Investors in Turkey are used to surprises. When political unrest over Gezi Park broke out last year — bringing down, among other things, the country’s equity index by 16% — it was another pothole in a long and expensive road to a busy and fully functioning equity market in the country.
Political instability and market turmoil of that kind is just one of the issues that have long kept equity issuance from Turkish companies at bay. With little visibility on calm valuations, matching expectations between investors and issuers has often been impossible, and has led to a dearth of supply.
Despite all that, banks continue to invest in the country, rolling out franchises and hiring despite no clear indication that there is any more money to be made. Most of those businesses are loss-making, taking hits on the high-profile but low-reward privatisation work in the hope of seeing some return in the future.
But politics and economics willing, 2014 could be shaping up to be the year that Turkish equity capital markets start to catch up with their peers, and banks’ investments begin to pay off.
The structural benefits of the market mean that while it might be challenging to invest there, the funds that look at the country are likely to continue to do so.
“Turkey is a market that has in the past had shorter and more extreme cycles than some other markets,” says Richard Cormack, co-head of ECM for EMEA at Goldman Sachs in London. “But structurally there is every reason to be optimistic about Turkey as an economy and an equity market. It is huge, it straddles Europe and Asia, and has some great companies. It sits in an interesting place for investors and is simply too large an economy to ignore.”
But those old fears — political instability and the country’s large current account deficit — still haunt investors.
May’s disruption threw off the secondary public offering for Emlak Konut, the state-backed real estate firm, in what was the second largest deal since 2009. It came back in November to calmer but weaker equity markets and found success. Those and other issues have left Turkey an underperforming market in a very strong year, and investors could be well positioned to capture some of the upside as the market recovers.
“Like Poland and Russia, the Turkish market continues to be a darling if banks can come with the right name, and they can find very good valuations,” says Yacine Amor, head of CEEMEA ECM at Bank of America Merrill Lynch in London, which ran the Emlak deal. “And since the disruption in May, there is some catching up to do and people will be getting ready to come back to the market.”
Though few at the beginning of 2013 could have predicted the political unrest and weakening environment for emerging markets, or the damage that they did to investor sentiment, potential disruptions to activity for 2014 are already beginning to show.
Municipal elections are set to be held at the end of March, followed by national elections at the end of August, during which the president will be elected directly by the electorate for the first time. Turkish elections have not historically turned out many surprises, but after the disruption of the last year many ECM specialists expect a pause in activity. The flow of cash into and out of Turkey ahead of the elections, even without surprises, is likely to be volatile enough to keep primary markets muted.
The gap between the two sets of elections, in the second quarter, is likely to be more quiet than usual, but might push issuance into the beginning of the year instead.
“It’s unlikely that the elections will cause long term disruption, but they will mean that there are certain windows when deals can’t be done,” says Yacine Amor.
Yet some companies will refrain from doing deals, no matter how conducive the environment.
“There is strong interest in the market from companies looking to list shares,” says Kayihan Kopmaz, head of Turkish investment banking at Citi. “But 2014 will not be an easy year, and there may be a very limited number of windows of opportunities to come to the market for equity deals.”
And the country is — like all emerging markets — preparing to be hit when the US Federal Reserve chooses to begin tapering quantitative easing. CEEMEA as a whole is expected to see that out better than other emerging markets such as Latin America, but it is still likely to be investors’ main worry.
“Fed tapering decisions will be at the front of investors’ minds,” says Kopmaz. “That will be the primary concern for investing in Turkey in 2014.”
The deals that manage to make it through those challenges will be for international, large and liquid names. Few ECM deals have come out of Turkey in recent years — but those that have are often among the biggest in Europe.
“The Turkish market is liquid, which gives investor confidence, and it has shown itself to be able to deal with very large transactions in the past,” says Cormack. “In the context of emerging markets, it is a properly functioning, liquid stock exchange.”
International investors, which tend to take around 80% of deals, are always sensitive about liquidity, but especially so in Turkey.
“For international investors to come into a deal, there has to be size and liquidity, or those funds aren’t at all interested,” says Claudio Villa, deputy head of global equity capital markets at UniCredit. “Without large international buying, the deal won’t get done. And that’s the best for the deal: it ensures a solid investor base, good aftermarket performance and drives demand in the long term.”
But domestic buyers may fret — if a deal is large enough to be worth playing, then international funds are likely to come in and snap it up. On privatisation deals, international banks must team up with a domestic one that can fight the corner of Turkish investors, though victory is rare.
That hunt for liquidity is increased in Turkey because of a history of small, illiquid listings for big corporates that investors in the country are stuck holding. Many conglomerates in the past have done small flotations for regulatory or technical reasons, but with no interest in the aftermarket. Investors are wary of finding themselves in that kind of situation again.
There is a strong domestic retail bid for Turkish equities, which tends to be active in the secondary market and can drive that kind of liquidity.
Turkey also has a special status among US funds, which tend to look at deals from the country more readily than they would other European emerging markets. And bankers report that since September, European generalist equity funds and sector specialists are looking again at Turkey and the Middle East, which is expected to drive valuations more in line with western European levels, at least for some sectors.
Investors are ready to look at the right deal. But the problem — as it often is in Turkey — is convincing those issuers that could bring the supply to come to the market.
Buildings, not banks
The bank names that have driven almost all Turkish ECM issuance in recent years are unlikely to play much of a part in 2014’s activity, as they are likely to be affected by rising inflation. Like South Africa and Russia, Turkey is likely to be hit by rising prices and it is probable that its central bank will raise rates.
But the retailers that can see out the inflation problem could enjoy a strong run of issuance.
And private and public infrastructure firms could also see strong demand, as they seek to raise money for a number of ambitious government projects and investors look to take advantage of an improving sentiment around the sector.
But the trouble will be — as it has been for some time — convincing those companies to list at current valuations. The bid offer spread is large in Turkey, as issuers look to command a premium for strong and fast growth but investors ask for discounts to factor in the country’s historic uncertainty.
“In emerging markets there tend to be more extreme cyclical peaks and troughs, which leads to a more volatile and binary equity capital market environment,” says Cormack. “The same feeds through to secondary market volatility, which can mean that valuation expectations on the buy and sell side can get shaped in more polarised ways.”
Turkish ECM has often been blighted by the attractiveness of other funding routes. In recent years, bank funding has been so easily and cheaply available at long maturities that any company looking to fund capital expenditure — a common need in a country with such fast growth — would pursue that route. And shareholders looking to monetise stakes are often tempted by private equity buyers, some of the most active in emerging EMEA.
But bank funding is getting more expensive, and PE sponsors that have long been unable to IPO their assets are looking to return cash to investors. Even if ECM isn’t getting more attractive for Turkish companies, the alternatives are getting uglier — and they have to raise funding somewhere.
Every bank that looks to have a European emerging markets presence — and many that don’t — has a franchise in Turkey. Almost all of them are loss-making, but they hope that the bet that paid off in Poland will do the same in Turkey. Bankers estimate that in a couple of years, the optimism around Turkey’s economy could start translating into ECM activity.
That could push it into the 10 or so deals a year that is seen in a good year in a market such as Poland. But those bankers are quick to point out, too, that the two-year timetable for conditions to improve has been on the table for years.
The next year could see the beginnings of that improvement. But in a market with such a tendency to throw up surprises, market participants should not get too comfy just yet.