ey capital insights q3 2012

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Deutsche Telekom CFO Timotheus Höttges on

collaboration, innovation and communication

Calling the shots

Metals and Mining M&A: What the future holds

Cross-border financing

Poland: Rising in the east

Insights

Helping businesses raise, invest, preserve and optimize capital

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For Ernst & YoungMarketing Director: Leor Franks ([email protected]) Program Director: James Horsman ([email protected])

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About Ernst & Young’s Transaction Advisory Services How organizations manage their capital agenda today will define their competitive position tomorrow. We work with our clients to help them make better and more informed decisions about how they strategically manage capital and transactions in a changing world. Whether you’re preserving, optimizing, raising or investing capital, Ernst & Young’s Transaction Advisory Services bring together a unique combination of skills, insight and experience to deliver tailored advice attuned to your needs – helping you drive competitive advantage and increased shareholder returns through improved decision making across all aspects of your capital agenda.

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Joachim Spill

Transaction Advisory Services Leader, EMEIA (Europe, Middle East, India and Africa) at Ernst & Young

If you have any feedback or questions, please email [email protected]

For more insights, visit www.capitalinsights.info where you can find our latest thought leadership including our market-leading Capital Confidence Barometer.

Helping businesses raise, invest, preserve and optimize capital

Pres

erving Optimizing

Raising

Investing

The quest for growth has seen many firms venture into new markets — and changing patterns in the direction of activity are becoming established. In Q2 2012, the value of global cross-border M&A rose to its highest level since Q4 2010 while the volume of outbound M&A from emerging markets jumped by 64% year on year.

And we are seeing a growing trend for corporate collaboration as more companies seek to expand while minimizing risks. This issue of Capital Insights examines these two complementary business trends.

Cross-border: as firms look beyond their own markets for growth, we explore three countries in Eastern Europe that offer exciting opportunities (page 24). And we are very pleased to have an exclusive interview with Poland’s former Prime Minister Jan Krzysztof Bielecki, who examines the political and regulatory background for M&A in the country.

In addition, for those looking to raise capital, we investigate the alternatives for cross-border fund-raising as banks retrench (page 20).

Collaboration: Deutsche Telekom CFO Timotheus Höttges tells us how partnerships with other corporates and entrepreneurs are driving innovation and growth (page 14). Meanwhile, on page 34, we explore how businesses can work with shareholders to head off “activism” and to channel shareholders’ passions positively. Combining the two threads of this issue, on page 31, we show you why joint ventures can be vital tools in overcoming cultural differences in cross-border M&A deals.

When it comes to optimizing asset portfolios, we examine how companies are refocusing and divesting in the metals and mining sector (page 10), and regular columnist Dave Murray discusses whether now is the right time to diversify or rationalize your business (page 7).

In these tough times, corporates that strive for expansion can no longer afford to be standalone or purely domestic in focus. For those looking to raise, invest, preserve and optimize capital, I believe that crossing borders and collaborating are the way forward. I hope this issue of Capital Insights points you in the right direction.

ContributorsCapital Insights would like to thank the following business leaders for their contribution to this issue

Steven Appelbaum

Professor Department of Management Concordia University

Mark Hutchinson

Head of Alternative Credit M&G Investments

Richard Lewis

Chairman Richard Lewis Communications

Stephen Benzikie

Director Pelham Bell Pottinger

Brian Coulton

Global Emerging Markets Strategist Legal & General Investment Management

Michal Mravinač

Director for UK and Ireland CzechInvest

Timotheus Höttges

Chief Financial Officer Deutsche Telekom

Liz Murrall

Director, Corporate Governance and Reporting, Investment Management Association

Jan Krzysztof Bielecki

Head of the Economic Council to the Polish Prime Minister

Wojciech Pytel

Member of the Management Board Polkomtel

Christoph van der Elst

Professor of Business Law Tilburg University

Peter Williamson

Professor of International Management Judge Business School

Capital Insights from the Transaction Advisory Services practice at Ernst & Young www.capitalinsights.info | Issue 4 | Q3 2012 | 3

Insights

24 Eastern promiseAs companies continually search for new sources of growth, Poland, Ukraine and the Czech Republic could provide opportunities for deal-makers.

28 In pole positionFormer Polish Prime Minister Jan Krzysztof Bielecki tells Capital Insights how his country’s growth has been driven, and what it plans to do to stay ahead of the pack.

Features10 Extracting value

Recent high-profile deals in the metals and mining sector have hit the headlines. However, a closer look at the sector reveals new trends with big implications for others.

14 Cover story: Calling the shots Deutsche Telekom CFO Timotheus Höttges explains how the company is negotiating turbulent and heavily regulated markets, while also looking for new opportunities.

20 Withdrawal symptomsWith banks reining in their cross-border lending activity, what alternatives are out there for corporates looking to raise capital for their businesses?

31 Dealing with differenceCulture clashes have an infamous history of disrupting M&A deals. How can your company manage social, corporate and linguistic differences to ensure a successful transaction?

34 Driving changeShareholder activism is on the rise across the globe. Capital Insights explores how a potential investor revolt can be turned into constructive stakeholder collaboration.

Regulars06

HeadlinesGlobal transactions news and how it affects you

07The real deal

Dave Murray discusses how optimizing portfolios by rationalizing or diversifying can aid businesses

08Transaction insights

A look at the rising trend in hostile takeovers

30The PE perspective

Sachin Date explores the globalization of private equity and its spread into developing markets

38Moeller’s corner

M&A Professor Scott Moeller explains how heeding shareholders’ advice can reap rich rewards

39Further insights

More insights on how to raise, invest, preserve and optimize your capital

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For further insights, visit www.capitalinsights.info

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#1 Ernst & Young – recognized by mergermarket as top of the European league tables for accountancy advice on transactions in calendar year 2011**As run on 11 January 2012

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. tech start ups

HeadlinesGetting smart on start-upsDeals for technology start-ups are very much to the fore at the moment. In May, computer firm Oracle bought social-media marketing business Vitrue for US$300m. Two months later, in July, it acquired social marketing company Involver and network vendor Xsigo for undisclosed amounts in separate deals. Meanwhile, in the same month, Google bought marketing start-up Wildfire for a reported US$250m. A July 2012 survey from print services com-pany RR Donnelley also highlighted the focus on buying tech start-ups. Respondents noted that the “stratospheric valuations” of relatively young companies mean “both financial and strategic buyers are looking to buy early in hope of a big payday.”

A call to actionNew research has identified the top 10 obstacles that those in the telecommunications industry need to overcome. A report from Ernst & Young has revealed that the inability to capitalize on new connectivity tools, uncer-tainty on new-market regulation and unclear security responsibility to customers are among the 10 key challenges facing communications companies. Other sectors should also take note as The top 10 risks in telecommunications 2012 survey highlights a lack of organizational flexibility and poor M&A and partnership strate-gies as key pitfalls — risks which can cut across all business areas. For a full copy of the report, visit www.capitalinsights.info. And for an exclusive interview with Deutsche Telekom CFO Timotheus Höttges, see page 14.

A comeback for IPOs?While certain high-profile initial public offerings (IPOs) have underperformed of late, it appears that companies are still looking to go public as a key way to raise capital. IPO activity world-wide increased in Q2 2012, according to a new Ernst & Young report. The latest Global IPO Update shows that 206 deals raised US$41.8b in the second quarter, a respective 5% and 141% increase on Q1 2012. Japan is seeing a rash of IPO activity — particularly from its air-lines. In July, All Nippon Airways (ANA) raised around US$2.1b while Japan Airlines (JAL) is aiming to relist on the Tokyo Stock Exchange in a bid to generate US$8.5b. However, compa-nies need to be fully prepared before they float. The next issue of Capital Insights will carry an in-depth investigation of IPO readiness.

PE assets hit new recordAssets managed by the private equity (PE) industry have hit new heights. They reached US$3t in value last year, according to Preqin. The data firm also said that the number of assets managed by the industry grew 9% from December 2010 to December 2011. Bronwyn Williams, Preqin’s Manager of Perfor-mance Data, said the figures indicate that PE “continues to be attractive,” and that “faith remains that PE fund managers can still deliver these returns.” Though the figures are positive, PE is continuing to search for new sources of growth in secondary markets. This is demonstrated by the tripling of PE investments in Africa to US$3b in 2011, according to Mthuli Ncube, Chief Economist of the African Development Bank. For more on PE manoeuvres in emerging markets, see page 30.

A ny personal finance advisor will tell you that the key to limiting investment risk is diversification. Sadly, for corporates, it’s not

that simple. With growth in many developed markets stagnating, companies need to ask themselves whether now is the time to rationalize or diversify their businesses.

At present, the trend seems to be very sector specific. In oil and gas, for example, we’ve seen rationalization. Major organizations such as Shell and ExxonMobil are divesting downstream operations in order to reinvest in core services such as exploration and oil field services.

However, we have seen a move toward diversification in the food and beverage sectors as companies try to gain rapid growth outside of their core business and markets. Kellogg is a prime example of this trend. In February, the breakfast cereal giant bought the Pringles chip brand from Procter & Gamble for US$2.7b. Kellogg viewed this acquisition as a way to drive global growth for its predominantly US snack business rather than go through the pain of growing their own operations organically in the same markets they sell cereals.

A company may look at diversifying in order to de-risk the business or to increase growth. For example, as supply chain risk

grows, businesses may want more control over their supplier base. This could de-risk operations, with companies buying suppliers and adding them to the core business. In addition, companies may diversify to gain entry to growing markets. This has been the case with PepsiCo and the Campbell Soup Company, which have recently bought healthy options brands to expand their reach.

As for those looking to refocus, the emphasis should be on core competencies and divesting those areas that are giving lower-than-average returns, so they can reinvest in higher-returning assets. Corporates are looking at the relative profitability of the business, even if it means selling off a key part of the company. Dutch firm CSM, the world’s largest supplier to bakeries, announced in May that it would divest its larger bakeries businesses to concentrate on its more profitable, yet smaller, bio-ingredients business.

However, before companies embark on either strategy, they need to be aware of the challenges. When businesses start to rationalize, they should get assets targeted for divestment into a saleable state. These assets are often intertwined, so management needs to consider the costs of separation.

Structurally, the company may need to carve the business out. And in the current

Making orbreaking

When it comes to optimizing asset portfolios, corporates can choose a strategy of rationalization or diversification, but knowing which way to turn can be tricky

climate, finding a buyer, at the right price, can be tough. Despite the fact that large companies are sitting on an estimated US$7.8t, according to Standard & Poor’s, bidders are unwilling to acquire assets at a premium if they feel they can buy the target for a bargain price. And sellers do not want to be seen by key stakeholders as shedding assets in what can amount to a ‘fire sale’.

Those considering diversification need to find the right assets, get the best value and work on a solid integration plan. Yet, traditionally, a diversified business may suffer in the markets. Stock markets historically discount conglomerates while rewarding those with a tighter focus. However, data from the Leipzig Graduate School of Management has shown that this “conglomerate discount” is shrinking. Between 2008 and 2009, the discount significantly decreased across the US and UK. While in Asia, conglomerates now command a market premium.

Firms should undergo a thorough health check before deciding which strategy to take. With the competition for growth intensifying, when it comes to optimizing capital, businesses need to make the right move.

Dave Murray is EMEIA Markets Leader, Transaction Advisory Services, Ernst & Young. For further insight, please email [email protected]

The real deal

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Payback time for investorsIt’s a bumper time for shareholder dividends. Firms worldwide are paying out record amounts in dividends, according to new data. Analysis by share registration services provider Capita Registrars has revealed that UK companies re-warded shareholders with payouts worth £22.6b (US$36b) between April and June this year, beating the £22b (US$35b) record for the same period in 2000. In the US, Standard & Poor’s Dow Jones indices said that net dividend rises totaled an all-time high of US$12b in Q2 2012. Meanwhile, in Russia, new legislation coming into force at the end of the year will compel firms to up their mandatory dividend distribution level to 25% of earnings. It would seem that, at a time when companies are sitting on US$7.8t, according to Standard & Poor’s, keeping inves-tors happy is all important. For more on share-holder engagement, see pages 34 and 38.

East side storyCorporates and private equity (PE) alike are waking up to the potential of the Central and Eastern Europe (CEE) region. In August, NYSE-listed WNS Holdings, a global business services provider, opened a new delivery centre in Gdynia, Poland, to service clients across Europe and Asia. Meanwhile, earlier this year, Chinese Deputy Premier Li Keqiang signed deals worth over US$16b in Russia and Hungary. Also from China, shipping giant COSCO has shown interest in the Croatian port of Rijeka (pictured below). PE activity is also on the rise. Figures released in August from the Emerging Markets Private Equity Association show that PE fund-raising in CEE hit US$2.6b in H1 2012, nearly double the total for 2011. Deal-makers should look eastward, with Poland a stand-out destination. For more on Eastern Europe, see page 24.


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TransactioninsightsKey facts and figures from the world of M&A. This issue: Hostile takeovers

While the volume and value of overall global M&A may have fallen in H1 2012, hostile takeovers (HT) are making a comeback. Hostile bid volumes, in which the bidder bypasses the target company’s board and appeals directly to shareholders, have risen by 54% in H1 2012 year on year, according to mergermarket (see figure 1). In Q2 2012, bids also almost doubled quarter on quarter from 7 to 13 — the fastest rate of increase since 2008. Recent examples include GlaxoSmithKline’s US$3.6b takeover of Human Genome Sciences.

Why is this happening? With the world’s top companies sitting on some US$7.8t, according to Standard & Poor’s, firms are certainly not short of capital, and with stock markets depressing some targets’ values, this could incentivize bidders to acquire targets at a bargain price — a feature of many hostile bids.

This action is often driven by the bidder’s shareholders who are now demanding that companies use surplus capital to drive growth (for more on shareholder activism, see page 34).

HTs may be on the rise, but the proportion of failed deals is also increasing. From 2009-2011, the number of completed hostile deals outweighed failed ones; however, so far in 2012, a bid of this nature is twice as likely to fail as it is to succeed (see figure 2 for more details).

Therefore, while these bids may be an attractive proposition for corporate bidders and shareholders alike, both should take into account that being ready for a failure is just as important as preparing for completion. Meanwhile, targets that are unwilling to be bought out can also take some heart from this data.

The failure rate of HTs may also be affected by factors such as geography and industry. Since 2007, less than a third (30%) of the 54 HTs in the US have ended in completion. For more country and sector specific data, see figures 3 and 4.

So, could this rise in HTs signal an upswing in M&A activity in general? Only time will tell. But with so much money on companies’ balance sheets and shareholders agitating for greater value, the signs are certainly there.

Failed vs. completed deals in the top five countries for hostile takeovers, 2007-12 (Figure 3)HTs can be affected by regional factors. These include takeover codes and regulations, which differ substantially from country to country. In the UK, for example, the Takeover Panel reformed its rules last year making HTs more difficult. The figure, right, shows that, over the last five years, the UK and Norway have completion rates comfortably above the halfway mark, with 61% and 71% respectively. In Canada, the completion rate for 39 HTs since 2007 is just 35%. Corporates contemplating HTs therefore need not only to look at the prospective target but also the regulatory framework of the country involved.

Across the top five HT-prone industries, 169 HTs have been attempted since 2007. The difference in deal completion is not as varied as with countries (see figure 3), although the consumer sector stands out. This is the only sector in the top five that has witnessed more completed HTs than failed ones since 2007, with 65% proving successful. Of all the sectors, the energy, mining and utilities industry has had the most HT bids, with 81 attempted takeovers, yet it had a completion rate of only 44%. The figures are good news for those in the consumer sector attempting HTs. However, for those in the other top four sectors, the data shows that HTs are not easy to bring to a successful conclusion, so corporates in these sectors need to think particularly carefully before going hostile.

Failed vs. completed deals, 2007-12 (Figure 2)

Percentage of hostile takeovers completed in top five hostile takeover-prone industries, 2007-2012 (Figure 4)

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Capital Insights from the Transaction Advisory Services practice at Ernst & Young

Extractingvalue

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Some recent high-profile metals and mining deals may have grabbed headlines, but closer scrutiny reveals new trends that have big implications for other corporates

The well-documented negotiations between commodities trader Glencore and diversified mining group Xstrata have overshadowed much of the M&A activity in the metals and mining

industry during 2012. Any deal aimed at creating a business with a market value of around US$90b will dominate the headlines.

But there has been volatile M&A activity and interest elsewhere in the metals and mining sector. Figures from Ernst & Young’s Mergers, acquisitions and capital raising in the mining and metals sector — 1H 2012 report show a slowing in activity, with the number of deals in H1 2012 falling to 470 from 580 last year, while the value of deals was just over US$55b — 38% down on H1 2011’s value. However, the first three months of 2012 saw mining companies completing no fewer than 10 deals with a value of US$1b or more, including Canada’s Pan American Silver Corp’s US$1.49b acquisition of exploration company Minefinders in March.

According to Lee Downham, Ernst & Young’s Global Mining and Metals Transaction Leader, there is a continuing appetite for deal-making, despite volatile markets and ongoing economic uncertainty. “There is a strong pipeline,” he says. “Miners are increasingly unwilling to sit out the volatility and are prepared to act opportunistically and strategically. Robust long-term demand fundamentals and strong balance sheets will drive deal activity through 2012.”

As Downham observes, the logic underpinning the proposed Glencore-Xstrata merger arguably says little about the factors driving deals elsewhere in the sector. “It’s a unique transaction with characteristics that are unlikely to be replicated in other deals and also brings together a company with significant marketing activities with a major diversified producer,” he says. “I don’t think we’ll know for some time whether the deal will have a wider impact on the thinking of mining and metals companies.”

Of more immediate concern is the state of the global economy and the perennial issue of securing sources of supply. On the buy side, volatile markets and depressed share prices are allowing mining companies to make

strategic acquisitions at a time when valuations are low. Meanwhile, the same conditions are also seen as driving divestment by businesses seeking to optimize portfolios. But if the fiery economic backdrop has created an appetite for deal-making, the level of activity is being tempered by market uncertainty.

A changing landscapeThe last few months have seen a marked change in the global economic landscape. Despite an unappealing patchwork of below-par growth, stagnation and contraction across Europe and a subdued recovery in the US, raw materials providers could rely on growing demand from emerging markets to keep shareholders happy. So, when the second quarter figures revealed that China’s growth had slowed to 7.6% from 8.1% in the first three months of the year, worry increased.

The concern is rooted in hard numbers. For instance, in June of this year, Australia’s Bureau of Resources and Energy Economics estimated that iron ore prices would average US$136 a metric ton in 2012 compared with US$153 in 2011. Shipments from the country were also expected to fall to 479m tons, from March’s estimate of 493m. Slower growth in China was seen as the main contributor to the decline.

According to a briefing published by Legal & General Investment Management (LGIM) earlier this year, growth in these countries has been driven by capital investment, fuelled by a high level of savings at home. As these economies mature and domestic consumption rises, investment will fall back, slowing the rate of growth. This trend will have major implications for commodities suppliers.

As LGIM strategist Brian Coulton observed: “The big change over the next 10 years will be a sharp decline in investment growth. In the last decade, Chinese and Indian consumers have foregone a rising share of income to fund growth. But, in the next decade, this pattern is likely to be reversed. If the last decade was the story of BRICS as producers, the next decade will be the story of BRICS as consumers. The effects will be felt across the globe.”

However, it would be wrong to suggest that raw materials suppliers are standing at a cliff edge. Peter Williamson, Professor of International Management at Cambridge University’s Judge Business School, has studied China’s investment in infrastructure. He has compared China’s current spending with that of countries such as Germany and Japan when their economies were at a similar stage, and he sees no sign of the bubble bursting.

Nevertheless, the prospect of even a moderate softening in global prices looks set to have a tangible impact on the mining sector. For one thing, just the idea of lower demand, even in the short term, could scare the markets and put pressure on share prices. “By its nature, the industry tends to work to very long-term horizons,” says Downham. “But in contrast, the markets have very short-term horizons.” Concern in the markets is borne out by a fall of around 14.4% in the FTSE Mining Index between January and August this year, as investors factored in falling metals prices and rising costs.

Clearly, falling prices put pressure on margins. According to Downham, such pressure is prompting companies to look at their portfolios and consider ways and means to optimize assets, notably through divestment. “If you can realize value from the sale of non-core assets, then in the current climate that may be a sensible thing to do.”

Getting to the coreIn July, Brazilian iron ore miner Vale sold its European manganese business to Glencore for US$160m, while Australian-based BHP Billiton announced in May that it planned to optimize and simplify its portfolio further by selling its Ekati diamond mine.

Moves to focus on core businesses are nothing new, according to Abby Ghobadian, Professor of Leadership Studies at Henley Business School. He cites the example of Anglo American which, in 2009, created a new group structure arched across seven key commodities businesses — namely platinum, copper, nickel, metallurgical coal, iron, thermal coal and diamonds. In tandem with the group restructuring, Anglo set about a US$3.3b divestment program that saw the company exiting its paper and packaging business and selling a range of mining assets.

So how are the diversified mining giants defining which assets are core and non-core? “The big issue is scalability,” says Downham. “If you look at recent announcements, both BHP Billiton and Rio Tinto have put their diamond operations up for strategic review, neither of which are considered to have the same scalability as, say, copper or iron ore.”

Top metals and mining M&A deals (2012)

Completion Target Buyer Deal valueJAN

2012 Nord Gold Severstal US$2.7b

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2012 European Goldfields Eldorado Gold US$2.3b

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2012 Quandra FNX KGHM Polska Miedz US$2.2b

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Capital Insights from the Transaction Advisory Services practice at Ernst & Young 11

Peter Williamson sees geography as a factor. “Businesses isolated in a particular geography may be sales targets as they are hard to integrate with the rest of the business.”

Optimizing the portfolio offers more than an opportunity to raise capital from the sale. For instance, Anglo American’s restructuring was intended to create a more responsive organization where decisions could be taken quickly and more effectively. Downham says efficient use of management time is a key theme. “There is a skills shortage across the sector,” he says. “So, it makes sense to focus your management talent on core businesses.”

However, there is a potential problem. Companies seeking to optimize portfolios in the current climate face a volatile market. Valuations are relatively low and securing a good price may not be easy. Downham recommends a measured approach to the sale process, starting with an assessment of potential acquirers that could range from trade buyers to governments or state-owned companies and sovereign wealth funds. “Consider all the options and, where possible, generate competition for the asset,” he says.

From there, it’s a question of preparing the asset properly. “That tends to be thought of in terms of due diligence, but you should ensure that you fully understand the business and its value. This may mean delaying a sale until market conditions are right,” Downham adds.

While IPO activity is subdued, one option is to float a percentage of the company — around 20% or 30% — and work toward a full exit over time.

Scaling up and synergiesThe big players in the mining industry have grown through acquisition. In the current climate, it is imperative for an industry that is faced with the long-term issue of diminishing resources to secure sources of supply.

It’s a complex market. On one hand, the “junior players” offer new sources of supply. On the other, much of the focus is on projects that are already up and running. “Mining companies want to grow,” says Williamson. “Good greenfield acquisitions aren’t always easy to come by so there is a strong focus on assets that are already producing.”

And if lack of scalability drives divestment, the potential to scale up is a key factor in acquisition strategy. “Scalability is top of the list for most companies,” says Downham.

He cites the example of Rio Tinto’s acquisition of the Riversdale coal asset, which specializes in Africa, for around US$1.1b in June 2011. Rio Tinto’s Chief Executive Tom Albanese said of the deal that it reinforced a strategy of buying long-life competitive businesses with growth potential. “Rio Tinto saw it as a scalable investment where it had a unique ability to grow a major coal operation,” says Downham.

As industry costs rise and metal prices fall, the potential for synergies is also hugely important for businesses that are assessing acquisition targets. This ties in with a renewed focus on core business strategies that enable miners to strip out costs by sharing systems and management teams.

Any acquisition strategy aimed at establishing synergies with an existing business will be tailored to suit the market position of the companies in question. But, says Downham,

there is particular interest in a number of key mining sectors.

“At the moment, with valuations hit so hard post-Fukushima, there is a growing interest in uranium assets,” he says. “A number of investors

are waking up to the fact that nuclear will be a vital part of the energy mix in years to come, and that is driving interest.”

And according to Energy Resources of Australia (ERA), the world’s fourth-largest uranium producer, while the short-term has seen the market struggle post-Fukushima, the long-term health of the market is promising. “Despite some slower growth in the medium term, as China transitions to an increased reliance on improved power generation technology, ERA expects that the country will be one of the largest uranium consumers within the decade,” it said in its half-yearly report.

Population growth is also having an impact on the market. “Increased population and urbanization means that there are greater demands on arable farmers to supply produce to growing markets,” says Downham. “That in turn increases demand for potash.” This is evident in Canada-based Potash Corp’s Q2 results, in which it cites “accelerating demand” as a key driver for a “gross margin of US$1.2b for the quarter, [Potash Corp’s] third-best quarterly total.”

Meanwhile, despite concerns about lower demand from emerging markets, copper, coal and iron ore assets remain sought after. Indeed, in value terms, coal was the most targeted commodity in 2011, accounting for deals totaling US$41.4b, according to figures compiled by Ernst & Young.

The financial conundrumEconomic uncertainty in the mature markets and slower growth elsewhere are already affecting the ability of mining companies to raise cash through debt or equity. It is, says Christian Schaffalitzky, CEO of mineral exploration company Eurasia Mining, an issue that is particularly acute in the “junior” segment of the industry, characterized by pre-revenue stage projects, often financed by venture capital. “I have never seen things quite so tough for companies seeking to raise finance,” he says. “Nobody knows what is going to happen, so everyone is sitting on their hands.”

As Downham sees it, mining company balance sheets are indeed strong after a period of deleveraging, but there is a reluctance to draw internal resources or risk their credit ratings by borrowing large amounts. Meanwhile, volatile share prices have made it more difficult for businesses to fund deals through equity. As Ernst & Young’s Mergers, acquisitions and capital raising in mining and metals — 2011 trends, 2012 outlook report observes, IPOs were down 18% in 2011. This year, the outlook is similarly bleak.

And there is a certain amount of frustration as companies see opportunities, but are constrained by limited financing options. Schaffalitzky cites the gold sector as an example. “Some valuations are ridiculously low and that creates M&A opportunities — but only if you can get the finance.”

Finance issues have affected the size of deals. Returning to Rio Tinto’s Riversdale acquisition, Downham says: “It was a deal that the company could finance without risking its credit rating, it added scale and was considered to be accretive — these are the type of deals we expect from the major diversified miners.”

There are alternatives to the bond and equity markets.Ernst & Young’s report outlines that mining companies will explore new sources of finance, notably sovereign wealth funds and private wealth. New buyers are coming into the market, notably players from emerging markets. “Companies in countries such as China are getting

LGIM’s Brian Coulton explores how investment trends in China could point to a slowing rate of long-term growth

China’s leaders tightened the country’s monetary policy in 2011 in response to inflationary concerns, and this has since been accompanied, to some degree, by a tightening of fiscal policy,

leading to lower investment in infrastructure.However, while spending on infrastructure is likely to rebound, this

could well be offset by what is happening in the real estate sector. At the moment, house-building numbers still look strong — but this is because of projects that are already under way. In the future, the likelihood is that we will see a fall in real estate growth.

This has clear implications for providers of raw materials. Lower growth in infrastructure and real estate will have an impact on demand for materials. As will the longer-term rebalancing of China’s economy, which will see a greater emphasis on services and less on manufacturing. Indeed, although it’s a long way off, the Chinese economy will ultimately come to resemble Britain’s.

All this needs to be put into perspective. China’s economy is bigger than it was a few years ago. So even with a slowing growth rate, it will continue to be the major center of demand for mining companies. However, while the markets are pricing in the impact of decelerating growth, there may still be some way to go in that process.

Viewpoint

Brian Coulton is Emerging Markets Strategist at Legal & General Investment Management (LGIM)

Lower growth in infrastructure in China will have an impact on demand for materials

tired of buying from the spot markets or relying on overseas suppliers. So China is acquiring resources,” says Williamson.

China’s burgeoning relationship with raw materials producers has been well documented. Chinese firms have been taking minority stakes in listed companies in Africa, Asia and South America. These deals can often be complex. For instance, in September 2011, a number of Chinese companies formed a joint venture to take a 15% stake in Brazil’s CBMM for US$1.9b. For sellers, the growing appetite of companies from emerging markets is providing a new tier of buyers at a time when juniors are struggling.

Slower deal flow in the mining sector in the first part of 2012 shouldn’t undermine an appetite for M&A. While the current economic climate may be a cause for concern; a focus on core assets and a diversifying lending market has put metals and mining back in the spotlight.

For further insight, please email [email protected]

555 dealsUS$69b

2007

2008

2009

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2012

903 dealsUS$211b 919 deals

US$126b

436 dealsUS$44b

1,047 dealsUS$60b

1,123 deals

US$113b

206 dealsUS$8b

470 dealsUS$55b

183 dealsUS$12b1,008 deals

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388 dealsUS$64b

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Securing sources of supply in the current climate is imperative, especially in an industry where diminishing resources is a long-term issue. Establishing synergies with other companies can also help to cut costs.

A focus on core assets and a diversified lending market has put metals and mining back in the spotlight

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Deutsche Telekom CFO Timotheus Höttges tells us how one of the biggest players in telecommunications is finding new growth opportunities while facing downturn, competition and regulation

T imes are tough for the telecommunications industry. The Eurozone crisis has hit most of the leading telecommunications firms hard, with many announcing falling profits from their European

operations. Timotheus Höttges is very aware of the threat and has had to manage risk appropriately.

”The Eurozone crisis, uncertainties in international capital markets, greater regulation, intense competition, new market entrants and the immense speed of innovation within the industry require rigorous risk management,” says Höttges, seated in his office in Bonn, the old West German capital city.

“We permanently monitor the potential impact of risks on our operations, ranging from foreign exchange, inflation, debt capital markets and legal issues to regulatory measures and IT risks. We also simulate potential outcomes of the euro crisis. A sober assessment of all relevant risks is a sound basis for entrepreneurial action,” he says.

However, despite this somewhat gloomy backdrop, the CFO of one of Europe’s largest telecommunications firms

— servicing 130 million mobile and 33 million fixed-line customers — is surprisingly upbeat.

The results from H1 2012 showed that Deutsche Telekom stabilized in the first six months, with revenue down only 0.9% compared with H1 2011 at €28.8b (US$36.1b). EBITDA remained consistent at €9.2b (US$11.6b) compared with the same period in 2011. A reduction in the company’s net debt from €43.3b (US$54.3b) in June 2011 to €41b (US$51.4b) after the first half of 2012 is also a cause for understated celebration from the CFO.

The company has also seen growth for its business in the US. T-Mobile USA, the subject of an unsuccessful merger attempt with AT&T in 2011, raised adjusted EBITDA in H1 2012 by 6.8% when compared with the same period in 2011.

Höttges believes that a focus on core markets, continued investment in innovation and maintaining financial stability have enabled the company to weather the storm.

“We have improved competitiveness and reduced costs,” he says. “On top of that, we have a balanced

Calling the shots financial strategy. Measured by total shareholder return,

Deutsche Telekom has been one of the top performers in the telecommunications sector over the last three years. This is primarily due to the reliability of our three-year commitment to all stakeholders — shareholders, debt holders, employees and entrepreneurs within the company.”

However, he is under no illusions about the challenges ahead. He says: “This industry is under a lot of pressure. There are serious levels of competitiveness and over-capacity. And huge investment is needed for modernization in certain areas — especially in the fixed-line space. We have to defend our leading market positions while radically reducing our cost base. And we need to do all of this in a regulatory environment that is cutting into our value.”

Yet, he also sees “huge opportunities for growth.” These come from what he calls the “new industries” — information and communications technology (ICT), cloud services and mobile data. “We need to seed for the Gigabit society today, if we want to reap a rich harvest tomorrow,” he says. “Our industry is schizophrenic. On the one hand, management needs to strictly cut costs and reduce staff to compete in our traditional telecommunication services. On the other hand, we need to invest heavily into new business areas.”

Strength at home Deutsche Telekom is, by far, the largest telecommunications company in Germany. And while it already operates in 13 very diverse European economies, including Greece, Hungary and Poland, as well as the US, the CFO will not be following other big corporates in adventures into emerging markets.

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1995 1996 1997 2000

Deutsche Bundespost Telekom becomes a public stock company and is renamed Deutsche Telekom AG.

2001

Deutsche Telekom takes over US mobile phone service providers VoiceStream and Powertel.

IPO: Deutsche Telekom (DT) shares traded for first time.

2000

Deutsche Telekom buys 51% stake in Slovenske Telekomunikacie from the Slovakian Ministry for Transport.

2001

Deutsche Telekom takes over Debis Systemhaus, a German IT services company, from DaimlerChrysler.

Deutsche Telekom launches T-Venture, its venture

capital division.

Deutsche Telekom obtains majority ownership of Hungarian

company Matav Hungarian Telecommunications.

“It was wise to focus on our strengths. For us, it makes no sense to try and grow in India or Africa,” Höttges says. “Our most important market is Germany. Here, we are leading in almost every category.”

The company invested more than €3.6b (US$4.5b) in Germany in the last year — a good proportion going into 4G LTE (long-term evolution, the fastest high-speed technology for wireless services). “By the end of 2012, all ‘white spots’ (areas currently uncovered) in Germany will be covered by 4G LTE.”

Stateside successOne country outside Europe where Deutsche Telekom is investing money is the US. After the failed merger with AT&T last year, Höttges reveals that the company will now look to grow the business.

“It is always right to continuously improve your operational business activities,” says Höttges, who does not rule out structural changes, “if they improve the business.”

As far as the merger with AT&T is concerned, the CFO has consigned the deal to history. “We believed that we had a ‘win-win’ deal for everyone,” he says. “Unfortunately, it wasn’t approved. We had to restart, which wasn’t easy. Our first and most important task has been to regain competitiveness in the US market. To that end, we have decided to modernize infrastructure toward 4G LTE.”

This modernization will involve an investment of more than US$4b. The company hopes that in the next two years, the whole US footprint will be covered by 4G LTE. In order to improve its position in the US market, Deutsche Telekom also agreed to swap certain wireless spectrum (which provides additional network coverage) from Verizon Wireless. The company envisages this

deal helping T-Mobile rise from its current place as the fourth-largest US wireless company. T-Mobile USA is also embarking on a large cost-cutting program called Reinvent.

“This year, we have saved US$700m [in the US] but we are taking money from the cost base to reinvest in the marketplace and are gaining momentum,” says Höttges.

Evolve or dieAs well as concentrating on core territories for growth, Höttges understands that the telecommunications industry needs to invest in the future. Fixed-line phones have been replaced by mobiles, which are themselves being usurped by smartphones — and, in terms of data, the world is now looking to the cloud.

There are three core areas into which Deutsche Telekom is investing — cloud services, mobile internet and new digital innovations. “We believe it is about creating an image of innovation and generating a future for the 230,000 people in our organization,” says the CFO.

Cloud computing services are on the rise. In Germany alone, market forecasts from Deutsche Telekom show an increase in expenditure on the cloud from €1.9b (US$2.4b) today to €10.7b (US$13.4b) in 2016. “There has been a huge uptake and we want to gain our portion,” says the CFO. “Many larger corporates are using our cloud services but we also want to bring them into the SME and consumer space.”

Deutsche Telekom will also be looking at investing in mobile internet. Investment will be concentrated in upgrading

networks. “The internet is increasingly going mobile, so users will need higher bandwidth wherever they go. High-speed data networks, in which we have to invest on a continuous basis, are a prerequisite for this,” says Höttges.

The third part of Deutsche Telekom’s investment strategy is focusing on digital innovations such as the smart grid for energy supply. “In the past, energy supply was vertical — it went from power plant to distribution network to retailer and then to end user. In the future, systems could be more horizontal. There will be people who produce energy and then people who consume energy,” says Höttges. “So how could you steer that? In every single household, you have connection to telecoms — wireless or wired. This information via our network could be steered at any time and you could know exactly how much consumption you have.”

Höttges realizes that investing in an uncertain future is risky, but the firm cannot afford to stay static.

“If you do not invest in innovative ideas today, you will not be rewarded in terms of growth in new markets tomorrow,” he says. “We need to take risks. There will be ideas that we are pursuing which will die over time. But if we don’t try, we will stay in the classical access business that is declining.”

In order to achieve these investment goals, the CFO has implemented a strategy that combines innovative partnerships and financial prudence.

Collaborate to innovateCompetition and the speed of technological advance mean that standing alone is not an option in the telecommunications industry.

A clear example of the significance of collaboration is Deutsche Telekom’s joint venture (JV) with France Telecom in the UK, which has created Everything Everywhere. The JV, which was formed in 2010, has proved successful for both partners. Figures from Q2 this year show that Everything Everywhere climbed 3.4% in revenue year-on-year, more than double the growth in the final quarter of 2011. But why

embark on what could have been a risky JV with a rival in the first place?

“We were in a difficult spot in the UK with T-Mobile and the same was true for France Telecom,” says Höttges. “We both felt a JV would be a good solution. It was questioned whether a German–French partnership could work. But, since the beginning, there has not been a single dispute. We are honest partners in the UK. We are increasing our market share while realizing synergies at the same time. Consistent execution requires all parties to pull in the same direction.”

So, does the progress made by Everything Everywhere mean that there will be more JVs in the future?

“If you are in a situation where you jointly win, then this builds trust among the partners. Consequently, there are other opportunities. We are, by far, the biggest buyer of hardware and handset equipment in Europe. That is why last year we started our procurement JV, named BUYIN, with a targeted annual run rate of €1.3b (US$1.6b) in combined savings,” says Höttges.

In July, Deutsche Telekom also went into partnership with Mastercard to produce products that enable consumers to use their mobiles as a secure payment method. Höttges realizes that using others’ expertise will be beneficial.

“We cannot invent new products alone,” he says. “Mobile internet services such as Skype and other applications make it possible to buy content under more attractive conditions. If we think we can bind customers to us in the long term with unfriendly price models, we’re wrong. Telecommunications companies should actively offer these kinds of products to their customers to prevent cannibalization.”

However, Deutsche Telekom is not just teaming up with large corporates such as France Telecom and Mastercard. It is also looking to new businesses that can help it advance. Recent deals have included a strategic partnership with mobile security firm Lookout.

“We need to invest in these businesses,” says Höttges. “This is the new world. These are agile players, growing at

A focus on core markets, rather than emerging market adventures, investment in innovation, strong partnerships, and maintaining financial stability have all helped the company weather the current downturn.


2008 2009 20102001

Deutsche Telekom becomes majority shareholder in HT — Croatia Telecom, with the Croatian Government retaining a 49% stake.

2006

René Obermann appointed as CEO of the group.

2008

Deutsche Telekom takes over wireless carrier SunCom Wireless, a wireless operator in the Caribbean and south-east USA, for US$2.8b.

Deutsche Telekom’s UK brand T-Mobile merges with Orange UK to create new telecommunications

company Everything Everywhere.

Timotheus Höttges appointed as CFO of

the group.

speeds you cannot imagine. We cannot build everything on our own in a vertical way, it’s a lateral world and therefore we have to be open.

“For example, in our strategic partnership with Lookout, we could not have created the security product on our own. Meanwhile, there are others who understand parts of the internet better or differently than we do, so we need to become exclusive partners with them.”

Saving for the futureYet this investment and these partnerships can only thrive if there are solid financial foundations. And the CFO has been building them during his tenure at the company.

“If you want to invest more, you have to save for it,” says Höttges. “In our private lives, we seem to understand this. But in business, that doesn’t appear to be the case.” To that end, the company implemented the ‘Save4Service’ (S4S) program in 2006. Since then, S4S has seen more than €10b (US$12.6b) of cost savings across the business

However, in terms of net savings, the figure is smaller. “Most of the money is reinvested into the business,” says Höttges. He believes that this reinvestment strategy is “good motivation for teams working on the projects. They are not just doing the job to improve short-term profitability; they are doing it to keep up long-term competitiveness.”

So in terms of S4S, where does the CFO see further capital optimization?

“Process standardization is the name of the game,” says Höttges. “To that end, Deutsche Telekom is looking at optimizing its Enterprise Resource Planning (ERP) systems. From hire to retire, from order to cash, from buy to scrap: we are trying to standardize nearly every process.”

Another area in which the CFO is looking to make savings is information technology (IT). “Outsourcing of IT is not rocket science. But integrating all different IT units while keeping the company up and running and reducing IT cost by €1b (US$1.3b) at the same time is creating complexity,” says

Höttges. “Our company is dependent on IT and, therefore, a lot of savings are dependent on IT.”

This is easier said than done. How does he intend to make these savings? His answer is simple.

“The mistake I made as CFO in the past was that I gave IT more money to push standardization. However, the lesson I learnt is the more money you give IT, the more complex your IT gets. The best way to drive standardization is to cut back spending and limit resources. The lack of resources drives people into more standardization.”

Capital complexitiesWhile the company has cut costs through the S4S program and is looking to invest €8—€9b (US$10b—US$11.3b) a year in the aforementioned projects, the CFO still needs to service a debt burden which stands at around €41b (US$51.4b). However, he feels that the debt is manageable as Deutsche Telekom is well covered with a broad range of instruments.

“There is absolutely no need for us to divest assets to raise the money as we have unrestricted access to capital markets,” he says. “The corridors for our balance sheet ratios are well known, they are accepted and they have not changed for many years — this makes us a predictable and trustworthy issuer of debt. Undisputed access to debt capital markets is a prerequisite for our company. Our additional liquidity reserves of a minimum 24 months being financed with no need to access capital markets remain untouched, despite the crisis. This helps us to ensure financing and reduces our refinancing cost.”

Deutsche Telekom enjoys favorable refinancing rates. An indication of this was shown when the company issued a US$2b bond offering in February 2012. A 5-year bond was set at a 2.25% coupon while a US$1b 30-year bond was issued with a 4.875% coupon.

“We are refinancing at a significantly lower cost than many governments,” says Höttges. “We don’t want additional debts and, in this environment, it may have been

better to deleverage further. But, with the break-up fee from the AT&T deal, we reduced our debts by €2.2b (US$2.8b).”

When it comes to equity, Höttges is adamant that a stable, long-term strategy is vital for the investors.

“After 2008, short-term gain was not the play for us,” says Höttges. “We believe that being reliable is valuable and we have a clear stakeholder approach in equity and capital allocation.”

In 2010, the company committed to paying its shareholders a dividend of at least €0.70 (US$0.9) per share for the following three years. It has kept that promise.

“My role is to do what is right for all stakeholders. This means that we have to consider the needs of the debt capital market as well as the needs of our employees. And, of course, the company’s investment needs. Our shareholders need to be happy in our transformations,” says Höttges. “In the past few years, we have changed our shareholder base tremendously — 70% of our investors are now long-term value investors. The short-term activists are out. We have a sustainable long-term shareholder base.

“These people rely on us keeping our policy on dividends and on the debt side. We have a clear strategy toward capital allocation — a commitment for a certain dividend yield. Investors aren’t worried about their investments. It has worked out well for them and for us.“

OverruledThe CFO has financially stabilized the business through the current crisis. But, according to Höttges, one major hurdle stands in the way of effective investment in the European telecommunications market — and that is overregulation. He believes that politicians are taking away the incentives for investment.

“Europe lags behind in terms of digitalization due to regulation,” says Höttges. “After more than a decade of regulation, we now have intense price competition. In most markets, it is time to release the former incumbents from regulation and to introduce symmetrical competition rules for all players. At the same time, regulators should foster infrastructure competition and create incentives to invest into network infrastructure. In Germany alone, to build an entire fiber network to the home, the investment would be €60b—80b (US$75b—US$100b). But if you don’t know what a product’s price will be in two years, how can you invest?”

But there seems to be hope. “The recent change in the regulatory environment announced by Neelie Kroes, Vice President of the European Commission, sounds positive. We welcome this change. But, of course, we have to wait for the measures on the European and national level to implement this new regulatory policy,” says Höttges.

The CFO remains optimistic about Deutsche Telekom’s future and believes that the combination of efficiency and innovative thinking will reap rewards.

“Risk management, strict cost discipline and the courage to drive innovation have helped us get through the crisis,” says the CFO. “However, at the same time, we have told a solid story to our investors. And this helps them. It is reliable, maybe even boring. But, right now, boring has its value.”

The CFOTimotheus HöttgesAge: 50

Appointed CFO at Deutsche Telekom: 2009

Educated: University of Cologne

Previous positions: Before becoming CFO, Timotheus Höttges was the group board of management member responsible for the company’s T-Home unit. He joined the company in 2000 as MD, finance and consulting, of T-Mobile Deutschland. Prior to this, he was a member of the extended management board responsible for controlling, corporate planning and mergers and acquisitions at VIAG Group in Munich. As project manager, he played a central role in the merger of VIAG and VEBA to form E.ON.

Deutsche Telekom Founded: 1995

Employees: 233,000

Countries: 50+

Market capitalization: €40.3b (US$51.6b) (as of 23 August 2012)

In order to drive standardization in IT, Deutsche Telekom’s CFO found the best way was to cut back spending and to limit resources. He realised that the more money he gave IT, the more complex IT became.

Deutsche Telekom acquires 25% stake in Greek telecom provider OTE. Raises its stake to 40% in the following years.

Raising

Withdrawal symptomsAs banks back away from cross-border lending, we look at the alternative borrowing opportunities that are coming to market

T he evidence of banks retreating from abroad and running home is growing. Figures from the Bank for International Settlements show that, in Q4 2011, banks heavily cut global lending, with those

in the Eurozone slashing lending by US$84b. Banks’ cross-border exposure fell US$799b to US$30.3t

in that period. The largest fall in lending was to developed nations — down US$626b. Lending to developed economies and emerging Europe fell US$77b and US$14b respectively.

Widespread deleveraging in Europe is reducing bank loan availability, as well as the distribution. In July, Ernst & Young’s Eurozone Financial Services Forecast predicted: “The Eurozone’s banks will shrink their balance sheets by €1.6t (US$2t) in 2012, as a result of disposals of non-core assets and a fall in lending activity.

“It is now expected that corporate loans will contract by 4.8% this year — representing the fastest pace of contraction for loans on record for the Eurozone.”

It could get worse. The International Monetary Fund’s (IMF) Global Financial Stability Report for 2012 states that: “…if the euro area crisis re-escalates, there is a risk that the deleveraging process could gather momentum and become a disorderly rush for the exits.”

The report warned corporates: “Those segments that are most dependent on bank funding — small and

medium-sized enterprises, as well as firms located in stressed countries and, in particular, countries under EU/IMF programs — remain more vulnerable to restrictions in the credit supply.”

The big squeezeChanges in finance cost and availability, especially in widely syndicated lending facilities where these types of loans are decreasing fast, are becoming a growing issue. Bloomberg data shows global syndicated loans fell by almost a third in H1 2012 compared with H1 2011, reaching only US$1.3t. In the EMEA region, lending fell by 38.3% in H1 2012 to US$363b, compared with H1 2011’s US$509b.

“It requires hard work to keep a syndicate together when a borrower is looking to refinance,” says Dougald Middleton, Ernst & Young UK Head of Lead Advisory Services. However, he adds that there may be room for optimism. “The situation is eminently manageable if banks and borrowers work closely together, and

if the renewing banks are prepared to take up the slack being left by exiting banks.”

A recent successful syndicated loan was the cross-border loan to Formula One. Its US$2.2b recapitalization in April was significantly oversubscribed in the US.

But the process may not be so easy for others. “To raise money from the international markets today, you need to be extremely well organized in terms of your business plan, your due diligence and credit risks,” Middleton says. “Would-be borrowers need to work much more closely with their would-be funders.”

One of the key issues in Europe is that borrowing from local or multinational banks has been the preferred way to raise capital. According to Germany’s Bundesbank, just 9% of corporate credit in the Eurozone comes from debt markets, compared with 64% in the US.

So, with banks greatly restricting their cross-border lending, what are the alternatives for those wishing to borrow?

A strong bondGlobal investment-grade bond issuance’s growth in value underlines the emergence of alternatives to cross-border bank lending. European corporates tapped more bonds than loans in H1 2012 — the first time

securities market issuance outpaced the loan market. According to Dealogic data, 52% of the €467b (US$586b) of new European corporate funding was via bonds. This compares with just 29% for 2011, the average rate since the euro’s introduction.

Large companies can today borrow at unprecedentedly low coupons and for unusually long maturities. British beer giant SAB Miller’s US$7b bond, priced in January, was the largest US bond sale since 2010. Issued in four tranches, the bond has maturities ranging from three years (with a coupon of 1.85%) to 30 years (at 4.95%).

Big bonds issued this year include British American Tobacco vehicle BAT International Finance’s US$2b note in May, while oil-exploration company Inmet Mining Corp issued US$1.5b the same month. In June, Brazil’s Embraer issued a US$500m 10-year US bond yielding 5.15%.

Chris Lowe, Partner in Ernst & Young UK Capital and Debt Advisory Group, says SMEs and above should consider bond issues, whether they are privately owned, publicly listed or backed by private equity.

Going privateThe US private placement market has proved very liquid, even when public markets closed. In a private placement, a company can typically source funding directly from investors in return for yield. Investors are usually large pension funds or asset managers. Deals don’t need to be registered or listed on an exchange.

Private bond benefits include flexible terms, maturities that can be set from 3 to 15 years and — unlike the public bond market — there is no need for the company to provide

One of the key issues in Europe is that borrowing from banks is still the preferred capital raising option. Companies need to explore bond issues,

private placements and new funding vehicles to meet their needs.

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a public rating (private ratings may be needed), although pricing in both markets are fairly equal. The private placement market has also stayed open for business in hard times.

“The advantages of a private placement issue are clear,” says Lowe. “From a borrower’s perspective, there is the ability to build a direct relationship with providers of capital. With a direct relationship, borrowers can negotiate more bespoke terms. Typically, buyers are not intending to trade out, but to hold their bonds.”

Private placement has grown significantly as the Eurozone crisis leaves many firms unable to secure bank financing. “We have completed a number of refinancings in the past 12 months in which borrowers have diversified their lending relationships among this newly reopened source of capital,” says Lowe. “Private placement investors are looking for more yields. Gilts and other government yields are down; they want a higher return and are prepared to take lower quality credit for a higher return.”

Middleton says firms should seek investors who know about the company, and about the sectors in which it is active. “This plays to the strengths of the larger US private placement investors,” he says. “Unlike some other investors, they like industrial companies, businesses they can understand, touch and feel. Industrial companies meet those criteria.”

In February, Glasgow-based Weir raised US$1b in the US over 7, 10 and 11 years to finance the purchase of a US fracking technology business. And French chemical company Air Liquide Finance raised US$700m in a US private placement in June. The company said that the financing will “contribute to the development of the group’s business in the US and enable it to continue to grow over the long term.”

“There needs to be a minimum size of around £30m to £40m (US$47m to US$63m) for private placements. And, more generally, if companies are in a position to go, they should go now,” says Lowe. “All-in coupons are at an all-time low, and markets are very uncertain looking ahead. Borrowers from just about any respected geography and any viable industry sector can tap the market.”

New avenues Strong multinationals have access to bond markets and others can tap private placements, but where does this leave the remainder of mid-cap companies who need to raise capital?

Non-European banks are increasing activity in the region as cross-border demand grows. Fitch Ratings says Japanese banks have benefited greatly from European bank deleveraging. Mitsubishi UFJ has reported a 27% increase in its overseas loan balance, while Mizuho and Sumitomo

Mitsui each revealed 24% increases. This growth means that overseas loans rose to 19% of loans at Mitsubishi, 16% at Sumitomo Mitsui and 13% at Mizuho. Fitch expects the banks to continue hunting growth by increasing their overseas exposure, most likely through direct lending.

In addition, Middleton believes that markets are continually evolving to fill the funding gaps. “The availability of long-term, low-cost funds from secondary banking, non-bank financial institutions, peer-to-peer lending and other less traditional sources also creates an excellent opportunity for corporate borrowers.”

Many organizations and funds are considering stepping in. “AIG is opening an office in London. Insurance firm Metropolitan Life and financial services institution Pricoa are active, and GSO, the credit arm of private equity house Blackstone, has US$46b under management — mostly CLOs (collateralized loan obligations) — but a significant portion is direct lending,” says Lowe. (See Discovering new sources, right, for more.)

Joining the crowdThese types of funds may be here to stay, but other options such as crowd-funding and peer-to-peer lending are on the rise. Peer-to-peer lending links lenders directly to borrowers. The arrival of John Mack, ex-CEO of Morgan Stanley at peer-to-peer company Lending Club, is widely interpreted as a serious enhancement of its credibility.

Although a largely consumer-focused avenue, some peer-to-peer houses are focussing on businesses. For example, Funding Circle matches private investors with businesses looking for finance, and has funded over £30m-worth (US$47m) of loans to 703 companies in the last two years.

Flexible friendsSo, how should corporates evaluate borrowing needs? Lowe believes that price shouldn’t be the only issue. Deliverability and flexibility have gained in importance as vendors see certainty that a bidder can follow through on a deal as increasingly critical.

“Deliverability is the ability to get funds to the lender,” says Lowe. “Where there is a shoot-out between potential providers, the decisive factor is normally who can provide the funds at the lowest cost. As an advisor, we think that’s important, but flexibility is also vital. The structure of a facility, and its covenants, should be right for the business that is doing the borrowing. Whichever method you are using, you need to ask yourself whether the facility and its structure meet the borrower’s needs.”


When it comes to evaluating borrowing needs, cost should not be the focus. Borrowers need to assess factors such as deliverability as well as flexibility. The structure and convenants need to be right for the business.

As traditional lenders increasingly retrench, a host of new players have entered the fray to fill the gap in the market

T he retrenchment by banks has left a gap that is being filled by debt funds. For UK companies looking to borrow, fund manager M&G has a UK Companies Financing Fund. Mark Hutchinson,

M&G’s Head of Alternative Credit, says the downsizing of banks was a key reason behind the fund, which has already lent £830m (US$1.3b) to firms such as hauliers Eddie Stobart and developer Taylor Wimpey.

“We felt it was necessary for UK companies to have access to long-term finance,” says Hutchinson. “International banks are withdrawing to their own borders. Companies need to find other forms of funding.” Additionally, Hutchinson doesn’t rule out the possibility of establishing a European fund.

London-based investment company Tenax Capital has raised a €250m (US$313m) fund which makes loans to small and medium-sized businesses across Western Europe. “With the banks in retreat, the Credit Opportunities Fund can and has stepped into their role, providing a vital source of lending,” says Andrey Panna, Tenax’s Portfolio Manager.

British multinational asset management company Schroders is also evaluating whether to provide debt finance to property owners and developers. A recent study by De Montfort University on UK banks’ lending intentions found that only 44% expected to raise loans to the property sector in 2012.

Duncan Owen, Head of Property Funds at Schroders, says the fund “would provide traditional senior loans.”

“We feel there is a dearth of lending to the market and Schroders is considering a debt fund. Although, at the moment, we are reviewing all possibilities.”

Anthony Fobel, Head of Private Lending at London-based fund manager BlueBay Asset Management LLP, believes these types of funds will increase.

“Many companies can’t get the credit they need for growth. In their simplest form, debt funds are a replacement to fill the gap left by banks retrenching,” he says. “There are a number of such funds now available and we believe that these will grow. The idea is to provide finance to SMEs at the senior end of the structure. More precisely, event-driven lending — for growth and acquisitions.”

Many of these loans offer longer-term financing than banks and can be more flexible.

“Banks are often rigid in terms of credit,” says Fobel. “The advantage of this type of fund is that it is more flexible in terms of covenants, delivery and duration.”

The challenge for companies is awareness. European corporates are used to dealing with banks and are, understandably, wary of new funding streams.

“When the board sees bank financing of 100–150 basis points less than the fund, they will often go with this option,” says Hutchinson. “However, decision-makers may forget that the bank loan is for 3 to 4 years and will ultimately have to be refinanced 18 months before the maturity date. Whereas our loan is for 7 to 10 years and, in that time, you may have three banks refinancing with all the fees that are associated with those.”

Fobel believes funds should reassure borrowers. “If businesses fall into difficulty, they aren’t sure what funds will do. It is up to fund managers to demonstrate that they can deliver what they promise in terms of flexibility and funding.”

There seems to be no set definition for companies who would qualify for loans, but a strong business plan is essential. Panna says: “Tenax is looking for fundamentally good companies with strong assets and good business models.”

“We don’t differentiate on companies,” says Hutchinson. “There are no set qualifications — we do our own due diligence. If the company fits with our criteria and the investors have an appetite, we then make our decision.”

“Our main focus on lending would be to SMEs, with a focus on senior lending against good-quality assets,” says Owen. “This is fixed income lending against property and gives investors a steady income stream.”

Fund managers agree that more non-bank loans will develop as banks retrench further and that there will be more financing along the US model. “In Europe, banks fund 70% to 30% against capital markets. In the US, it is more like 80% capital markets and 20% banks,” says M&G’s Hutchinson. “There needs to be a shift in terms of education for banks in marketing alternative forms of funding to mid-sized and the larger SMEs.”

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Three countries in Central and Eastern Europe in particular offer interesting deal-making opportunities. Capital Insights explores the transaction climate in Poland, Ukraine and the Czech Republic

W hile the Eurozone crisis brings negative growth to much of Southern Europe, there is room for optimism further east. Several countries in the Central and Eastern Europe

(CEE) region have withstood the crisis well. They are continuing to attract deal-makers and investors who seek to maximize returns through low labor costs and high levels of new technology skills. Ernst & Young’s M&A Maturity Index, published in July, identified the Czech Republic, Poland and Ukraine as the region’s strongest destinations.

Their move to market economies is a continuing process involving privatization and the development of capital markets. These economies are characterized by fast-expanding consumer demand that domestic companies often don’t have the capacity to meet fully.

Each of these countries can boast that GDP growth, and M&A activity — both internal and cross-border — has remained stable despite the global downturn. However, each country faces different challenges and offers different opportunities as they progress to becoming modern market economies.

PolandPoland is the fastest-growing economy in CEE and the second most attractive destination for foreign direct investment (FDI) in Europe, according to Ernst & Young’s European attractiveness survey 2012. It attracted 3% of all European FDI last year, bettered only by Germany and Russia.

Poland has the largest population of any former communist EU Member State and is fully committed to economic reform. It outperformed all other OECD countries during the global economic crisis. The OECD expects growth of 2.75% to 3% in 2012 and 2013. Ernst & Young predicts that the rate will reach 4% in 2014.

External investors are recognizing Poland’s potential as its economy matures. FDI lines have changed from labor-intensive processes to knowledge activities, with high levels of investment in modern automotive production. For example, automotive companies Volkswagen and Bridgestone were major investors last year.

Poland is a strong performer in M&A terms. There has been year-on-year growth since 2009, with 2011

seeing a five-year value high of US$23b. However, in line with the global M&A slowdown, Q2 2012 saw deal values down by over 50% compared with Q1 2011, despite deal volume staying the same at 25. Last year, large deals were happening, particularly in the telecoms sector where Polkomtel was acquired by Spartan Capital Holdings. This deal was Europe’s largest leveraged buyout in 2011, valued at PLN18.1b (US$5.5b).

Brendan O’Mahony, Managing Partner in Ernst & Young’s Transaction Advisory Services in Poland, sees the growth in the mid-market as the new direction for M&A in Poland.

“Since Polkomtel, there have not been many large deals. But M&A activity is not dependent upon big deals. There is a growing middle market that has substantial potential for investment by Polish entrepreneurs and for foreign investors,” he says.

Call to consumersMultimedia and consumer sectors will present opportunities for acquirers and investors alike, according to O’Mahony.

“I think we will continue to see M&A in consumer goods, because of the strong consumer demand,” he says. “Health care is another up-and-coming sector. It’s an area in need of reform and that presents opportunities.”

Recent deals in the consumer space have included French financial institution AXA acquiring confectionary company Delic-Pol in June. In March, Czech-based PE house Penta bought a 39.6% stake in NFI Empik Media & Fashion for US$134m.

The IT and computing sector also has great potential, according to Wojciech Pytel, a member of Polkomtel’s management board. “The internet market in Poland is significantly bigger than in other EU countries. Approximately 40% of inhabitants live outside of big cities, with limited alternatives for internet access,” he says.

Private partnersPoland’s privatization program offers profitable openings. The Government regards the completion of its privatization program and the adoption of public private partnerships (PPPs) as fundamental to the development of its capital markets.

It is seeking to generate €40b to €50b (US$50b to US$62b) in investment through PPPs and remains committed to privatization. “A lot of the main privatization deals have been done, but there are discussions over energy, chemicals and mining, but when and how those will happen is difficult to know,” says O’Mahony. “The Government has already raised 40% of the 2012 privatization target by selling down shares in certain listed entities. So it doesn’t need large transformational deals to meet its privatization targets.”

Deal driversA key to Poland’s success is its large internal market and growing consumer culture. According to the Polish statistical agency, retail sales grew at an annual rate of 6.9% in July.

Poland has also developed a qualified and knowledge-rich workforce, backed by a positive business environment, low taxes and a transparent legal system. In the Ernst & Young M&A Maturity Index, it scored 92% in the demographics category, which looks at the percentage of the population aged between 15 and 64.

However, deal-makers need to consider other issues. Poland scored poorly in the Maturity Index on areas such as property registration and enforcement of contracts. It also suffers from high levels of bureaucracy.

O’Mahony also warns that acquisitions can be costly. “The Polish stock market has given some generous valuations on some mid-market companies,” he says. “This raised pricing expectations, which we have seen in some consumer market deals in recent months.”

He suggests a commonsense approach mixed with solid due diligence when it comes to deal-making. “Ensure you have good advice and know the market. And be aware that, with due diligence, sometimes the depth of mid-market data is not the same as you would expect in other parts of Europe.”

Polkomtel’s Pytel says the secret to deal-making in Poland is understanding the country. “There is a need for advice on local laws,” he says. “The demographics and customer segments need to be understood. From the customer perspective, society is still cost sensitive, but overall disposable income is growing, with high future potential.”

Top three Polish M&A deals (2012)

Completion Target Buyer Deal valueJAN

2012 PGNiG TermikaPolskie Gornictwo Naftowe

US$1.3b

APR

2012 Polbank Raiffeisen Bank US$670m

JUN

2012 TU Europa Talanx/Meiji Yasuda US$430m


Poland

Population 38.2m (2011)

FDI US$15.1b (2011)

GDP US$513b (2011)

GDP growth 4.4% (2011)

Source: CIA World Factbook

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Top three Czech Republic M&A deals (2012)

Completion Target Buyer Deal value JUNE

2012 Starbev Molson Coors US$3.5b

JAN

2012 LMC Alma Media US$51m

AUG

2012 PSJ PPF US$49m


Top three Ukrainian M&A deals (2012)

Completion Target Buyer Deal valueMAR

2012 OAO DniproenergoDonbas Fuel and Energy

US$150m

MAR

2012 CHAO Kolos Glencore US$80m

JUN

2012 PJ-SC Ukragno OSTCHEM US$35m*

Source: mergermarket *58.04% stake

Czech RepublicThe Czech Republic is one of CEE’s rapid-growth markets. Growth of 1.7% last year was led by exports, which in the third quarter of 2011 were some 13.5% above pre-crisis levels. Despite this, the Eurozone crisis has damaged the Czech economy. Ernst & Young’s Emerging Markets Center expects GDP to fall 1.4% this year.

Vladislav Severa, head of Transaction Advisory Services for Ernst & Young in Central and South-east Europe, says: “The Czech Republic is outperforming many CEE countries, but it is underperforming against Poland. The biggest growth section of the economy is exports.

“The EU is still the main export market, but the fastest-growing aspect is the emerging economies such as India and China. This is encouraging because it reflects the innovation taking place in the Czech Republic and the high value added.”

Deal activity in the country fell in H1 2012, with 19 announced according to mergermarket data, down from 35 in H2 2011. But brewer Molson Coors’ US$3.5b acquisition of StarBev in June skewed disclosed values, meaning that H1 2012 totals have already surpassed those for all of 2011.

Innovation leads the wayTapping consumer demand growth isn’t acquirers’ only route. The energy and IT sectors offer potential, says Severa.

“[Energy company] RWE is looking to divest its Czech gas pipeline subsidiary, Net4Gas. That is such a large deal that it should attract foreign buyers,” he says.

Severa also points to the growth of Brno’s “Silicon Hill” — where university research in IT is beginning to spin off into start-up businesses. This innovative spirit is seen in anti-virus software developer AVG, which listed on the New York Stock Exchange in February. “The only way for the Czech economy to grow is through innovation,” says Severa.

There are no immediate privatization plans, according to Severa; but there will be calls for public private partnership (PPP) investment. “There could be some PPPs with the state-

run utilities. These have large investment plans, which need to be financed,” says Severa. “There are plans to upgrade the Czech highway network, which may involve PPPs. There are also plans to expand nuclear facilities, managed by national electricity company CEZ.”

Deal driversErnst & Young’s M&A Maturity Index states: “The Czech Republic should be an obvious destination for M&A investors, and the quality of its potential targets for investment is the most clear sign of its maturity as an M&A market.” It scores well in terms of infrastructure and assets, getting 80% for its railways and 100% for roads.

Michal Mravinač, director for UK and Ireland operations for CzechInvest, expects the country to attract more investment. “In the latest Gartner benchmarking report, the Czech Republic scored highly on education and IP security, and favorably on all other indicators, including cost, making it a desirable location for offshore services, particularly in IT,” he says.

In Ernst & Young’s M&A Maturity Index, the country scored lowest in the economic and financial category (which looks at GDP size, growth, inflation, equity market development and credit availability) and the regulatory and political category (which observes factors including rule of law, completion formalities, property registration, tax payment, cross-border trading, contract enforcement, political stability, sovereign debt rating and corruption). While its large economy scored 75%, it only scored 20% for its GDP growth. And while it scored 82% for political stability, it got 8% for tax administration ease and 44% for the ability to finish

contracts with little interference.Investors must note the risks, including

the koruna currency’s valuation, says Severa. “Investors need to ask themselves three questions when it comes to Czech deal-making,” he says. “What are the opportunities? Where is the Government seeking investment? And what are the Czech public procurement rules? You need to answer these or get solid advice before investing in the country. Also, get familiar with the regulatory environment in the sectors where regulation is relevant.”

UkraineThe Ernst & Young Rapid-Growth Markets Forecast predicts 3.1% growth in 2012 for Ukraine, down from 5.1% in 2011. Growth is expected to approach 5% in 2013 and 6% in 2014.

In terms of M&A, Ukraine has recovered from the low of Q3 2011 even though announced volumes fell 49% in Q2 2012, compared with Q1. Deal volumes were 12% lower on the year. Announced deal values for Q2 2012 were 39% lower quarter-on-quarter and 77% lower on the year. Average deal values, in contrast, were 18% higher compared with the previous quarter, at US$86m.

In the past 12 months, two cross-border deals stand out. In December 2011, Russian mining company Mechel bought steelmaker DEMZ for US$537m. In March, Glencore acquired grain and oilseed producer CHAO Kolos.

Return tickets Ukraine’s economy is open to foreign investment via privatization and M&A, despite not being as developed as some in Europe. There are opportunities in consumer sectors, as well as energy and mining.

Vladyslav Ostapenko, an Ernst & Young Ukraine Senior Manager, says investment can create high rates of return. “There are only a few cases where you will hear of a company that is growing by less than 25% per year,” he says. “That’s a good indicator of the opportunities that exist. I have never heard of any reputable or large company that, once it entered Ukraine, has exited. This tells you that they are making significant amounts of money.”

However, infrastructure needs improving. Given the Government’s fiscal deficit, it cannot fully fund such projects, so development is likely to involve PPPs. Indeed, a legal framework for PPPs was agreed by the legislature in 2011. Sectors needing PPPs include toll roads, sea ports, gas, electricity and water.

Many privatizations have occurred — including last year’s US$1.3b buyout of state telecoms provider Ukrtelecom, with Vienna-based PE firm Epic acquiring 93%. This was one of CEE’s largest privatizations in recent years.

Ernst & Young estimates that 70% of Ukraine’s potential privatizations have happened. But one of the largest asset sales — agricultural land — has yet to occur. There are 40m hectares of farmland, owned by the Government and private individuals, with a value of up to US$1,500 per hectare.

“The President is coming to accept the idea of opening the market for agricultural land sales,” says Ernst & Young Ukraine Partner Dmitriy Litvak. “Land is the biggest opportunity for privatization. But it is hard to predict when it will happen. The ban on land sales could be lifted

after this autumn’s elections and the framework legislation has already been prepared.”

While the recession hit Ukraine in 2008, “right now we are seeing a recovery,” says Litvak. “The economy is growing.This is a country of 45 million people with significant natural resources.” In the M&A Maturity Index, Ukraine performs best in socioeconomic factors, scoring 84% for population size and 85% for population demographics.

“Whatever you think the challenges are, the opportunities here will outweigh them,” says Litvak. “The question for any company or investor is risk tolerance.”

The difficulty of doing business in Ukraine is at the top of the risk factors. Ukraine is ranked 152 out of 183 countries in the World Bank Doing Business Index, marking it out as Europe’s most difficult country for trade. To overcome this, Litvak suggests a thorough knowledge of the country’s legal and economic structures is needed before seeking deals. “It is wrong to assume close parallels between Ukraine and other CEE countries,” he says. “The way that business is done, the way the economies function, the legal frameworks — they are very different. You need to have extensive risk tolerance.”

However, Litvak also feels that companies need to move fast. “The ‘first-mover’ advantage is huge,” he says.

“If you compare risk and reward in Ukraine to other EU states, it may provide higher returns. But if you take too much time to analyze the situation, you can lose that opportunity.”

Czech Republic

Population 10.5m (2011)

FDI US$5.4b (2011)

GDP US$215b (2011)


Source: CIA factbook

Ukraine

Population 45m (2011)

FDI US$7.2b (2011)

GDP US$164b (2011)


Source: CIA factbook, Ernst & Young

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Poland is the fastest-growing economy in the CEE region. It also continues to perform strongly in terms of deal activity (despite a dip in the first half of 2012) and foreign direct investment (FDI).

To understand its current unique economic standing, one needs to look back to over two decades ago. A year after the deep shock that our economy received in 1991, due to structural economic and political reforms, we experienced our first GDP increase in post-transformation history.

Since then, despite a few major setbacks in the global economy, including the dot.com bubble and credit crunch crisis, Poland has never been in recession. This demonstrates Polish economic success and is a key factor in our growing importance in Europe today.

Growing up Among almost 30 CEE countries that transformed their economies in the nineties, only Poland has never come off the path of growth. We’ve had a clear goal ahead of us — to catch up with “the Western world,” or to come back to where we were in 1937 when the standard of living in Poland was comparable to that of Greece.

I would dare say a spirit of sporting competitiveness has been awakened in the nation with the beginning of the transformation. We want to belong to the “world of the strongest” — so much so, that the success we already achieved makes us crave for more. It is a sort of perpetual motion that can be easily observed in the statistics. For 18 of the last 20 years, we have experienced faster growth in workforce productivity than the growth in average salary.

White collar FDIOur motivation and the internal driving force have been helped by external factors, such as EU funding and FDI.

Since Poland joined the EU in 2004, the amount of external support for our economy coming from EU funding and FDI has been more or less equal in terms of capital expenditure. Nowadays, we are seeing a shift in the perception of Poland as an investment destination. In the beginning of the transformation process, we were perceived as a low-cost, and low added-value manufacturing location.

Now, FDI is becoming more and more focused on exploring the Polish nation's intellectual capital. Today, we're seeing numerous outsourcing centers opened in Krakow, Wroclaw, Łódź and many other cities. We are starting to attract R&D investments: the Polish Information and Foreign Investment Agency reports that 45 multinational companies currently run R&D centers in Poland, with firms including Samsung, General Electric and IBM. We are also hoping to become the center of operations for a number of

As Poland’s stature grows as a destination for M&A and investment in general, Capital Insights hears from former Polish Prime Minister Jan Krzysztof Bielecki about the country’s remarkable growth over the past two decades and how it plans to stay ahead

positionpole In

Polish Prime Minister in 1991. Minister for European Integration in the Cabinet of Hanna Suchocka. From 1993 to 2003, represented Poland at the European Bank for Reconstruction and Development. Later, CEO of Bank Pekao S.A. (now UniCredit Group). Now Head of Economic Council to the Polish Prime Minister.

Jan Krzysztof Bielecki

multinational companies in Europe. To put it simply, FDI to Poland is now looking more for white, than blue collar workers.

The privatization projectIn the years to come, privatization of the state-owned companies will be one of the key drivers of investment inflows to Poland. There are around 600 state-owned companies in Poland today.

Having said that, the Government's goal is to remain involved in a dozen or so strategic asset ownerships — mainly in the energy and utilities sectors. For Polish privatization, it is vital that these assets are privatized in the full meaning of this word. We do not consider an acquisition of a state-owned company by another state-owned company, only from a different country, to be a fully effective privatization. And we have been receiving many bids of this kind in recent years.

As far as capital outflows are concerned, the expansion of Polish companies outside of the country is gaining momentum; however, it is still extremely cautious.

FDI requires lots of experience, which Polish companies gained by investing in the East — mainly, in Ukraine and Russia. We must admit that not all of these investments were successful. Nowadays, this situation is changing and we see large foreign investment projects from Polish companies, helped by the fact that the projects are preceded by reliable financial analysis, while geographic proximity plays a smaller part.

Back to businessPolish companies’ cautious approach to outbound FDI is no coincidence. Avoiding risk and being cautious — even in fiscal decisions where we have been conservative — is what Poland has been all about recently.

Our monetary and fiscal policies have been strict and cautious for years, which is proving to be effective and has positively influenced the current state of the Polish economy. Back to basics practice in business is what Poland welcomes these days and, to be honest, it is something that works in our country.

Let us hope it will work for the whole of Europe as well.

For further insight, please email [email protected] l G

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www.capitalinsights.info | Issue 4 | Q3 2012 | 29Capital Insights from the Transaction Advisory Services practice at Ernst & Young


Private equity has gone global over the last ten years as international and local firms spot openings in emerging markets. But with greater competition for deals in the BRICS, many are looking further afield for new opportunities

T he last decade has seen a dramatic expansion of private equity (PE) beyond the established Western economies

and into emerging markets. In 2003, PE fund-raising for emerging markets was US$4.6b. By 2011’s end, funds targeting rapid-growth economies raised US$38.5b, according to data from the Emerging Markets Private Equity Association (EMPEA). Last year, investment in these markets reached US$26.9b, or 11% of the global PE total by value; in 2002, emerging markets’ PE investment accounted for just 2.5%.

PE has sought to capitalize on the opportunities that these markets present as disposable incomes rise. In 2011, for example, disposable incomes for Chinese urban residents rose by 14.1%, according to the National Bureau of Statistics. Popular sectors for investment among PE firms in emerging markets include consumer-related areas, such as fast moving consumer goods, retail and food. Yet PE is also getting involved in financing infrastructure improvements in some countries, with funds such as Actis having raised a specialist infrastructure fund.

As the lifestyles of people in rapid-growth markets change, health care is becoming another key investment sector for PE. For

example, in Eastern Europe, Mid Europa Partners has created large health care groups through roll-up acquisitions.

There is evidence that PE firms are bringing their experience into new markets. An Ernst & Young study of exits in Latin America demonstrated that EBITDA growth was the main driver of returns, mirroring similar trends in North America and Europe.

While openings are developing in many growing economies, competition is increasing in some larger countries. As much as 43% of the total raised for emerging markets funds was destined for China, while Brazil had 18%. India’s PE market has developed fast and there is now a significant capital overhang (the amount that is waiting to be invested) in the country. At the same time, some markets are starting to slow down. China’s Q2 2012 GDP growth, at 7.6%, was the slowest recorded for three years.

Greater competition and overheating fears in the main markets are leading PE pioneers to seek out new growth sources. Not only are local and international firms branching out into smaller cities in markets such as Brazil and China, many are also looking to countries with strong growth fundamentals such as Peru, Colombia, Indonesia and some African markets.

These new markets can be challenging. Intermediary networks and legal and due diligence capabilities are in their early stages, and corporate governance standards may be lacking. However, many firms are using innovative methods of risk mitigation. They are harnessing local knowledge via partnerships with regional PE firms and corporates, alongside building local teams.

A recent example of this includes US PE firm TPG’s share swap with buyout group Northstar Pacific in Indonesia.

PE will continue to drive into new markets. This expansion provides not only new deal opportunities, but also the prospect of increased levels of capital from investors. Many PE limited partners are looking for new growth sources at a time of stagnation in developed economies. And they have a clear appetite for emerging markets. A recent EMPEA study showed that three-quarters of limited partners expected their commitments to emerging markets’ PE to increase in the next two years. As this trend grows, PE will become a truly global form of investment.

The PE perspective

Sachin Date

Sachin Date is the Private Equity Leader for EMEIA at Ernst & Young. For further insight, please email [email protected]

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www.capitalinsights.info | Issue 4 | Q3 2012 | 31

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Cultural differences — be they social, corporate or linguistic — are not always taken into account in transactions. However, they can have a signifi cant impact on deals. How can companies manage the culture clash?

F or a cross-border deal to succeed, deal-makers need to get to grips with the tangible business staples of financing, due diligence and

regulation. However, making deals across borders requires businesses to engage with other, less obvious, cultural factors. And how you manage these could have just as big a bearing on whether your transaction turns out to be a successful one.

Cross-border deal levels are rising and the direction of deal flows are changing. According to mergermarket, in Q2 2012 the value of cross-border M&A rose to its highest level since Q4 2010 to stand at US$243b. In addition, the volume of outbound M&A activity from emerging markets increased by 64% in Q2 2012 (US$32.2b) from the same period in 2011 (US$19.7b).

Europe was the top destination for rapid-growth markets, accounting for US$28.5b of deals in H1 2012 — an impressive 87.1% up on H1 2011.

Yet culture doesn’t figure highly on deal-makers’ agendas. “Culture in deals is generally not looked into and that’s one of the reasons why the failure statistics are around 85%,” says Professor Steven Appelbaum, from the Department of Management at Montreal’s Concordia University.

This is borne out by new research from the Economist Intelligence Unit (EIU) and Education First (EF) which has found that a large number of companies face big cultural challenges when investing capital across borders. Forty nine percent of firms have suffered financially because communication misunderstandings or problems stood in the way of a major cross-border transaction.

An example of how culture can affect deals comes from pharmaceutical firm Bayer. Despite the company being in the process of buying a Chinese medical care company, Bayer’s Head of Global Business Nigel Sheail was reported by healthcare intelligence provider Biopharm Insight as saying culture was one of the challenges as to why there might “not be many deals in China.” l

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Dave Murray, EMEIA Markets Leader, Transaction Advisory Services at Ernst & Young, says that culture is an aspect deal-makers can’t afford to overlook. “In some countries, culture is the number one issue for deal-makers,” he says. “There is no point in investing money in a deal if, on both sides, there is unwillingness to work together.”

The right networks One key cultural issue that firms have to deal with in cross-border transactions is getting the right connections. Over half of the respondents in the EIU/EF survey stated that cross-border collaboration was very important when dealing with external partners, suppliers or outsourcers.

Murray saw an example of this when working with a company bidding for an asset in an African country’s privatization program. “In this case, what was vitally important was the ability to understand how the culture affected the way in which the decision would be taken by government officials,” he says. “This was even more important than due diligence or the financial aspects. Without the cultural nous to influence the Government, the deal would never have happened.”

The issue of making the right connections is particularly true for deal-making in China, says Alexis Karklins-Marchay, co-leader of Ernst & Young’s Emerging Markets Center. “The deal climate is very different,” he says. “You need good intermediate people. A key principle in Chinese business is ‘Guangxi,’ which in essence means creating the right networks. This can be expensive and time consuming, but it is vital for dealing in China.”

Another issue that corporates often overlook is access to the right decision-maker. “This is true in certain emerging markets, where identifying the key decision-makers is not always easy, especially in family-run businesses, so you may have difficulty finding who makes the final decisions,” says Karklins-Marchay.

Management stylesDifferent cultures have various management styles. Some are more centralized, others decentralized; some are more hierarchical, others more entrepreneurial.

To overcome a management style clash, deal-makers must be more astute at doing “cultural due diligence”. “When you look at who you’re going to merge with, you need to have done your due diligence not just financially, but culturally,” says Appelbaum. “Have you done attitude surveys and psychological examinations of the key players that are going to be on the management team? Most companies don’t. They take for granted that everybody will cooperate.”

Samy Walleyo, Ernst & Young Partner and Operational Transaction Services Markets Leader for Southern Germany,

Switzerland and Austria points out that information in a deal data room is of limited value in doing cultural due diligence. “You should be able to draw some conclusions from management interviews,” he says. “And your sales people could provide some feedback based on data they’ve picked up from customers you share with your target company.”

New approachesCompanies across the globe must adapt to new ways of doing business with new partners. “For example, in many rapid-growth markets, it takes more time to build trust,” says Murray. “You often need more face-to-face meetings. In China or India, for example, you may need as many as half a dozen face-to-face meetings before the client will open up to you.”

Conversely, Asian companies looking to Europe will need to modify the way they do deals if they are to get value. As Japan’s outbound M&A hits new peaks, its companies need to alter a number of their traditional approaches. Saburo Nakao, partner at law firm Squire Sanders, at a mergermarket M&A event in May, noted that Japanese firms tended to be “too serious or honest” with their written correspondence, even when such correspondence is not legally binding.

Corporates must understand and adapt to the culture of the country they are doing business in. “Don’t go into the deal with preconceived ideas of behavior,” says Murray. “You need to interpret behaviors and social styles so you don’t make a bad impression. I’d recommend having local people with you to bridge the cultural divide as well as someone who knows the culture as part of your deal team.”

It’s easy for negotiating teams to get off on the wrong foot, simply because of language difficulties.

“The issue for those speaking a second language is that you’re searching for words,” says Walleyo. “As a result, what you say may not always be quite what you mean. It is not that the meaning is lost in translation, but more a case that listeners may fail to ‘read between the lines’.”

The EIU/EF survey says that the key strategy companies employed to improve cross-border communications was sending managers to operating markets to learn their teams’ language and customs.

Culture is so pervasive in cross-border deal-making that it can even influence the way corporates approach meetings. “Various nationalities go to meetings with a different concept of the meeting’s role and with different aims,” says Richard Lewis, author of the book When Cultures Collide.

He recalls a culture clash at meetings of the One World airline confederation, which includes BA, Iberia, Finnair

and Chile’s Lan Airlines. According to Lewis, the

Spaniards and Chileans were put out by the tightly focused way the British and Finns were running the meetings. To resolve the problem, the Spaniards and Chileans were given the opportunity to organize meetings. “They ran the meetings very differently,” says Lewis. “They worked from an agenda but allowed more opportunities to digress from it.”

While it is not certain that companies will encounter all these problems, there are four key ways in which they can mitigate cultural risk:

Partner up Joint ventures (JVs) and minority stakes are becoming increasingly important as companies seek ways of sharing and mitigating risk in cross-border deals. The cultural and financial risks inherent in cross-border deals mean that many companies are taking a more gradual approach to gaining a foothold in the market.

In the July 2012 Clifford Chance report, Perspectives in a changing world, partnerships came top of deal structures that corporates would pursue in cross-border deals.

A clear example of this is US fast food firm Burger King, which in June this year, allied itself with the Kurdoglu family and the Cartesian Capital Group in order to expand its business into China. Meanwhile Mexican telecoms company America Movil, took on a cross-border minority stake in June, agreeing to take a 23% stake in Telekom Austria and has offered to buy up to 28% of Dutch firm Royal KPN. America Movil’s Chief Financial Officer Carlos Garcia Moreno said that the company felt more comfortable taking minority stakes in Europe, because it is less familiar with that continent’s competitive dynamics and customer preferences.

JVs and minority stakes are particularly beneficial when dealing with family-run business cultures. “When dealing with a family-owned business, we recommend maintaining a family presence,” says Murray. “Companies entering into a new culture should typically take a minority share in a family business. This will help minimize risk and provide continuity.”

Allied to this is “the war for talent”, according to Karklins-Marchay. “If you invest in a company, you need to ensure that you have the right staff in place to drive the business locally,” he says.

Understand the impact“Deal-makers who take such cultural characteristics on board from the start are likely to be more successful in negotiating a merger and handling the integration afterward,” says Lewis.

Murray agrees. “Before you even do the deal, you need to have a culture briefing beforehand,” he says. “Make sure the team is experienced and do a pre-transaction review, talking through what the local social and behavioral issues may be.”

A clear example of the importance of corporate cultural understanding comes from Japan’s Takeda Pharmaceutical’s US$14b acquisition of Swiss company Nycomed last year. Takeda recognized from the outset that the companies’ respective cultures could be fused together successfully.

Takeda made note of the cultural synergies in its 2011 annual report, saying: “Nycomed’s corporate culture has a distinctive, entrepreneurial ‘can do’ corporate spirit that has underpinned its progress in Europe and emerging markets thus far. The ‘can do’ spirit contains common elements with Takeda-ism (integrity = fairness, honesty and perseverance). Takeda will work to capitalize on the strengths of the Nycomed culture to transform the global organization.”

It’s good to talkThere is no better way of understanding the culture of the counterparty in a deal than by spending face-to-face time with them, according to Murray. “Some businesses, particularly in more developed markets, don’t always understand the need to physically meet people regularly.”

He uses the example of a deal which was snatched from an over-confident team. “They had relied too much on phone and email and had been unable to pick up the nuances they would have gained from more face time,” he says.

Post-deal persuasionCultural problems may only emerge after the deal is done. Then management needs to find a route that absorbs the best of the merged organizations’ respective cultures.

Indian group Tata’s success following its acquisition of Jaguar Land Rover in 2008 has been based strongly on cultural integration. In 2011, Ravi Kant, Vice Chairman of Tata Motors, was quoted as saying: “We try to be a local company wherever we are present. We try to be a South Korean company in South Korea, a British company in Britain and a Thai company in Thailand. We assimilate the culture, nuances and their way of working.”

For cross-border deals to work, according to Applebaum, the participants have to adopt a clear value system. “This [system] is going to be the new culture of the organization. And that has to be communicated over and over again to all of the employees of new organization,” he says.


This figure shows responses to the question: To what extent can better cross-border communications improve the following three aspects (profit, revenue and market share) at your company?

Profit Revenue Market share

Not at all8%

Not at all7%

Not at all8%

improve somewhat

54%improve significantly

35%improve

somewhat

51%improve

significantly

35%

improve somewhat

55%

improve significantly

33%We try to be a local company wherever we are present. We assimilate the culture, nuances and the way of working.Ravi Kant, Vice Chairman, Tata Motors(% respondents)

Source: Economist Intelligence Unit/Education First

change Driving

The widely reported “shareholder spring” appears to have caught some companies off guard. But with boards and investors united by a shared interest in growth and success, how can damaging revolts be turned into constructive collaboration?

The last few months have seen many high-level executives forced out of public companies. They were the victims of assertive shareholders who backed up their concerns about issues,

such as executive remuneration and company performance, with action. Sly Bailey’s departure from media group Trinity Mirror and Andrew Moss’s resignation from Aviva are just two examples. Elsewhere, several board members at railway firm Canadian Pacific have quit in an intense proxy battle, which exemplifies the phenomenon that has been dubbed the “shareholder spring.”

Shareholder engagement with companies is nothing new. However, the difficult economic environment has brought many concerns into sharper focus for investors faced with the prospect of lower returns.

“Many of the issues that are causing shareholder

dissatisfaction have been under discussion between shareholders and companies for some time — it’s just that they have come to a head over recent times,” says Liz Murrall, Director, Corporate Governance and Reporting at the Investment Management Association (IMA). “Many of the shareholder revolts have been caused either by management not listening or not taking into account the broader economic context. Some executives, for example, continued to extract value from companies when they had failed to deliver value for shareholders.”

Indeed, figures from UK proxy advisor PIRC show a spike in investors voting against remuneration packages.

An average of 9% have done so in 2012, up from a historical average of around 3%.

Getting active Part of the reason for this spike in investor dissent is the greater focus among asset managers on being more active in managing their clients’ capital, particularly at a time when their performance has been adversely affected by the downturn. “There is increased pressure on institutional shareholders to strengthen their stewardship role,” says Christoph van der Elst of the Tilburg Law School and a research associate of the European Corporate Governance Institute. “They should be voting on many of these matters in any case.”

“Investors have stepped up to the mark,” adds Murrall. This is due to a variety of factors: “The Stewardship Code, continuing weakness in perceived pay for performance, and media and government interest in areas such as executive pay. This in turn has driven clients to ask more of asset managers, and fund managers are responding to the wishes of their clients.”

The IMA’s annual Stewardship Survey of asset managers for 2011 found that stewardship resources had increased by 4% from 2010 figures. It also found an increase in voting levels from 81% in 2010 to 86% in 2011.

The US has seen similar trends as new regulations such as Dodd-Frank have increased companies’ disclosure requirements, leading to a more focused approach from investors. “The fact that there is so much more disclosure required of companies now, such as the publication of the ratio of CEO pay to average employees, means that investors can be much more targeted and sophisticated in their engagement,” explains James Buckley, executive vice president and partner at investor relations consultancy Sharon Merrill.

Deal focusYet corporate governance is not the only target for investors. A September 2012 report from law firm Schulte, Roth & Zabel (SRZ) on US corporate investors found that 84% of respondents expect shareholders to be more active in influencing company M&A strategy over the next 12 months.

There are many recent examples of how this is already affecting companies’ investment plans. Mining businesses Glencore and Xstrata originally postponed the shareholder vote on their proposed merger in July in response to investor concerns about the terms of the executive retention arrangements offered by the merged entity.

“No matter how attractive the acquisition, a company cannot assume that it will get its M&A transaction rubber-stamped by its investors,” says Buckley.

Perhaps one of the most interesting aspects of the trend is that shareholder activism is now no longer seen as the preserve of hedge funds. While these are certainly among the most active — the SRZ study found that 74% of respondents expected hedge funds to increase activism over the coming 12 months — others are getting in on the act. As an Ernst & Young paper published earlier this year, Proxy Perspectives, points out: “US institutional investors continue to work together on governance issues

and are increasing coordination with European investors, who are also increasingly engaging.”

“Activist investors have always been around,” says Tim Medak, M&A Partner, Head of PLC and Equity Capital Markets at Ernst & Young UK. “These investors, often hedge funds, have aggressively built up stakes to shake up businesses. But now we are seeing institutional investors being more vocal and active — they are vociferously opposing or not supporting board proposals.”

And while hedge funds might previously have been viewed with some hostility by longer-term investors, this is changing. “Despite the efforts toward increased transparency by many companies in recent years, in some instances, there remains a perception that there is no state of equality or that boards are not meeting their fiduciary responsibility,” says Buckley. “In those cases, activists are no longer seen as just stirring the pot; they are welcomed as agents of change.”

For example, the involvement of American business magnate Carl Icahn at Chesapeake Energy Corp has helped rally investors, who have been agitating for change at the top since allegations of potential conflicts of interest between the CEO’s personal investments and corporate duties were revealed in July.

Rules of engagementThe signs are clear: boards need to ensure that they are actively engaged with shareholders to head off any potential confrontation. “Once you’re on the back foot with shareholders, life becomes very difficult indeed,” says Medak. “Boards should seek to avoid this at all costs.”

A large part of this is good, old-fashioned investor relations. “There needs to be regular dialogue between boards and shareholders,” says Medak. “That doesn’t mean just pitching up to road shows. Having a proactive investor relations program means updating investors quarterly at least and being as inclusive as possible. While the focus will often be on the larger investors, boards need to find ways of communicating effectively with smaller shareholders wherever possible.”

Regular dialogue should increase understanding between boards and shareholders, leading to a relationship of greater trust between the two sides. Most shareholders would rather negotiate behind the scenes with management than enter into a public battle. In the SRZ study, dialogue with the board was cited by the highest proportion of respondents — 50% — as the

With investors increasingly taking a more active role in their investments, corporates need to make sure they are fully engaged with shareholders in order to make certain that any potential problems are headed off before they begin.

Preserving

Investing

The difficult economic environment has brought many concerns into sharper focus for investors

What do you expect to happen to the volume

of shareholder activism over the next 12

months/next proxy season?

Significantly increase

26%

Somewhat increase

52%Remain

the same

22%

Source: SRZ/mergermarket

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www.capitalinsights.info | Issue 4 | Q3 2012 | 35Capital Insights from the Transaction Advisory Services practice at Ernst & Young

Stephen Benzikie discusses the key ways in which companies can keep their investors onside

Today, chief executive officers are believed to spend around a third of their time engaging with three core stakeholders — the buy side, the sell side and the financial media. Yet 15 years

ago, support from the buy side, or the company’s investors, was taken as read. A lot has clearly changed since then, as larger institutions in particular have hired dedicated people to monitor companies’ corporate governance, pay levels and trading issues. Even some of the smaller institutions have in-house people, while others, particularly in the US, look to proxy advisors to help them keep tabs on the companies in which they have stakes.

Boards of public companies, for their part, now treat shareholders — much more appropriately — as owners of the business, dedicating much more resource to investor relations activities. Yet mistakes are still made, with the result that board members fail to gain shareholder approval for re-election and mergers get stalled or rejected. Poor or irregular communication between the board and shareholders tends to be at the root of many of these issues.

As recent examples have shown, it’s more important now than ever before to keep shareholders onside; so boards must engage closely and carefully with them, and consult widely on strategic issues such as M&A activity. If investors fully grasp a company’s strategy, they are far less likely to make a fuss if a particular acquisition might at first appear a slight departure from the strategy previously articulated. Early buy-in to a company’s vision is vital for successful execution. Some of the best companies now have quarterly capital markets days. At these events, corporates can invite both the buy side and sell side, allowing management to outline what they see as the key value drivers in their business and how their proposed action will affect their people and profits.

Most importantly, boards need to be as open and honest as possible with their shareholders. Don’t think for a minute that you can pull the wool over their eyes. That’s simply not sustainable and is not in the interests of either management or investors. The more visible and regular the communications effort, the better for all of the parties involved.

Viewpoint

Stephen Benzikie is a Director at financial and corporate communications consultancy Pelham Bell Pottinger.

Boards must engage Boards must engage closely and carefully closely and carefully with shareholders with shareholders and consult widely on and consult widely on strategic issues

most effective means of achieving desired results. As Murrall

says: “Investors tend to vote against board

proposals only if their prior engagement has not worked.”

Positive outcomesThis dialogue should pay dividends at times of

stress. “When a company is facing challenges, this is a critical time for the board to have its

finger on the pulse of investor sentiment,” says Buckley. “Equally as important, discussions need to be two-way communications, where the company is gathering information from the street just as much as promoting its own messaging. This will help avoid nasty surprises down the road and fortify relationships with the company’s investor base in the event that activists come calling.”

Yet, while effective investor relations activity is important, it is unlikely to be enough. Shareholders are monitoring results even more keenly than before. “Investors are watching performance closely and, if

you are a company with average performance compared with your peer group, you may find that shareholders will engage to ensure your performance improves to above average,” says van der Elst.

Boards need to examine each aspect of their business, ensuring they have correct strategies in place for growth as well as the right people and systems to support them. Board makeup, for example, is an obvious shareholder target. “Take a look at your board composition,” suggests Buckley. “Are there any weaknesses? Do you have the right financial experience or M&A expertise if you are doing a lot of deals? Assess what areas might make you more vulnerable to an activist that becomes involved with your company.”

Examining dividend policies in conjunction with executive performance metrics is vital given recent shareholder dissent over board pay. “Companies often argue that they need to pay well to get the best people,” says Stephen Benzikie, Director at Pelham Bell Pottinger, the financial and corporate communications agency. “That’s fine, but packages need to be linked very clearly

to performance to ensure alignment of interest between management and investors. You can’t have a miserly dividend policy if your investors feel that executives are being overpaid.”

Boards should also look at their shareholder register and attempt to attract new investors if needed. “If your shareholder base is highly concentrated and a couple of your top investors disagree with you on a proxy issue, it is likely to be hard to turn the situation around,” says Buckley. “It’s important to consistently work on your shareholder base to ensure it is diversified.”

While boards need to protect themselves from hostile takeover bids that aren’t in the business’s interests, measures such as poison pills (implementing methods to make a company unattractive to an unwelcome bidder) and staggered boards (when only a portion of the board is elected annually rather than all at once) can only invite unwelcome attention and so should be carefully scrutinized. “These kinds of provision leave you wide open to shareholder criticism, particularly if your performance dips,” says Buckley.

However, there are advantages to seeing shareholder engagement in a collaborative light rather than as confrontational. “Shareholder activism will continue to be on media and Government’s agendas,” says Murrall. “But large dissenting votes, press coverage and CEOs standing down are not good for companies or their owners over the long term. As a result, I would expect this to drive more and better dialogue between shareholders and boards. Those boards that may not have responded in the past will do so in the future.”


In which sector(s) do you expect to see the most shareholder activism over the next 12 months*?

Financial services 79%


Industrials and chemicals 60%

Energy 44%

Pharma, medical and biotech 27%

Construction 25%

Real estate 13%

Business services 6%

Retail 21%

TMT 50%

Government 10%

Defense 8%

*Respondents could select more than one sector

Compared to the last year, how active will shareholders be in influencing companies’ M&A decisions over the next 12 to 24 months?


Which activist strategy is most effective for achieving desired results?

More active38%

Proxy contest/consent solicitation

32%

Significantly more active

46%

Dialogue/negotiations with management

50%

Remain the same

16%

Publicity campaigns

10%

Shareholder resolutions

8%

There may be trouble aheadWhat should boards do if they find themselves targeted by an activist investor or organized shareholder revolt?

1

245

3

Know what you’ll do in advance. It helps to be prepared, even before the prospect of revolt looms. “Think about what the potential areas of opposition could be and what your strategy should be to protect the interests of the company and shareholders,” says Michael DeFranco, partner at law firm Baker & McKenzie. “Should your response be through formal legal action or would it be better to go for discussions with the activist?”

Work out the likelihood of being targeted. If there are signs that this may happen, “get ahead of the issue and take action so that you are controlling the story,” says DeFranco. “That way, you’ll be taking management’s preferred actions rather than being forced into a strategy you may not believe in.”

Examine who is agitating. If it looks like short-term investors, get your long-term supporters on side. Explain why those agitating aren’t acting in their best interests. If it’s longer-term

investors that are unhappy, negotiate. “You are more likely to compromise if several long-term investors are dissatisfied versus an investor who has parachuted in for short-term gains,” says Buckley.

Engage more with shareholders and the press. “Make clear to investors what your strategy is and how that benefits them,” says Stephen Benzikie. “Also, gain the confidence of respected financial journalists so they can help tell the story about where the company is heading.”

Remember what is in the best long-term interests of the firm and its shareholders. “Boards need to be cognisant of what it is that might lead to a compromise and avoid an expensive, protracted battle,” says Buckley. “Sometimes, however, the best option is just to dig in your heels because it’s the right thing to do for the long-term performance and value of the company, as well as being in the best interests of all shareholders.”

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Listen learn

Shareholders don’t just put capital on the table; they also bring expertise that corporates should tap into

Our findings showed that shares in acquiring companies that were purchased by investors with foreign expertise in the market outperformed the FTSE All-Share by 37 percentage points over the two years following the deal. Companies that were not supported by these shareholders saw their stock rise only 14 percentage points.

So what can corporates learn from these “monitoring investors”?

On a cross-border deal, investors can provide local market knowledge. Our research suggests that superior returns can be gained by building a dialogue between companies and investors with knowledge of a target market, before entering.

Long-term investors may also be able to help with planning issues. It’s not just price that matters within a local market, but also time frames and the terms of an agreement.

While firms can get data about local markets from bankers and other advisors, expertise from your institutional investors enables you to test the information received from your advisors and check up on how accurate the information is ”at ground level.”

A good example of a company that gained a competitive advantage by acting, in some ways, as its own monitoring investor, is banking group Santander. In 1988, way before it began fully acquiring banks in Northern Europe, Santander formed an alliance with Royal Bank of Scotland (RBS). In 1999, Santander’s merger with Banco

Central Hispano brought with it a 5% stake in Germany’s Commerzbank, while, by 2005, it had built up a 10% stake in Italian lender Sanpaolo (however, this stake was sold after Sanpaolo/IMI merged with Intesa in 2006). With this came board seats. This was part of Santander’s long-term strategy of expansion outside its existing exposure and ultimately resulted in them taking over the UK’s Abbey in 2004. In 2008, it acquired Alliance & Leicester and bought Bradford & Bingley’s branch network, renaming all three Santander in 2010.

Even though Santander ended the RBS partnership after the Abbey deal, the bank would have learnt a significant amount about the Northern European market. This intelligence gave them an edge over their competitors.

Clearly, regulations do not allow a company to have a confidential conversation with one shareholder that is not then shared with others and the market. Discussions should abide by appropriate market rules, especially those of the country in which the company is listed.

Incorporating these experienced investors is critical. While a little learning can be a dangerous thing, if you listen to your shareholders, it’s your competitors who may be faced with danger.


Famed US businessman Jack Welch once said: “A company’s ability to learn, and translate that learning into action rapidly, is the ultimate

competitive advantage.”But when it comes to deals, who

should organizations listen to and learn from? Surprisingly perhaps, shareholders are a group that companies should be tapping into more readily when it comes to transactions — especially cross-border deals. The right shareholders can bring extensive market knowledge.

A July 2011 study from Cass Business School entitled Learning from your investors: shareholder support in M&A transactions revealed that institutional investors clearly affect the chances of management making a successful cross-border merger or acquisition.

and


Professor Scott Moeller is Director of the M&A Research

Centre at Cass Business School. He also teaches Mergers & Acquisitions

on the MBA and MSc programs.

Moeller’s corner

Prof. Scott Moeller

Buyouts — a waiting game?Multiple: European buyouts watch Q2 2012

While European private equity (PE) is waiting for macroeconomic conditions to stabilize, parts of the market remain active and the pipeline continues to grow. This report finds out when and where deal flow will return.

Private Equity Transaction Advisory Services

With fewer assets coming to market, what deals are being done and where?

Europe plays the waiting game

MultipleEuropean buyouts watchQ2 2012 The rise

and fall of M&AM&A Tracker Q2 2012

Ongoing uncertainty has restrained Eurozone M&A activity in Q2 2012. This report finds the small upswing in average bid value and a strong pipeline of megadeals could indicate an increasing level of confidence among buyers.

M&A Tracker

The rise and fall of M&AAfter falling for four consecutive quarters, does recent global bid activity show that M&A is once again on the rise?

Q2 2012Transaction Advisory Services

Enter

Growth in new marketsRapid-Growth Markets Summer 2012

Although recession, stalling growth and high unemployment are continuing to impact many consumer markets, the data and insights in this Summer 2012 forecast predict strong prospects for RGMs.

Ernst & Young Rapid-Growth Markets Forecast Summer edition — July 2012

Rapid-growthmarkets

Growing Beyond

Further insightsM&A in a two-speed worldM&A Maturity Index 2012

When planning a deal, it pays to find out where the best opportunities lie. This 2012 report, published in collaboration with Cass Business School, explores investment conditions for M&A across 120 countries including 25 rapid-growth markets.

M&A in a two-speed worldAssessing risks and opportunities in rapid-growth markets

Growing Beyond

M&A Maturity Index 2012

Brazil: capturing the momentumBrazil attractiveness survey 2012

Brazil leads the attractiveness scores in Latin America. Learn more about the strengths, challenges and future growth opportunities for the 2016 Olympics host in this 2012 attractiveness survey.

Growing Beyond

Capturing the momentumErnst & Young's 2012 attractiveness survey

Brazil

Positioned for growthRussia attractiveness survey 2012

Although Russia offers a high-growth economy, a large domestic market and a highly-skilled work force at moderate cost, investment challenges remain. This survey explores the opportunities for growth.

Growing Beyond

Positioned for growthErnst & Young’s 2012 attractiveness survey

Russia

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Capital Insights app available now via www.capitalinsights.infoFeaturing key content from the magazine enriched with interactive features and regular updates from the website.

Coming soon to Capitalinsights.info• Ernst & Young Capital Confidence Barometer — A regular survey of senior executives from large companies around the world, that gauges corporate confidence in the economic outlook and identifies boardroom trends and practices in the way companies manage their capital agenda. Available from 8 October 2012.• Ernst & Young Eurozone Forecast — How is the Eurozone performing in the ever-changing global economy? This Autumn 2012 edition looks at the risks and opportunities for business and governments. Available from 27 September 2012.

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At Ernst & Young, we understand that in sport, as in business, you succeed by getting talent to work together.

That’s why we are proud to be an Official Partner of The 2012 European Ryder Cup Team.

Find out more at ey.com/rydercup

See More | Teamwork

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