By Julian Evans
Bigger deals – and plenty of them. Is this really the turning point for investment banking in emerging markets?
Emerging markets are having a great year. Suneel Bakshi, global head of Citigroup’s emerging market corporate banking business, says: “From our point of view, emerging markets are in a sweet spot at the moment. Volumes are high in every product from M&A to debt products.”
Growth in both the size and number of debt, equity and M&A deals has been driven by ideal external conditions. Low US rates and under-performing developed stock markets has meant around $12 billion in western pension fund money has in the last 12 months, according to the IMF, channelled into emerging markets in a global search for yield.
In addition, commodities prices have been at all-time highs. That’s led to record pools of corporate liquidity in regions like the CIS and Middle East. A lot of that money has been flowing into local capital markets, or been used for M&A activity.
As a result, both debt and equity emerging markets have been out-performing developed markets. The MSCI emerging market equity index is up 11.5% year-to-date, with stock markets from Moscow to Istanbul hitting all-time highs. The JP Morgan emerging market bond index, meanwhile, has tightened 12 points in the first half of the year.
Investment banks have made good money from these rallies, through their proprietary trading desks. John Davitte, head of emerging market research at consultancy firm IDEAglobal, says: “This year, banks’ prop desks have been heavily involved in some fixed-income plays, particularly on Brazil and Turkey external debt.”
Secondary trading
Secondary trading commissions have been a good source of revenue too, according to John Lomax, chief emerging market strategist at HSBC. He says: “Volume in the secondary market has been almost double what it was in 2004, as emerging markets have been increasingly attracting global and developed market funds, in addition to dedicated emerging market funds.”
Banks have also been making good money selling to an increasingly important client – hedge funds. Banks have made money packaging bonds and loans into credit derivative baskets, which have proven very popular with hedge funds. Alexis Rodzianko, CEO of Deutsche Bank Russia, says: “Banks have been doing a lot of deals through the credit derivative markets. They get less publicity but higher margins. You’d do a straight lending deal, then repackage it through CDS. It’s a growing business.”
The rallies in debt and equity secondary markets have been tempting many emerging market companies into new debt issues and IPOs.
In debt, bankers complain that fees for regular issuers have compressed to new lows. Fergus Edwards, head of Asia debt syndicate at JP Morgan in Hong Kong, says: “Compression has been fairly severe for regular issuers. The Philippines, for example, paid just 0.03% fees on its $250 million, 10-year bond in May.”
However, fees have been better for debut and high-yield issuers, of which there have been many, particularly from Hong Kong and Brazil. Ukraine and South Korea have also been good sources of debut debt issuance.
Banks have been doing well from IPOs this year, in Russia and particularly Asia. Hardly any Russian companies floated stock in 2004, but this year over $4 billion has been raised, including Sistema’s $1.56 billion London offering. CSFB and Morgan Stanley have totally dominated the CEE IPO market. Tom Ahearne, head of CEEMEA equity capital markets for CSFB in London, says: “IPO fees have stayed fairly steady over the last 12 months, and the business remains profitable.”
The world’s biggest IPO, however, came from China – China Shenhua Energy’s $2.95 billion IPO in June. It was the first of six Chinese state companies looking to raise $15 billion through IPOs this year, which will make lead managers around $500 million in fees. UBS and Goldman Sachs have done best in this sector in 2005.
M&A thrills
Perhaps the most exciting growth area in emerging markets has been M&A. After a quiet 2004, this year has seen some big deals, particularly in the oil and gas sector as Chinese, Russian and Indian oil companies undertake multi-billion dollar deals. In Russia, Gazprom is raising a $10 billion loan – the biggest ever emerging market loan – to buy Sibneft from Roman Abramovich. The banks in the deal, yet to be mandated, stand to share a total fee-pot of $1 billion on the loan, according to one lawyer working on the deal.
In August, CNPC, advised by Citigroup, bid $4.1 billion for CIS oil company PetroKazakhstan. Another Chinese oil company, CNOOC, was only frustrated in its $18 billion bid for Unocal when US Congress kicked up a fuss. Finlay Thomson, oil and gas analyst at ABN Amro, says: “We’ll see more big deals involving Indian and Chinese oil companies, because their appetite for energy is so big. China is using so much oil at the moment, that PetroKazakhstan’s total reserves account for just 100 days of China’s energy consumption.”
While CNOOC may have been unsuccessful in its bid for Unocal, emerging market companies are increasingly acquiring assets abroad, including in developed market companies. Mexican cement company Cemex, for example, bought UK cement company RMC for $5.8 billion at the end of 2004. High corporate liquidity has made Middle Eastern companies important buyers too. Jesse Solomon, EMEA research analyst at HSBC, says: “Gulf investors have announced $8 billion in overseas acquisitions in the past 18 months, with targets ranging from Celtel in the Netherlands, to the Tussauds Group in the UK, to CSX Corp’s World Terminals in the US.”
Broader trend
Suneel Bakshi of Citigroup says the overseas expansion of emerging market companies is part of a broader trend: “We’re seeing emerging market companies really come of age, becoming more sophisticated in their financing, meeting international levels of corporate governance, and expanding beyond their domestic borders. That means banks have to re-think their relationship model, basing it on a strong local knowledge and presence.”
Most investment banks have been doing just that – building up local teams and occasionally acquiring local brokers to give them strong local presence. For example, Deutsche Bank recently bought up all of UFG, a Moscow brokerage, for around $150 million. UBS likewise bought 100% of a Moscow brokerage, Brunswick, in 2004.
Banks will be hoping they aren’t making the same mistake they did in 1997 – of setting up large local operations, only to see emerging markets collapse. But most bankers and investors feel optimistic that emerging markets are more resilient now than perhaps ever before. One banker in Mexico City says: “Emerging markets have gone through their crazy, unpredictable years. Now, they’re increasingly a normal part of the global market, so we can start doing some really sizeable deals.”