately owned investment company, will continue to look outside the country. “Fosun willl try to find more opportunities overseas to obtain cheap capital,” Liang Xinjun, chief executive, told FinanceAsia. “I think [we could buy] one or two more financial companies, like an insurer or a bank, especially from Europe or Japan,” because European and Japanese interest rates will remain low for years, he said.
Even as growth slows sharply in some sectors, some investors see value. “We are potentially seeing the beginnings of a blood bath” in the commodities sector, said Robert Petty, of Asian credit investor Clearwater Petty. “Coal miners and surrounding infrastructure in Indonesia and Australia is just beginning to feel the jolting impact of the fundamental shift in energy infrastructure.”
Petty told delegates at a private equity conference in November that he saw opportunities for senior-secured direct loans charging interest of 15% to 20% borrowers shunned by banks, such as credit-starved small- and medium-sized enterprises as well as to consumers in China and India.
Amid growing political uncertainty in Hong Kong, the city’s tycoons are expected to keep diversifying away from the territory. Li Ka-shing’s Cheung Kong Holdings, for example, has been looking far beyond Hong Kong and is expected to keep seeking assets in regulated and transparent markets that offer a steady yield.
Elsewhere, Indonesia could see an uptick in capital markets activity following parliamentary and presidential elections. This is already happening in India, where cash-starved companies have flocked to raise capital after Prime Minister Narendra Modi assumed office in May.
Meanwhile, in Japan desperate efforts to beat deeply embedded deflation are flooding the markets with liquidity. The result of so-called Abenomics so far has been to push Japanese banks to increase lending across Asia in a search of higher yielding opportunities. This will keep financing costs down for many companies that might otherwise have turned to capital markets.
But the pressure for investment banks to be more efficient and to get more bang for their buck remains strong. Banking serial dealmakers from Alibaba and Samsung to Fosun International and Cheung Kong has become more important than ever, as is identifying emerging giants such as Xiaomi.
“In a world where resources are limited every bank has realised the benefit of focusing on the clients where you can make the biggest difference,” said Mark Slaughter, head of regional corporate and investment banking at Citi. His employer is putting its efforts into cultivating the world’s largest crossborder companies.
As we look into 2015 and the Chinese year of the goat, here is our guide to navigating the waters on the themes to drive dealmaking.
Tech coming of age
If there’s one sector that was big in 2014, it was technology. And it’s likely to stay that way next year. E-commerce giant Alibaba, founded by Jack Ma, captured the imagination of investors with its $25 billion IPO. Riding on its success, more Chinese internet and technology companies are expected to tap capital markets next year.
The majority of them are expected to head to the US where investors are more receptive to technology stocks and the listing regime is friendly to growing companies.
“Companies could also obtain a better valuation multiple in the US because its investor base has a greater willingness to pay for high growth,” said John Hall, head of Asia Pacific technology, media and telecoms at JP Morgan.
The re-opening of US IPO markets for Chinese technology companies augers well for investment banking fees. On average, fees for a $200 million IPO in the US are around 7% compared with 1% in Hong Kong, according to one banker in Hong Kong who works on these deals.
However, bankers are unlikely to see a repeat performance of 2014’s enormous volumes, in absence of a mega IPO like Alibaba’s.
Not all Chinese technology companies will go to the US. Xiaomi, the world’s third-largest smartphone supplier after Apple and Samsung, is looking to list but no definite timeline has been set, according to bankers familiar with the matter.
The four-year old company, which is valued at $50 billion, is said to be considering an IPO in Hong Kong, as local investors tend to be more comfortable with hardware firms than software companies.
Another potential vein of deal activity is investors selling down stakes in Alibaba. While it remains to be seen how many shares will be sold, the lock-up on about 300 million Alibaba’s shares will expire in March. If all those shares are sold, that’s worth about $33.3 billion based on prevailing prices.
M&A deal flow also could get a boost from regulatory changes. Bankers expect China regulators to relax their stance towards variable interest entity-related transactions in the near future, which could spur more consolidation. VIE structures, used by many Chinese internet companies to enable foreign investors to invest in otherwise restricted sectors, are not officially sanctioned by the Chinese government.
SOE reorganisation
Chinese state-owned enterprises are not the gravy train they used to be but the reorganisation of their sprawling assets is expected to be a key source of deal flow in 2015. For investment banks, helping these behemoths to restructure will position them for potentially more lucrative business down the road.
For example, Sinopec, which sold a 30% stake in its retail unit to investors for $17.4 billion, is now expected to seek a listing for the retail unit. The oil giant is also expected to spin off another unit, called Sinopec Oilfield Services. Another jumbo deal could include the merger of train-makers China Northern Locomotive & Rolling Stock Industry Group and CSR group.
“The broader Chinese SOE restructuring will encompass a wide range of deal flow, including mergers and asset injections,” John Kim, head of M&A for Asia ex Japan at Goldman Sachs, said. “Some deals will not require advisory but may require financing, such as having to raise equity to fund an asset injection.”
Given the sheer size of China’s state-owned giants, there could be a number of multi-billion dollar deals. While the push to restructure has ostensibly been for reform and improving corporate governance, China’s leveraged SOEs also need funds.
However, a number of the deals could be domestic in nature, offering Chinese investors and banks more opportunities than their foreign peers. For example, oil giant PetroChina’s plans to introduce private capital into two oil fields, but that is likely to be handled by domestic banks, according to one banker who is not involved in the deal.
Bank capital will be big
China, the world’s second-largest economy after the US, is likely to account for the bulk of dollar-denominated Basel III-compliant bank capital issued next year as the country’s banks look to shore up cheaper forms of funding.
The mainland’s top five banks have obtained approvals to issue a combined Rmb270 billion ($43.5 billion) worth of Basel III-compliant bonds from 2014 to 2016. The banks are Agricultural Bank of China, Bank of China, Bank of Communications, China Construction Bank and Industrial and Commercial Bank of China.
So far, Bank of China has issued the nation’s first $6.5 billion preference share or Additional Tier 1 note. ICBC is expected to sell a similar instrument. China’s three other large state-owned banks are likely to follow in 2015. Each deal is expected to be about $5 billion or more, meaning the total size of the first batch of AT1s may easily top US$20 billion to $25 billion. Total AT1 issuance from China’s 16 biggest banks will likely exceed $100 billion eventually based on 1% of their risk-weighted assets, Morgan Stanley said in an August 22 report.
In addition, Asian banks could ape their European peers and embark on liability management exercises next year, retiring old legacy bank capital in exchange for new Basel III compliant bonds.
“We expect to see more bank capital from Asia-Pacific, including Southeast Asia, next year,” said Alexi Chan, head of Asia debt capital markets at HSBC.
PE to put money to work
Private equity firms have raised some impressive war chests to dip into and invest in Asia. KKR closed a $6 billion fund in mid-2013, Asia’s largest-ever fund, CVC Capital Partners raised $3.5 billion in May for its fourth Asian fund, and Carlyle sealed a $3.9 billion Asia fund in September.
Credit markets remain willing to fund large deals with high debt-to-equity ratios: witness Carlyle’s $1.9 billion acquisition of ADT Korea.
So far this year private equity has raised $35.3 billion for deals in Asia, up on the $32.13 raised in 2013. The funds are more evenly targeting the region, compared with 2011 when about two thirds of the capital raised was aimed at China, according to data providers PEI Research.
“The environment today is quite conducive to a good vintage for private equity investment,” said David Shen, regional managing director of Olympus Capital.
Private equity’s biggest challenge in Asia is finding large enough deals, preferably where the funds can secure control of the target company. Foreign private equity players also face increasing competition from Chinese funds with plenty of liquidity. Sinopec’s 30% stake in its retail unit, for example, was predominantly sold to Chinese funds.
“As Chinese SOEs introduce private capital, foreign private equity players which need to meet higher internal rates of return might find it hard to compete with the liquidity in the mainland domestic market in certain areas,” Lian Lian, co-head of North Asia M&A at JP Morgan, said.
One avenue where Chinese private equity funds look likely to have success in 2015 is in partnering with Chinese state-owned firms and helping them to acquire abroad. Take Hopu and China food giant Cofco’s acquisition of a 51% stake in Noble Agri Ltd. for $1.5 billion.
M&A advisers would do well to stay close to these serial acquirers who are often more generous on fees than Asia’s tycoons or the region’s SOEs.
Japan and Taiwan banks to shop abroad
Taiwanese and Japanese banks are likely to continue their spending spree in 2015 as they look to expand outside their home markets where profit margins are wafer thin.
People familiar with their thinking say Philippine banks are in their crosshairs following an easing of ownership restrictions. Foreign bidders are likely to take part in the government’s planned sale of a controlling stake in United Coconut Planters Bank. Taipei-headquartered Cathay Financial is acquiring a fifth of the Philippines’ Rizal Commercial Banking for $400 million.
The tumbling yen is unlikely to put off Japanese buyers, in fact the additional liquidity in the banking system from the Bank of Japan’s stimulus programme announced October 31 is likely to push financial institutions to look overseas for yield.
Japan’s J Trust completed in November its purchase of 99% of Indonesian lender Bank Mutiara for $350 million.
Fosun said it would seek to help Japanese banks with their overseas ambitions. “Fosun has the ability to help a Japanese financial institution improve its return on assets,” Liang Xinjun, chief executive, told FinanceAsia.
Indonesia could reopen
Indonesia could be set for a nervy 2015 with banks and companies waiting to see how the economic and business-focused policies of newly elected President Joko “Jokowi” Widodo are implemented. Parliamentary and presidential elections helped subdue market activity and left many foreign investors waiting to make sense of the outcome.
August, September and October saw net foreign equity capital outflows as the mixed election results were digested.
According to one M&A banker, it is difficult for foreign acquirers to take majority stakes of size in Indonesia.
Analysts expect Indonesian companies to remain hesitant next year about embarking on large acquisitions or tapping capital markets for funds as economic conditions bed down following election year.
How Widodo’s policies begin to be implemented is still uncertain and his fuel price increase, while expected, was met with criticism by poorer sections of society.
Indonesia’s economy is expected to soften as consumer spending slows, due in no small part to the fuel price rise, while an expected US rate hike later in the year could pressure emerging markets.
That said, Indonesia’s central bank has lifted its GDP forecast for 2015 to 5.8% from 5.6%, and the new president should at least begin to make good on his promise of spending big on infrastructure projects.
This means contracts will be awarded to domestic and foreign companies to build roads, bridges, ports and transmission lines. So project financing could produce some interesting deals. A number of power-related projects are also in the pipeline for 2015 as Indonesia continues to pursue alternative methods of electricity generation. The country’s finance ministry has said it will frontload its G3 bond issuance ahead of the expected US interest rate rise
Moody’s believes the total value of foreign currency bonds issued by Indian companies in 2015 could exceed the predicted $14 billion for 2014, assuming the cost of hedging exchange-rate risk declines.
Renminbi goes global
The renminbi will continue its path towards internationalisation as China accelerates the pace of fomenting the growth of offshore renminbi centers. As more renminbi clearing banks are appointed across the world, this will increase the offshore renminbi deposit base. To date 12 countries have been established as offshore renminbi centres.
The Formosa bond market got a boost in June after Taiwan regulators allowed domestic insurers to classify all bonds with a local listing as domestic securities, even if denominated in a foreign currency such as the renminbi. Such bonds would have previously been considered foreign instruments, in which Taiwanese insurers can only invest up to 45% of their assets.
“Recent changes in regulation in Taiwan have encouraged the development of the Formosa bond market and we expect more such issuance given the liquidity of the Taiwanese investor base,” said Alexi Chan, head of Asia debt capital markets at HSBC.
The dim sum market is expected to grow. China Construction Bank in August priced the first dim sum Basel III compliant bond to be issued by the headquarters of a Chinese bank, which offered a reset over the benchmark CNH Hong Kong Inter-bank Offered Rate (Hibor).
“One of the features of the offshore renminbi bond market was the absence of a suitable interest rate mechanism for a reset but, with the [Hibor fixing] being established last year, we have now seen the first offshore renminbi bank capital deal with a reset,” said Chan. “We expect more banks to consider raising capital in the offshore renminbi market going forward.”
China property to get helping hand
China’s property sector will continue to struggle in 2015 but the People’s Bank of China’s recent rate cut is expected to help cash-strapped property companies.
The PBoC on November 21 cut the benchmark one-year lending rate by 40 basis points to 5.6% and the one-year deposit rate by a quarter percentage point to 2.75%.
The rate cuts, the first since 2012, are expected to help mainland property firms with high levels of onshore bank loans linked to the floating PBoC rate.
Fitch expects onshore funding conditions to become more favorable for developers in 2015, which will benefit smaller developers in particular.
For example, onshore perpetual bonds have become popular among developers to gradually replace onshore trust loans.
While onshore costs are coming down, China property companies are expected to continue to tap the offshore bond markets for funds. Recent events such as the detainment of Agile Property’s chairman have also worried investors and lenders.
Beijing’s relaxing restrictions on developers’ financing will be minor stimulus rather than a big boost. The interest rate cut in November may not improve developers’ financial profiles or stimulate housing sales in any meaningful way because it is modest, said analysts.
Moody’s says nationwide residential property sales will decline by as much as 5% year-on-year in 2015, compared with 9.9% during the first 10 months of 2014.
Infrastructure deals
Opportunities are increasing for infrastructure M&A, from the Japanese government’s sale of the operating rights for New Kansai International Airport for over 2 trillion yen ($16.85 billion) through to the privatisation drive in New South Wales, Australia.
The Asian Development Bank estimates demand for infrastructure investment in Asia at $730 billion a year for the next decade.
“Without infrastructure, GDP growth suffers,” agreed V. Shankar, group executive director at Standard Chartered Bank. Comparing China to India, he reckons India’s poor infrastructure has cost it 150-200 bps annually of lost GDP growth.
The reformist governments in India and Indonesia are working to remove the red tape holding up infrastructure projects.
Meanwhile, China’s President Xi Jinping pledged $40 billion for infrastructure investment at the APEC summit in November to build a New Silk Road in the spirit of the old trading route.
Xi said China plans to build a “Silk Road Economic Belt”, a network of highways and railways connecting China to its neighbours, and a “21st Century Maritime Silk Road” of ports and industrial parks across the Pacific and Indian oceans, perhaps as far as the Mediterranean Sea.
This follows agreements to establish the Asian Infrastructure Investment Bank, seeded with $50 billion by China, and is in line with the growth of China’s outward investment, which is likely to surpass inflows this year.
