Darkest before dawn?

Turkey Report 2012
13 min read

Relative to the size of its economy, Turkey’s equity market has consistently failed to deliver on its potential. But after 2011 which was the definition of a false dawn, could that finally be about to change?

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At the end of 2011 there were just 366 companies listed on the Istanbul Stock Exchange, according to figures published by Turkey’s Capital Markets Board. Total market capitalisation, meanwhile, fell from just over US$300bn in December 2010 to US$225.7bn by the end of the year.

Those numbers are modest – and by all accounts frustrating – by emerging market standards.

A comparison of Turkey’s stock market indicators with those of the BRICs, published last year by the IFC, makes unflattering reading for the Istanbul Stock Exchange.

Market capitalisation in 2009 ranged from 70% of GDP in Russia to 90% in India and just over 100% in Shanghai. The comparable metric from Turkey was just 36.58%. By the end of 2011, Turkey’s market capitalisation to GDP had slipped to just over 30% of GDP.

Pickings were certainly depressingly slim in the Turkish IPO market in 2011. There were promising, if very modestly sized, offerings early in the year with the exchange welcoming cash and carry firm Bizim and retail group Kiler Holding in January alone. Three months later Kiler was back listing property assets with Kiler REIT. Deals were oversubscribed and each attracted reasonable demand from overseas investors, with BlackRock a significant participant in the Kiler REIT transaction, buying more than 5% of the TL184.1m (US$121m) sale in April 2011.

The following month saw a small IPO for Akfen, raising TL123.4m (US$80m) from a balanced mix of foreign and local investors, but the month was notable chiefly for the abandonment of a planned US$325m IPO from another REIT, Ronesans. That more or less brought the shutters down on the market for IPOs of any meaningful size, and it has yet to reopen.

Last year was not, of course, a representative year for most emerging equity markets, especially for those as dependent on foreign investors as Turkey, which still own a sizeable – if declining – share of the market. According to the CMB data, foreign ownership accounted for 61.9% of the Turkish equity market at the end of 2011, down from 66.2% a year earlier.

Long-term dynamics

Nevertheless, Mert Yildiz, Turkey and emerging European market economist at Renaissance Capital, said there were longer-term dynamics in play, both from a demand and supply standpoint, than those arising from global sentiment towards emerging market equities.

“The problem on the demand side is that Turkey isn’t a saving nation,” said Yildiz. “Turks prefer to buy gold or put money into one-month deposits than to invest in longer-term savings products such as equities.”

That, he said, was largely a by-product of the size of the informal economy in Turkey, which ensures that extensive pools of cash bypass the banking system altogether.

“That creates a savings deficit, which is one reason why there is so little retail demand for equities,” said Yildiz.

The figures speak for themselves. According to Renaissance Capital, while consumption in Turkey rose by 10% between 2008 and 2011, savings fell over the same period. By the end of last year, gross savings amounted to an estimated 12.9% of GDP, compared with 17% in 2010.

The size of the informal economy, said Yildiz, also acted as a drag on equity supply in Turkey. He explained that with some 40% of the country’s massive labour force working in the grey economy, reporting standards in the corporate sector inevitably leave much to be desired. The quality of reporting, Yildiz added, will only be dragged out of the dark ages by updated regulation, encompassing new commercial and tax codes.

Others agreed that the broader issue of substandard corporate governance deters a large cross-section of family-owned companies in Turkey from embracing a public listing.

“Turkey trades at a much lower emerging market discount than Russia, largely because almost 50% of the index is accounted for by banks which are very well-regulated, efficiently managed and transparent”

“We worked on a number of IPOs last year that did not make it to market, not just because of management’s concern over low valuations,” said Claudio Villa, deputy head of equity capital markets at UniCredit. “Corporate governance was also an issue for them.”

Poor corporate governance is not necessarily reflected in a Russian-style discount for Turkish equities.

“Turkey trades at a much lower emerging market discount than Russia, largely because almost 50% of the index is accounted for by banks which are very well-regulated, efficiently managed and transparent,” said Yildiz.

Bankers said that another factor that had held back the Turkish IPO market had been competition from trade sales.

“There have been a number of examples where private equity has favoured trade sale solutions over IPOs,” said Richard Cormack, managing director of ECM for new markets at Goldman Sachs in London.

“For example, Mey Icki could have been an IPO, but was sold instead to Diageo.”

Diageo’s gain has probably been equity investors’ loss. Mey Icki is the largest spirits company in Turkey, and the leader in the local market for raki, where, according to Diageo, consumer spending is growing at twice the rate of GDP.

Mey Icki would have been a welcome addition to the universe of listed companies by providing equity investors with exposure to a rare play on demand among Turkey’s emerging middle class.

Consumer staples stocks accounted for 11.4% of the ISE’s market capitalisation at the end of 2011, and consumer discretionary companies for just 7.1%, compared with the top-heavy banking sector, which made up 45.7% of the benchmark.

Full of promise

ECM bankers said, however, that after a number of false dawns, they were hopeful that some essential building blocks were now in place that will put the Turkish equity market on much firmer long-term footing.

“At the end of 2011, almost without exception international bank strategists were looking at Turkey through a glass that was half empty,” said Robin Osmond, head of CEEMEA equity capital markets at Citigroup in London. “They focused relentlessly on the current account deficit, the fear of inflation and the dangers of a depreciating currency.”

“In 2012, investors have been adopting a glass half-full perspective,” said Osmond. “They are focusing more on the potential for economic growth, which we think will be 2.5% this year and between 4% and 4.5% in 2013, on the high degree of political stability and on the strength of a number of the leading listed sectors. The banks, in particular, have low exposure to bad loans and share very few of the weaknesses of their troubled counterparts in Western Europe.”

“Investors are focusing more on the potential for economic growth, which we think will be 2.5% this year and between 4% and 4.5% in 2013 … The banks, in particular, have low exposure to bad loans and share very few of the weaknesses of their troubled counterparts in Western Europe”

Timothy Ash, head of emerging markets research at RBS in London, had an even more upbeat take on the outlook for growth. “Economists’ views on Turkey tend to fall into two camps,” he said. “Those in the first camp argue that the economy is slowing down and may be heading for a hard landing. Those in the second believe that growth will be resilient.”

Ash said he was in the second camp, and is forecasting GDP growth this year of 4%-plus, driven principally by domestic demand.

“One and a half million new jobs were created last year, which is underpinning demand for housing and consumer goods,” he said. “Turks generally feel very confident about their future.”

So, apparently, do the foreign investors who are the main driver of demand for Turkish equities. Increasingly positive sentiment towards emerging markets in general and Turkey in particular, said Citi’s Osmond, has been reflected in rising inflows of international funds into ISE-listed stocks.

“Many of the fund flows we’ve been seeing at our trading desk in Istanbul have been programme trades from global funds moving into emerging markets,” he said.

Bankers agreed, however, that there were still a number of formidable macro-driven challenges lying ahead for Turkey’s listed companies. One of these is the vulnerability of the Turkish lira, the value of which fell by about 20% in 2011 versus the dollar and euro.

As Moody’s cautioned in a report published at the start of this year, “although this provides relief to exporters, it is a burden for corporates that have significant amounts of dollar-denominated debt as they face higher refinancing costs. Headroom under certain financial covenants could also become constrained, heightening the funding challenge”.

One potential source of activity in Turkey’s new issue market is the country’s stop-go privatisation programme, which according to figures published by the Ankara-based Privatisation Agency has generated revenues of US$47.4bn through the sale of 200 companies since 1985.

Although the government has reiterated its commitment to accelerating the sell-off, opinion appears to be divided on the immediate prospects for the programme.

“Large-scale privatisation bringing in fresh long-term money would be a constructive way of helping to address the issue of Turkey’s current account deficit, which is now over 10% of GDP,” said Marcus Svedberg, chief economist at East Capital. “But many of the juiciest assets have already been sold, and Turkey is under no political pressure to push ahead with its privatisation programme.”

Nevertheless, residual government holdings of companies such as Turkish Airlines, Turk Telecom and a number of banks are expected to be put on the block during the next 12–24 months. Other potential new issues in the pipeline over the same period include IPOs from Sabanci’s technology retail unit, Teknosa, the petrol retailer OPET, the low-cost airline Pegasus, and the Istanbul Stock Exchange.

National Bank of Greece, meanwhile, has announced that it plans to sell a 20% stake in its successful Turkish subsidiary, Finansbank, as soon as market conditions allow. Given favourable tail-winds, this batch of IPOs could add as much as US$5.2bn of new equity supply by the middle of 2013. The fact that Finansbank was first mandated back in November 2010 shows that number could turn out to be far lower.

Hopes on utilities

Further ahead, bankers are hopeful that the utility sector, which accounts for a tiny 2% of the ISE 100 Index, may also emerge as a source of new issuance in Turkey.

“Restructuring and privatisation of Turkish utilities has led to local and international consortia buying a number of generation and distribution franchises,” said Citi’s Osmond. “Given how capital-intensive the industry is, we may see some of these utilities becoming IPO candidates.”

The jewel in the crown in this sector, he says, is the Enerjisa joint venture between Sabanci and Austria’s Verbund, which has an ambitious target of carving out a 10% share of Turkey’s power market by 2015.

“Enerjisa has talked about an IPO in 2014, and there are a number of other high quality companies in the utility sector that may need new equity capital over the next two to three years,” said Osmond.

Some warned that if privatisation and restructuring was to breathe new life into Turkey’s equity market, adding much-needed liquidity and diversity to the narrow universe of listed stocks, it will need to be accompanied by the emergence of more durable local institutional demand for equities. According to the IFC’s analysis, the equity exposure of local institutional investors is no more than about US$5bn, with insurance companies’ investment accounting for around 1% of the market capitalisation of the ISE.

The good news is that with Turkish pension assets so modest, the only way is up, with the IFC’s report forecasting that by 2023 the value of these assets will reach 20%. To put that total into perspective the OECD average is 67.1%, suggesting that the longer-term growth potential of the Turkish pension fund sector is significant.

The sun sets over Ottoman-era Suleymaniye mosque in Istanbul
Workmen put the finishing touches on a giant Turkish flag painted on stones