2010 Outlook for Gulf M&A Financing: Part II
IFR: Can you infer from that that perhaps valuations are a bit depressed on that basis?
Peter Fort: No, that’s the interesting thing because I think there has actually been a tremendous disconnect between valuations – not necessarily here in the Dubai market where public company values remain depressed – but when you look across the globe I think a lot of clients feel that there has been valuation slippage.
Public companies have got way ahead of reality and that has resulted in a fairly large buyer-seller valuation gap. Public companies are saying, “Well, okay, I can just go to the public markets, do a follow on, at what I personally feel may potentially be an inflated share price. Why should I even start discussions with a buyer who has run their intrinsic models and it is coming at a substantial discount to the public company valuation?”
It is interesting because I think this is the first time at least in a dozen or so years where it is becoming very difficult for us to justify public market valuations on an intrinsic valuation basis. You have to make assumptions that are simply unreasonable. That leads to what I mentioned before, a little bit of stagnation in deal activity going forward because it is difficult to bridge that valuation gap.
IFR: Interesting point. Ziad, what do you put that gap down to? Is this exuberance on public investors’ part? Why is there this intrinsic model value differential?
Ziad Makhzoumi: I see the issue from a different perspective. What we witnessed last year in Dubai and the GCC in general, is there is always a risk element that analysts come up with out of the blue. If you look at most of the analysis written about Arabtec, there is a consensus (probably based on too many drinks in Zuma) that there has to be a 30% discount on shares listed on the Dubai Financial Market. If I look at all the analysis that is done, I think it is a series of things: lack of knowledge, lack of understanding of the industry. When I ask analysts why they do that they said, “So when we are extremely conservative and the price goes up everyone says that you are a brilliant analyst”.
So there is no logic in what is happening. We still manage our balance sheet very well, we still manage our P&L very well, we manage our cash very well. I think we negotiate very good deals with the banks, we are not screwed on the cost of finance, but still our share price is highly discounted and I think specifically it’s because we are listed in Dubai.
Probably if we were listed somewhere else, irrespective of whether or not our work is mainly in Dubai, we probably wouldn’t be as discounted, so there is this unreasonable correlation between the share price and being in the region. What we hope will happen is the international firms will come in with people who understand markets and when they do their valuations and their analysis they are more reasonable, first, in the model that they use; and, second, in investor expectations. I think that will take some time.
There is also the issue that most of the big corporations are privately held and their reporting requirements are almost non-existent. How can a bank or a private equity firm come up with something unless it is based on name lending, or on a balance sheet that probably is not properly audited, not because the auditors are not qualified, it is just that how would you value something that you are not aware of?
How would you know if the same asset is mortgaged many times over by certain groups who don’t declare it to the banks in one way or another? Anybody can go to 10 banks and borrow the same amount based on the same letter they get from their employer, so they would go in and borrow AED50,000 based on their income of AED10,000, but from 10 banks, and they put a deposit on property and sell it to the folks back home and make a killing.
But now they can’t sell so have to make the second payment and they say, “Oh, bloody hell, I’m leaving“. The banks have to co-operate on these issues. One of the reasons we didn’t have a form of credit rating is that the banks didn’t want to share information about their clients, worried that somebody would nick them. Unless we look at the picture as a whole and try to resolve the issue in a regional manner and not just pay lip service to it, I think we will always have idiosyncrasies in the system, which as an investor is great because you have incredible opportunities to go in and make a killing if are you are aware of it and bring in the right partners.
IFR: Just to close up this theme about positioning in 2010, Steve I’m just going to give you your opportunity to talk about what your expectations are.
Steve Perry: I think as with every bank, if you have record profits again – as we did last year – it means your budget goes up again this year so it becomes an ever-fulfilling prophecy in many ways. We have had a very good start. We closed three deals in January so we have got the ball rolling and it is important for us to get a good quarter because obviously the analysts are looking at Standard Chartered's and saying, "Is it sustainable?"
I think all banks have these issues of sustainability and that's a key focus for us. Our management are very keen to see a very strong first quarter to prove that we are going to have another good year. I think in terms of business propositions, we have quite a healthy pipeline and it is not just new money, there are also refinancings. Companies are not in the position where they can just repay their debt at the moment. So that's one side of the business where we can add significant value.
The second side of the business is new money and there are opportunities out there and our clients know that if they need it, they can call on us and we will support them. I see it as another tough year, don’t get me wrong, I’m not saying it is going to be a walk in the park, but I think basically if you have got balance sheet and you know your clients well enough, you shouldn’t be afraid to lend.
At the end of the day the lending issue has been the main problem. Banks have got themselves in this predicament where they don’t want to put money on the table and that’s created a little bit of the black hole we find ourselves in at the moment.
IFR: What about deal structure in this environment? The loan market has been pretty top heavy in the last 18 months. Clubs indications are the order of the day and there’s been little underwriting. I guess your point would that that means you make more money. But if the market comes back again, how do you see the structural issues?
Steve Perry: I don’t think we are afraid of underwriting. We have two underwritings on the table at the moment to clients, one of which is signing imminently and another one which is out there, which could happen. I think for the right client and the right deal we are happy to underwrite. It is really a case of what the client wants at end of the day because we have gone through a very tricky time and all the borrowers have been interested in is getting money on the table and to do that, the safest way to do it is to get all your relationship banks together and form the club.
OK they are paying a little bit more, but they are still getting the money and the banks are happy to support that client. I think the issues will be when more banks return to the market. When exactly that will be? It could be second quarter, third quarter; who knows? When they do return that will create the dynamics of opening up more competition, which then may lead to more underwriting, but I can't name many banks that have appetite to underwrite in this region at the moment. So it is going to be a club market again this year I think.
IFR: With a tendency towards short tenors?
Steve Perry: Probably, yes. I still think the one to three year is going to be the optimal thing that borrowers can get. Owing to the current environment we find ourselves in.
IFR: The refinancing mountain is kind of scary. From your conversations with your peers and colleagues and competitors, how much of a concern is that for the loan market, in an environment where a lot of the banks have pulled out?
Steve Perry: I think the favourite market has been the bridge to bond. The bond market has been very strong the last 12-15 months and it has really basically worked hand-in-hand with the loan market, so you have had banks willing to put big numbers on the table for a one-year deal on the expectation that they will take it out with a 144a, or a sukuk, or whatever it is going to be.
I don’t see that changing until the bond market dries up. If and when that happens, it is going to put a hell of a lot more pressure on the loan market. But I would like to think that the loan market is generally there consistently. It doesn’t dry up per se. I think if push came to shove, banks would continue to lend rather than just rely on bond take-outs.
IFR. What is the issue for acquisition finance? Do you see the structure of that financing evolving and, if so, how?
Peter Fort: It continues to be difficult and I think it is what Steve mentioned, which is we and other banks are willing to commit capital for specific situations, but generally on a short-term basis and generally with a view of a public market take-out, so it certainly is all underpinned by the health of the bond markets and in particular the high-yield bond markets. That’s more obviously a European and US story than the Middle Eastern story. There have been very few, if any, high-yield deals in the markets here and so the question is can the high-yield market develop in this region? That remains to be seen.
IFR: We’ve covered a lot of ground so far, but can I go round the table a final time and ask you about what your key takeaways are?
Ziad Makhzoumi: We still have a lot of uncertainty in the market and it is very difficult to predict how the market will pan out. I said last year I don’t expect 2010 to be better than 2009. I hope I am wrong. We are working very hard to make sure I’m wrong. There are still lots of variables which are not clear and not predictable beyond a quarter or so, and I think we will need probably until September to get some balance in the market worldwide and regionally before we can predict. If you ask me the same question in September/October of 2011 probably I can give you a better prediction.
Steve Perry: I think fight-to-quality back-to-basics banking is going to be prevalent this year again. I think the stronger areas of the GCC such as Abu Dhabi, Qatar, Saudi to a degree, will benefit from banks looking at the top-rated clients to lend to. Dubai, I think, will be difficult to analyse until probably June after they have sorted themselves out and the standstill agreement has gone through the cycle. I’m generally optimistic. but there are a lot of people who think there will be a double dip in the second half, so who knows what is round the corner, but our view is we are there to do deals, so we are optimistic.
IFR: Ali, what are your final thoughts?
Ali Al-Gwaiz: As far as equity capital markets, I am optimistic though cautiously. I think the Saudi economy stands a better chance than neighbouring economies and the global economy overall, relatively speaking.
IFR: Peter, final word to you.
Peter Fort: As I mentioned earlier, it is difficult to predict the global macro trends, I’m not going to try to do that, but I would say for the region what is important is, both from the corporate and fund perspective, to continue to increase the focus on transparency and disclosure because that will only help people in the long-term, number 1. Number 2, from a government regulatory institutional perspective there continues to be a need to strengthen regulation and clarify it, in particular on the M&A side.
Saudi obviously has implemented a takeover code but even there it has its flaws and, as Ali mentioned, the regulator continues to have a very heavy hand and so I think there is definitely a need to look to more transparent, streamlined, clear M&A regulations and, to the extent that it is put in place around the region, that will clearly spur M&A activity and will bring long-term dividends for the region as a whole.
IFR: Thank you very much, gentlemen, for your comments.