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— Cover Story —
These markets "didn't suffer the same fate as their G-7 counterparts," says Nick Chamie, who heads emerging markets research for RBC Capital Markets in Toronto. For Brazil, India and China, "this turned out to be more a cyclical recession than a multigenerational crisis." Investment flows reflect this rush. Stock markets have come roaring back, propelled by offshore investors. Initial public offerings are gaining momentum. Acquisitions, strategic investments and outbound investments are following fast. Private equity shows renewed vigor.
"If the tone of capital markets is to be believed, the crisis in emerging markets is already a distant memory," Standard & Poor's managing director Diane Vazza wrote in a recent research paper. For developed nations, all this activity represents more than just interest from afar. Economists and investors alike are now convinced that this time, emerging markets for the first time ever will lead a global recovery, not follow it as in the past. What happens in Asian and Latin American powerhouses is vital. "These economies have real dynamism and momentum today compared to some misfiring economies in the West," said Michael Geoghegan, HSBC Holdings plc group chief executive, in a statement last month. HSBC economists predict emerging markets growth in 2010 will reach 6%, while developed economies will register an anemic 1.8%. Expect investment flows to be outsized as well. "When we look at our dealflow between the first half of the year and now, there's been a massive uptick in term sheets," says Akil Hirani, managing partner of Mumbai's Majmudar & Co. This year, China's GDP growth should top 8%. India's could reach 6.5%. Brazil will register a 1% growth rate, although the second half of this year should come in at 3.5% growth, the Brazilian government predicts.
Dealflow patterns in these three countries also are worth examining for lessons learned -- or not -- from last year's financial collapse. While upbeat once more, investors are generally more cautious. That's reflected in both deal size and acquisition price multiples. While megadeals haven't disappeared completely, they have diminished in number. Small and middle-market transactions, always more numerous than their larger counterparts, are rising in importance, as are distressed deals. Bank financing has returned, but strategic investors continue to weigh carefully cash reserves. In M&A terms, Western investors are approaching these markets more tentatively than investors in the countries themselves. "In an uncertain market, a lot of those [multinationals], whose own parents have pulled back, find it much more difficult," says Lawrence Chia, Deloitte Touche Tohmatsu's managing partner for financial advisory services in China and Asia-Pacific. But "domestic M&A, that is, China buying China, has always been robust and far, far greater than [foreign direct investment]." Domestic deals are getting done. "Valuations seem to be more acceptable" for domestic acquirers than for foreign competitors, he says. Investment decisions also reflect bets on how economies are developing and changing. These, too, have worldwide implications. "People have started looking at the next growth story," says Sebastien Chatel, Bank of America Merrill Lynch's co-head of Latin American equity capital markets. "Clearly, it's the emerging-markets consumer." This anticipates the long-term transformation of various emerging markets, notably China, in which domestic consumption -- not just exports -- fuel the economy. For India and Brazil, already relatively dependent on domestic markets, it's accepted wisdom that a growing middle class will be able to afford to buy up and buy more. With collapsed demand in developed economies, the recent crisis offered ample proof that this change in emerging markets is necessary. While Chinese exporters felt the pinch, "Chinese companies that didn't export didn't feel the downturn at all," says Benjamin Ye, a Shanghai partner with PricewaterhouseCoopers. Some high-stakes transactions both illustrate this new territorial imperative and demonstrate the emerging markets' recovery. Take wireless telephones, where millions of users are being added every month in China, India and Brazil. France's Vivendi SA earlier this year offered $2.9 billion for Brazilian mobile operator GVT Holding SA. Spain's Telefónica SA, which already owns Brazil's Telecomunicações de São Paulo SA, countered Vivendi by offering $3.7 billion for GVT, and on Nov. 4 topped up its initial offer with a further $200 million. "It's a great surprise to see a bidding war," says Marcello Hallake, a New York-based partner with law firm Thompson & Knight LLP. In recent times, he says, "Brazil's wireless industry has been depressed and M&A has been distressed." Investors in these emerging markets are sniffing around what might best be called consumer-related infrastructure. Brazilian supermarket chains are exploring deals, Hallake says. Private equity firms are investing in Indian retail distributors. The latest involved Britain's Henderson Equity Partners Ltd., which late last month completed an investment in a New Delhi-based luxury fashion designer retailer called Genesis Colors Pvt. Ltd., joining previous investors Sequoia Capital and Mayfield Fund. In October, South Korean department store giant Lotte Shopping Co. Ltd. bid up to $625 million for Times Ltd., a hypermarket chain in Eastern China. Lotte beat out an offer by Chinese retail chain WuMart Stores Inc., which in August gained a $120 million investment from private equity firm TPG Capital through a private investment in public equity. "It's China as a market, rather than China as a manufacturing base," explains Ye. "That trend will continue." By no means is every emerging market firing on all cylinders. Russia -- the "R" in Bric, short for Brazil, Russia, India, China -- remains mired in the collapse of its oil-based economy and debt-fueled spending spree on the part of its business oligarchs. Many other Central European countries will register steep declines this year, with even weaker fundamentals than their brethren further west. Mexico is shaky as well, dependent as it is on tapped-out American consumers. Even the ability of the emerging markets' Big Three to sustain recovery long-term isn't universally accepted. Debates continue to swirl around China's muscular economic performance. "I'm not sure this is quality growth," says Daniel Rosen, speaking of China. Rosen, a principal in New York research firm Rhodium Group LLC, isn't alone in questioning the soundness and the impact of the $600 billion or so in loans with which the Chinese government flooded the market after last year's crisis. Some of these loans are bound to turn sour. All three equities markets exude heat. Public companies' multiples can skew acquisition multiples, some fear. At the same time, a steep correction will cause some corporate investors a rethink as well. The breathless pace of recovery has some investors and advisers alike wondering whether these markets got ahead of themselves and whether hot money will leave as quickly as it's arrived. "Emerging market equity fund flows setting records again makes me nervous," says Brad Durham, a managing director for EPFR Global, which estimated more than $45 billion flowed into emerging capital markets through mid-October. Brazil's government imposed a tax on foreign purchases of Brazilian shares, but the money keeps coming. In November, the World Bank warned of the danger of a speculative bubble, especially in China. "The recovery [in China] happened almost too quickly," says Laure Wang, co-founder of Asia Alternatives Advisor Hong Kong Ltd. But even the more skeptical acknowledge that investors in these markets have steadied themselves from the tremors that shook capital globally. They're back doing deals. "There is liquidity in the system. Bankers are interested in cutting deals," says Majmudar's Hirani. "Everyone is reasonably positive about the India story." He could just as well be talking about China or Brazil. BRAZILLatin America's biggest economy was hit hard when global commodities prices collapsed. Brazil's stock market, which offshore investors had buoyed, fell precipitously after last year's global meltdown. As a result of these capital outflows and the "flight to safety," the Brazilian currency, the real, depreciated within days by more than 30%. Yet this country of almost 200 million people escaped relatively unscathed. "Brazil never went into a deep crisis," says Martin Sanchez, who heads Latin America M&A for Bank of America Merrill Lynch. Now, optimism, the economy, the real and investors have all returned. "The economy turned the corner pretty quickly," says Douglas Smith, who heads Latin America research for Standard Chartered Bank plc. Smith anticipates "a significant pipeline of deals coming in the first quarter of 2010," as well as a good number of IPOs.
In the past year, the Brazilian stock market has more than doubled. The real is almost back to pre-crisis levels. Rio de Janeiro won the right to host the Olympics in 2016, and that means a huge increase in infrastructure spending. RBC predicts Brazil's economy will average 5% growth annually for five years. "That's remarkable," Chamie says. Brazil's M&A activity fell in the aftermath of the market crash but is staging a recovery, dominated by domestic consolidation plays. Government banks, notably the country's development bank, Banco Nacional de Desenvolvimento Econômico e Social, or BNDES, is pumping tens of billions of dollars into the Brazilian economy and playing a prominent role in backing deals, says Thompson & Knight's Hallake. The idea is to promote larger Brazilian companies better able to compete globally. In May, for example, Brazil's largest food processor, Perdigao SA, took over smaller rival Sadia SA in a share swap valued at $5.3 billion. The new BRF Brasil Foods SA boasts revenue exceeding $7.5 billion and global distribution. The deal sent other companies scrambling. In September, beef producer JBS SA agreed to pay $800 million for a 64% stake in bankrupt American chicken and turkey processor Pilgrim's Pride Corp. In September, meatpacker Marfrig Alimentos SA said it will pay $900 million for chicken processor Seara Alimentos Ltda., Cargill Inc.'s Brazilian subsidiary. That followed Marfrig's July deal for a French-owned turkey operation. Consolidation is roping in the country's ethanol and sugarcane industries as well. They experienced a boom pre-crisis but overextended. The biggest deal to date involves France's Louis Dreyfus Commodities BV, which last month acquired control of Santelisa Vale for $460 million plus debt and created a joint venture, LDC-SEV. That will be the country's second-largest ethanol producer. Goldman, Sachs & Co. and BNDES together own 13% of the venture. The IPO market is just now gearing up. In June, Visanet SA, the Brazilian operations of credit card company Visa International, raised the equivalent of $4.3 billion. It was Brazil's biggest-ever IPO until early last month when the Brazilian unit of Spain's Banco Santander SA raised just more than $8 billion. Late last month, an IPO for clearinghouse Cetip SA raised just over the equivalent of $500 million, which BofA Merrill's Chatel says is about the minimum IPO. "I expect to see much more activity next year," he says. Outbound investment has noticeably lagged, however. "It's not as much as you'd think," Smith says. Some of the biggest names in Brazil are too busy doing deals domestically but could well soon turn their sights to regional expansion. INDIAFor the first three months of this year, India's IPO market was closed. M&A activity had pretty much shut down. In April, the markets showed signs of life after it became apparent all Indian banks had survived last year's meltdown relatively unscathed. Then came May, the national elections and a resounding victory by the ruling Congress (I) Party. "An amazing result," says James Winterbotham, a London partner at India Advisory Partners. In one day, the stock market jumped 17%. The deal pipeline began to flow once more.
Since the March lows, the stock market more than doubled before easing back somewhat amid concerns of a bubble. From June until the end of October, 15 companies launched IPOs, according to data compiled by Meghraj Capital Advisors Pvt. Ltd., a Mumbai-based investment bank. At least 30 more have filed prospectuses for listing. "We're definitely seeing a resurgence of IPOs," says Parag Saxena, New York-based chief executive of New Silk Route Partners LLC, a growth-capital firm. "It's a mixed blessing," adds Hirani. "Some [IPOs] are trading below issue price." Those listing for the first time include India's second-largest state-run oil and gas exploration firm Oil India Ltd. and power generator Indiabulls Power Ltd., which together were able to raise almost $1 billion. While direct investments have also returned, deals post-crisis tend to be smaller. "When we look at 10 to 20 million-dollar transactions, we see a huge amount of interest. When we see 75 to 100 million, there's very limited interest," Saxena says. In June 2008, Japan's Daiichi Sankyo Co. Ltd. paid $4.6 billion for Ranbaxy Laboratories Ltd., India's largest generic-drugs manufacturer. At the time, the consensus was that the Japanese overpaid, a belief reinforced after Ranbaxy got into hot water with the U.S. Food and Drug Administration for falsifying information and 30 of its drugs were banned. In January, Daiichi Sankyo took a $3.8 billion charge on the acquisition. In today's environment, more typical are two deals in August involving distressed Indian drugmaker Wockhardt Ltd. In one, Wockhardt agreed to sell its nutrition business to Abbott Laboratories for $130 million. The same month, Wockhardt sold 10 hospitals from its Wockhardt Hospitals Ltd. subsidiary to Indian hospital network Fortis Healthcare Ltd. for 9.09 billion rupees ($195.78 million). Earlier this year, banks forced Wockhardt, which piled on debt to finance deals in France, Germany and the U.S., to restructure and sell assets. Gone especially are the days when private equity firms such as Apollo Management LP, Warburg Pincus and Morgan Stanley -- not to mention Lehman Brothers Inc. and American International Group Inc. -- invested hundreds of millions of dollars in Indian real estate. The capital overkill bloated land values to New York and London levels and caused construction costs to skyrocket. In the aftermath of the financial crisis, property values plummeted. Sales stopped cold. Projects were abandoned.Had property markets not begun to firm in recent months, "many of these companies would have been insolvent in another six months," says Vijay Sathye, a Meghraj Capital managing director. Indian corporations went on an overseas buying spree in the year or so before the financial crisis. Tata Group led the charge first with the $11 billion acquisition of European steel company Corus Group plc, then with the $2.3 billion purchase of Land Rover-Jaguar. Those kind of trophy properties have lost their appeal, say investment bankers. "You haven't seen Indian companies looking to buy, say, Opel. They're more cautious," Winterbotham says. Sathye agrees that the number of India-related megadeals will remain low, but he doesn't think they'll disappear entirely. He points to Bharti Airtel Ltd., which sought to acquire for $24 billion South Africa's biggest wireless carrier, MTN Group Ltd. The deal fell through when the Indian and South African governments wouldn't compromise on listing requirements. "Larger Indian companies keep growing globally," he says. "Transactions will start to happen." CHINAEarlier this month, China launched ChiNext, a Nasdaq-type stock exchange based in Shenzhen. ChiNext promises high-growth issues with fewer restrictions and easier listing requirements than its main boards, where it can take years to go public. In a wave of speculative frenzy that first day, investors drove up the prices of the initial 28 companies by as much as 200%, with price-earnings ratios reaching stratospheric levels. ChiNext instantly gained the reputation of more casino than capital market. Like many others, Deloitte's Chia is dubious of the long-term viability of ChiNext, pointing out that similar markets elsewhere have declined after an initial burst of enthusiasm. But Chia also sees ChiNext as a welcome addition to China's capital markets. "This second board market is going to be attractive to a lot of companies. They're looking for an exit," Chia says, as are their venture capital and private equity investors. "There's pent-up demand for companies that want to get listed." (For more on private equity in China, see "The search for auspiciousness.") Aided by the government's stimulus program, China's economy decelerated but never declined. Dealflow, however, fell very sharply. "Through the first quarter of '09, it was really quite slow," says Wang. "There was so much uncertainty in the environment." The government imposed a nine-month moratorium on IPOs that ended only in June. According to Rhodium Group's Rosen, inbound foreign investment during the first half of this year was down a modest 18%. Outbound investment, however, fell by a massive 52%. Fear, not lack of capital, kept Chinese investors back. "The uncertainty of Chinese investors was overwhelming for firms with very little experience investing abroad," says Rosen. "They had very little stomach for what could have been the buying opportunity of the century." Investment is now opening up on all fronts, including private equity. "There's been a recovery of M&A activity across the board," says PwC's Ye. The most dramatic deals involve acquisitions overseas by large Chinese companies, many of which are state-owned, as well as the country's sovereign wealth fund. Last month the Australian government gave Yanzhou Coal Mining Co. Ltd. the clearance to buy Brisbane-based coal-mining concern Felix Resources Ltd. for $3.26 billion. It's China's biggest investment in Australia to date. To gain approval, Yanzhou, of Zoucheng, China, promised to move Australian assets into an Australian company, list that company on a local stock market by 2012 and reduce ownership to less than 70%. Yanzhou is also listed on the New York Stock Exchange.
Yanzhou's willingness to meet Australia's ownership demands illustrates the lengths China will go to acquire through investments and outright takeovers natural resources concerns. This is an undisguised effort to ensure raw materials supplies for its industries. "Most outbound [foreign direct investment], $50 to $70 billion a year, will be in natural resources for some time to come," Rosen predicts. That kind of unbridled hunger can induce pushback. Most notably, Rio Tinto plc nixed in June a deal that would have had Aluminum Corp. of China, known as Chinalco, China's largest mining company, invest $19.5 billion for an additional 9% stake in the Anglo-Australian resource giant. Those kinds of investments represent a huge outlay of cash but also reflect China's need to recycle the more than $2 trillion in foreign exchange reserves it has accumulated. (Most are now in Treasury bills.) China Investment Corp., the country's $200 billion sovereign wealth fund, is the government's designated exporter of capital abroad. In one week in late October, CIC invested a total of about $1.2 billion in two separate Mongolian mining ventures. A month earlier, CIC spent almost $1 billion on an 11% stake in Kazakhstan oil and gas venture KazMunaiGas Exploration Production JSC. Rosen and others see shifts in economic patterns that will have monumental impact on investments. One is the need to move up the value chain. So it's not just raw materials that Chinese companies have in their sights, but distribution, marketing and sales networks. Those looking at China-related transactions say most deals are small -- less than $50 million -- and fly well under the radar. Only occasionally do they attract attention, such as Sichuan Tengzhong Heavy Industrial Machinery Co. Ltd.'s deal last month to buy the Hummer brand from General Motors Co. An even bigger shift will involve the Chinese market itself, that mother lode of 1.3 billion people clamoring for ever-more goods and services. "Once [the Chinese] start adjusting away from heavy industry to a new era of consumption-led growth, there will be hundreds of billions of dollars in investment, gargantuan investment opportunities in consumer-oriented infrastructure," Rosen says. Some deals give an inkling of what this could mean. This summer Bain Capital LLC invested $233 million in Gome Electrical Appliances Holding Ltd., China's equivalent to Best Buy Co. Bain wanted to invest more, but Gome's founder thwarted that through participation in a rights offering in August while, improbably, imprisoned. "The world definitely wants to keep investing," Rosen concludes. "That's where the growth is. That's where the money is." | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
While the United States and Europe grapple with how much longer it takes to recover from last year's near-death experience and get gingerly back on economic track, China and India have already returned to a sprint. Brazil is coming on fast. It's a stunning recovery for three of the world's largest emerging markets.
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