Down but not out

IFR Russia and CIS Loans Roun
10 min read
Emerging Markets

Global credit crunch aside, Turkey should be an ECM hot spot with a government eager to privatise former state enterprises and widespread familiarity with equity issuance as a means to raise capital.

However, a much touted run of deals has not yet materialised and two transactions have already been cancelled this year.

Most ECM bankers involved in the country retain high hopes, meanwhile, citing robust macroeconomic prospects over the short and medium term. Annual GDP growth is tipped to exceed 5% next year as the economy continues to bounce back from a crisis in 2001. The government is eager to be perceived as friendly to foreign investment and up to 70% of the country's stock market is in non Turkish hands.

"Turkey is an economic growth story. It has a growing population that is becoming more wealthy," said Christopher Laing, managing director and co-head of Central and Eastern Europe, Middle East and African ECM at Deutsche Bank.

Though it falls into the emerging markets category, it is also far from being labelled "frontier" like some of its neighbours further east. "It's a little less scary than some markets in the region," said one ECM banker familiar with the market.

Deutsche Bank's Laing also points to the "secular" nature of society, boasting a populous middle class with similar consumer spending habits as peers in other emerging markets across the GCC region and East Asia. In spite of this positive outlook, however, investors are notoriously unforgiving when it comes to Turkey, and prone to withdraw at the slightest sign of trouble.

"Turkey is absolutely fantastic in a good bull market... but in a bear market it can be very exposed," said one ECM banker who asked not to be named.

Any upset to economic outlook and Turkish equities are punished hard, in part because unlike other emerging markets such as Russia, it does not have the benefit of large oil reserves to fall back on. A graph of relative stock market performance over the past two years illustrates the point, with the ISE National 100 index evidencing considerable volatility.

In terms of equity issuance, therefore, valuation sensitivities are heightened significantly at the first sign of clouds on the economic horizon. This is exacerbated by the fact that under Turkish law, at least 30% of an equity issue must be made available to local investors who are notoriously jumpy during a bookbuild.

In practice, much of the domestic allocation in an IPO finds its way into the hands of international investors who buy the shares shortly afterwards in the market. But the locals still have to be kept on side for an issue to be successful, particularly given that local regulator, the Capital Markets Board, is mulling an increase in the domestic allocation rule to around 45%.

Indeed, one banker with experience of the country said a publicity budget of at least $100,000 was a standard expense of leading a deal in Turkey because of the importance of winning over local retail investors.

International investors can also be fickle about Turkish opportunities. The country's location at a cultural crossroads between Europe, the Middle East and central Asia has its advantages but also presents its fair share of problems that can spook investors.

Trouble involving Kurdish separatists in the east of the country and unruly neighbours such as Syria, Iran and Iraq make investors demand more assurances than usual when taking a punt on emerging markets.

There is also a tendency towards political instability, though the current Justice and Development Party (AKP) led by the prime minister, Recep Tayyip Erdogan appears to be consolidating its hold on power.

Unfortunately, Turkey is suffering from just such a downturn in sentiment currently which has resulted in pulled deals and delayed launches. Many fund managers continue to fret about fiscal and monetary irresponsibility which has led to a stubbornly high current account deficit. This has led to a number of investors going underweight on Turkey while they wait for the balance-of-payments to look less ominous.

Ongoing political squabbles have not helped sentiment either. In a strategy note in early April, economists at Morgan Stanley downgraded Turkey to equal weight from a previous rating of 'overweight' citing "deteriorating political risk scores."

A perceived decline in enthusiasm for joining the European Union on the part of the Erdogan government has also dented sentiment. From an ECM perspective, closer integration with Europe was expected to heighten interest in Turkish stocks and smooth the way for more issuance. The combination of all these uncertainties contributed to two deals being pulled recently after they became snagged on hypersensitivity over valuations.

One of these, Koza Gold which had sought to raise in excess of US$500m, surprised many when it was postponed given that the gold price continues to brush record highs. Cancellation came as the bookbuild was scheduled to begin in early February with pricing due on February 11. UBS, Merrill Lynch and local bank Ak Yatirim were joint bookrunners on the transaction. Koza Gold's owners, two Turkish holding companies, Koza Davetiye Magaza and Koza Ipek Holding, had planned to list 40% of the company in Istanbul.

Also put on ice was the IPO of Turkish Islamic bank Kuveyt Turk after two weeks of premarketing with the company citing market conditions. The planned deal was an all-primary IPO aiming to raise in excess of US$250m, with HSBC acting as global co-ordinator. The bank, which is majority owned by Kuwait Finance House, intended to list 18.5% of its shares in Istanbul.

The lead managers are confident the deal will come to fruition eventually, however, given bright prospects for the Islamic banking sector in Turkey. "The penetration of Islamic banking in Turkey is very small compared to many other Muslim countries," said Brendan Spinks, associate director of equity capital markets at HSBC.

He highlights that a youthful and growing population suggests demand for religiously acceptable financial services is likely to balloon in coming years so pioneers such as Kuveyt Turk are set to benefit.

In contrast, one sector that has recently lost its appeal to investors is property which until recently was tipped as a growth area, particularly by way of REIT issuance.

Emerging market investors are now more likely to look to Egypt and the Arabian Gulf for property exposure and vulnerability to economic difficulties in Europe have not helped Turkey. "REITs do not appear much of a near term prospect as the property market is very difficult at the moment," Deutsche Bank's Laing said.

Nevertheless, Turkish ECM is scheduled to receive a significant boost from the government's apparent determination to pursue a programme of privatisations. The policy reflects a policy priority of a liberalising government to dismantle the legacy of a one-time protectionist state sector.

However the privatisation agency, OIB, that is responsible for the sale of state-owned assets in sectors such as energy, petrochemical, steel, transport and banking has been making slow progress.

The authorities are also keeping a nationalistic eye on the process with mandates awarded on condition of partnership with local banks.

Nevertheless, one prominent deal that is about to launch is the planned IPO of Turk Telekom, scheduled for mid-2008. Expectations are running high that the transaction, if successful, will add much needed momentum to other privatisations. The government has appointed Deutsche Bank alongside local institution Garanti Bank as financial advisers.

The state currently owns 45% while the remaining 55% is held by Saudi Oger, which paid US$6.55bn for the stake in November 2006. Based on that valuation, the deal size for the planned divestment of around 15% will be about US$1.8bn. The deal will doubtless act as a telling barometer of sentiment and if successful, could provoke a profound change in the direction of Turkish ECM.

Another expected bonus comes from increasing interest from investors beyond the traditional sources of western Europe and north America. Interest in the economy from investors in the Middle East is illustrated in part by the involvement of Saudi Oger in Turk Telekom as well as the Kuwaiti venture through Kuveyt Turk.

But increasing proportions of portfolio investment is also sourced in the Gulf area.

HSBC's Spinks put the level of Middle Eastern money flowing into Turkish equities at around a fifth of the total. "I would say Middle Eastern demand for Turkish IPOs is around 20% and growing," he said.

This should go some way in taking up the slack in demand from other investors in the country and may end up alleviating the problem of stampedes for the exit at every sign of economic trouble.