The Rise of Emerging Markets in Mergers and Acquisitions - Siemens

The Rise of Emerging Markets in Mergers and Acquisitions Developing countries are gaining strength and influence

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he rise in the number of mergers over the past five years has been dramatic. Unlike previous merger waves, however, companies in emerging markets are playing an increasingly important role. Indeed, while the number of majority acquisitions increased globally by 6 percent, acquisitions of established companies by emerging firms grew at an annual rate of 26 percent. Although their motives differ from traditional M&A activity, it is clear that, in the near term, emerging competitors present a potential threat to companies in developed countries.

Mergers and acquisitions have become a staple of newspaper headlines. Although most M&A activity is initiated by companies in the developed world, a recent A.T. Kearney study of global M&A reveals that a paradigm shift is occurring: Beginning in 2002, deals between developing and developed countries grew at an annual rate of 19 percent— far in excess of the industry average and four times faster than deals conducted within either developing or developed countries alone (see figure 1 on page 2). While not large in absolute terms, this rate of growth indicates how rapidly the developing world is catching up in the M&A business. In fact, the study found that companies from developing countries such as China, India, Malaysia, Russia, the United Arab Emirates and South Africa are snapping up established firms at an astonishing rate. Of the 2,168 majority acquisitions between developed and developing

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countries in 2007, almost 20 percent — a total of 421 — were driven by companies from developing countries. Furthermore, this pattern is growing by 26 percent annually. This paper highlights the key findings of the global M&A study, and lays out a strategy for established firms to gain a competitive edge from the changing dynamics they reveal. The rise of developing nations in M&A activity is creating unprecedented pressure on companies in the developed world. Companies need the appropriate levers if they are to maintain their positions in the market.

Asian Countries Lead the Developing World Companies from India, Malaysia and China are at the forefront of M&A activity in developing nations. Together, these three nations accounted for 56 percent of the deals that took place from

The Rise of Emerging Markets in Mergers and acquisitions

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Figure 1 An increase in deals between developing and developed countries

Global majority acquisitions

Majority acquisitions between developing and developed countries

CAGR = 6% 22,496

CAGR = 19%

25,377 23,576

902

925

1,113

1,522

1,901

2,168

2002

2003

2004

2005

2006

2007

19,413

18,705 17,096

Majority acquisitions within either developed or developing countries CAGR = 5%

2003

2004

2005

2006

2007

1

2

2005

2006

23,204

16,170

2002

2003

2004

Sources: Dealogic; A.T. Kearney analysis

2002 to 2007 (see figure 2). While India is spearheading the acquisitions market, Malaysia is a surprising second—primarily due to the government providing substantial tax incentives to engage in high-tech business deals and promote exports. This is in sharp contrast to Chinese companies, which sometimes encounter political problems clinching deals. Consider the case of the China National Offshore Oil Corporation (CNOOC), which ran up against severe political obstacles in its bid to acquire U.S.-based Unocal. China is first among developing nations targeted by companies from developed countries. Almost one out of every four such transactions are conducted within its borders. India follows

21,677

18,300

17,803

2002

20,974

2007

CAGR = compound annual growth rate

at second place in this greatly dispersed market with 6 percent. Among developed countries, companies in the United States lead the ranks of both the acquired and the acquirers by considerable margins. U.S.based companies participated in one of every five mergers and acquisitions between developing and developed countries from 2002 to 2007, acting as the major acquirer in 19 percent and the main target in 23 percent of M&A activity.1

Governments Help Drive Acquisitions from Emerging Markets As companies from developing countries make equity investments in developed nations, their

Dealogic; A.T. Kearney analysis.


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Figure 2 China, India and Malaysia are at the forefront of M&A activity*

Acquirers from developing countries

24%

Countries targeted by companies from developed countries

24%

29% 38%

3%

6%

3% 6%

5%

14% 8%

3% 13%

5% 3%

3% 4%

4%

5%

India

Russia

China

Mexico

Romania

Malaysia

Mexico

India

Russia

Malaysia

China

United Arab Emirates

Poland

Czech Republic

Other

South Africa

Other

Brazil

Hungary


*Percentages from 2002-2007

objectives dovetail neatly with the political goals of their governments. Governments in China and Russia, for example, are eager to enter established markets and grab a share of economic power. China recently invested $3 billion in the private equity firm The Blackstone Group and now holds almost 10 percent of the firm’s outstanding shares. We believe this is just a beginning. China recently founded a state-owned company to make $300 billion in investments this year, with the expectation that the organization will earn higher returns than traditional government bonds. Russia is nearly in line with China. Its Stabilization Fund will cap reserves that exceed 10 percent of the GDP and divert them into the

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newly organized National Welfare Fund. This fund was established in February 2008 with an estimated $32 billion for riskier investments. Such sovereign wealth funds (SWFs) — stateowned investment funds that manage mainly foreign currency assets — are growing in number worldwide, and have been accumulating assets rapidly. Both oil-exporting countries such as Russia, Norway, Malaysia, and the Gulf states and non-oil-exporting countries in Asia such as China and India have gained huge current account surpluses in the last decades. Traditionally, countries turned these surpluses into risk-averse financial assets to reduce currency volatility and stabilize their economies by investing in importing


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Figure 3 Oil-exporting countries represent the majority of sovereign wealth funds

Asset value in $ billions*

Inception

Abu Dhabi Investment Authority (ADIA)

875

1976

Norway

Government Pension Fund of Norway (GPF)

380

1990

Singapore

Government of Singapore Investment Corporation (GIC)

330

1981

Kuwait

Kuwait Investment Authority

250

1953

China

China Investment Corporation (CIC)

200

2007

China (Hong Kong)

Hong Kong Monetary Authority Investment Portfolio

163

1998

Singapore

Temasek Holdings

159

1974

Russia

Stabilization Fund of the Russian Federation**

157

2004

Australia

Australian Future Fund

61

2004

Qatar

Qatar Investment Authority

50

2000

Libya

Libyan Arab Foreign Investment Company

50

1981

Algeria

Revenue Regulation Fund

43

2000

Country

Fund

UAE

*Asset values as of January 2008 **Includes the National Welfare Fund with an asset value of $32 billion

countries with a current account deficit. China, for example, supported the strong consumption economy of the United States by buying U.S. government bonds. Lately, however, there has been a strategic shift in the way the money is being invested. Instead of traditional investments, sovereign wealth funds are favoring equity-type investments either through state-owned investment funds or companies—thus gaining exposure to strategic companies with more capabilities and know-how in industries that are crucial to their own economies. In this way, emerging countries are evolving from lenders to owners. What are the implications of this shift for established firms? Although SWFs are still in a 1

4

Sources: Sovereign Wealth Fund Institute; A.T. Kearney analysis

fledgling state, developing countries are expected to make a giant leap forward in the acquisitions market once their funds reach the anticipated potential. Sovereign wealth funds already represent a larger class of investors than hedge funds, with assets totaling $2.5 trillion in 2007.2 By 2015, Morgan Stanley projects that SWFs will reach $12 trillion collectively. The Abu Dhabi Investment Authority, established in 1976, is currently the largest state-owned fund with $875 billion (see figure 3). By 2009, however, China’s state-owned investment company is expected to overtake it. Given that China alone can dispose of $1.2 trillion in currency reserves, it’s clear that a strategic change in investment activity by SWFs will

Morgan Stanley, Currencies: How Big Could Sovereign Wealth Funds Be by 2015?, 3 May 2007. Merill Lynch estimates the current value of SWFs at $5 trillion, reaching $8 trillion by 2011.


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have a dramatic effect on financial markets. Yet with the rapid increase of their assets, these funds are under growing pressure to invest, which may lead to overpaying for acquisition targets. One roadblock to their continued success is that the investments and political agendas of some SWFs are secretive. Because of this, the Government of Singapore Investment Corporation, Abu Dhabi, Norway and the International Monetary Fund are working on common standards for SWFs to sustain the growth trend and avert a tendency toward financial protectionism among recipient countries.

Developing

Different Motives for M&A

expected to make a giant leap

Private companies in emerging countries also pose a challenge to mature M&A market competitors because of the rapid growth of their activities. Nonetheless, their motives differ from the way M&A is traditionally pursued, so we need to consider the possibility of a new type of competitor in the market. Acquirers in developed countries usually pursue a merger to cut costs and create growth opportunities. The aim is to establish or broaden their presence in high-growth markets, so they are constantly on the lookout for acquisitions with growth prospects. These companies also focus on low-cost environments for manufacturing and sourcing. Well aware of the growing threat from emerging rivals, they want to strengthen their competitive positions. In contrast, acquirers from developing countries focus on gaining access to production and new technology. These firms are also entering established markets to maximize the advantages

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of their low-cost structure against traditional competitors. This strategy pushes expansion plans by broadening the customer base and increasing market share in developed countries. It relies on a new, more educated class of executives driven to expand the scope of their business activities. Consider the motives behind Tata Motors’s pursuit of the traditional but recently suffering British brands Jaguar and Land Rover. So far,

countries

are

forward in the mergers and acquisitions market once their sovereign wealth funds reach the anticipated potential.

Tata has produced only simple, cheap compact cars, and it is now trying to expand into Western markets. Acquiring the Jaguar and Land Rover brands offers Tata access to production technology and distribution channels. It also changes the perceived quality of Tata products in the established world. While this brand-buying may well result in a positive spillover for the Tata brand, it could also harm the established brands as the spillover effect works both ways. Their motives may differ, but acquirers from both developed and developing countries


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Figure 4 Firms from both developed and developing countries target the same industries*

Industries targeted by developed and developing countries

Industries targeted by companies in developing countries 8%

9%

9% 13%

12%

34%

8%

14% 9%

4%

8%

8%

7% 5% 6%

8%

5%

2%

15% 9%

12%

4%

7%

Financial institutions

Communications and media

Process industry

Real estate and construction

Consuner and retail

Mining

High tech and electronics

Automotive


are targeting many of the same industries. The majority of deals (51 percent) are in mining, consumer and retail, financial institutions, real estate, communications and process industries (see figure 4). Not surprisingly, these targeted industries exhibit strong rates of growth, with mining (41 percent) and real estate and construction (40 percent) at the forefront. Companies from developing countries typically promise to make significant capital investments to grow the business. Their goal is to best competitive bids from mature companies that focus on cost cutting as a route to profitability. This approach usually offers a more attractive value proposition for the management team of the targeted firm.

Spectacular Majority Acquisitions by Developing Countries 6

12%

34%

37%

3%

Industries targeted by companies in developed countries

Other

*Percentages from 2002-2007

Acquirers from developing countries are pursuing spectacular majority acquisitions. For example, petrochemical giant Saudi Basic Industries Corporation (SABIC) recently acquired GE Plastics for $12 billion. This transaction gave SABIC, already in the top 10 of petrochemical companies globally, strategic access to markets in the United States and Europe and improved competitiveness. Dubai Ports World invested about $9 billion to acquire the companies CSX and P&O in the past two years and is now one of the top three leaders in international marine terminal operations. The strategic acquisition of CSX in 2005 gave the company a strong presence in Asia and operations around the world. P&O, acquired in March 2006, expanded Dubai Ports World’s portfolio of terminals and added P&O Ferries, P&O


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Estates and P&O Maritime Services to the group. Both acquisitions established a strong basis for future development and expanded the company’s network across key markets. India, the Czech Republic, Indonesia and Russia have all stepped up the pace and size of their acquisitions over the past five years, as evidenced by their above-average M&A growth rates. Acquisitions in India, for example, grew by 49 percent annually, followed by the Czech Republic and Indonesia (both at 38 percent) and Russia (37 percent). This trend could be bolstered by the fact that stock markets in high-growth emerging countries have significantly higher price-to-earnings ratios than those in mature markets. Thus, allstock transactions might enhance emerging companies’ opportunities for deal making. Russian companies are also anxious to strengthen their foothold in established markets. For example, the steel company Severstal initially made an unsuccessful “white knight” bid to circumvent Arcelor’s takeover by Indian-based Mittal, one of the world’s biggest steel companies. Instead, Severstal was able to expand internationally by buying U.S.-based Rouge Steel in 2004 and making a 62 percent investment in the Italian firm Lucchini in 2005. (That investment rose to 80 percent in 2007.) Severstal wanted to diversify its business further and focus on higher-value customers and products. By signing the deal, Severstal, the fourteenthlargest steelmaker in the world, gained access to the European market and acquired technology and know-how in higher value-added prodA.T. Kearney

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ucts while bypassing import quotas. Lucchini, the twelfth-largest, regained balance sheet strength and returned to profitability. The key success factors were improved investment decisions and shared technologies. Acquisitions by companies from developing countries have shifted the balance of power

As emerging firms acquire state-of-the-art products and technology, they are diminishing established companies’ advantages in innovation and threatening their global market superiority.

between developing and developed nations. Fortune magazine’s prestigious list of top companies, the Fortune Global 500, reveals that since 2003 emerging firms have been superseding companies from established countries at an annual rate of 27 percent (see figure 5 on page 8). Huge deals are nevertheless not one-way events. Transactions by developed countries into emerging markets still represent the majority of deals, as evidenced by transactions such as Vodafone’s purchase of Hutchinson Essar in India or Lafarge’s acquisition of Orascom Cement in Egypt. Lafarge,


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Figure 5 Emerging firms are superseding companies from established countries

Fortune Global 500

480

481

Emerging firms

474

470

Established firms

460

451

CAGR = 27% 20 2002

19 2003

26

30

40

49

2004

2005

2006

2007

4%

4%

5%

6%

9%

11%

Percent of emerging firms in Fortune Global 500

Top 15 companies from emerging countries in 2007 Company name

Country of origin

Sinopec

China

17

132

4

China National Petroleum

China

24

111

13

State Grid

China

29

107

2

Pemex

Mexico

34

97

4

Gazprom

Russia

52

81

20

Petrobras

Brazil

65

72

13

Lukoil

Russia

110

55

7

Petronas

Malaysia

121

51

13

Indian Oil

India

135

45

2

Industrial and Commercial Bank of China

China

170

37

6

China Mobile Communications

China

180

36

6

Koç Holding

Turkey

190

34

0.4

China Life Insurance

China

192

34

0.2

PTT

Thailand

207

32

3

Bank of China

China

215

31

5

Sources: Fortune magazine; A.T. Kearney analysis

a French cement maker, paid $14.8 billion for Orascom Cement to enhance its presence in an emerging market and leverage economies of scale to cut costs and increase revenues.

Managing Competition: A Fight-Back Strategy for Established Companies The rapid consolidation between developed and developing worlds will put pressure on margins for companies on both sides of the divide. As companies from the developed world enter emerging markets, they are increasingly able to lower their factor costs—historically the key competitive advantage of emerging companies. 8

Revenues Profit Rank ($ billions)* ($ billions)*

*Figures rounded

Similarly, as emerging firms acquire stateof-the-art products and technology, they are diminishing established companies’ advantages in innovation. Indeed, established firms need to make use of their global market superiority while they still have time. With this in mind, we identified the following levers that established companies can pull (concurrently) to remain competitive. Maintain the innovation advantage. Core strengths such as technological leadership and superior quality must be maintained despite the challenges posed by emerging competitors. Companies can preserve these advantages by


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Figure 6 Key success factors for M&A performance in China

Target selection and due diligence • Evaluate the level of information realistically available and plan for extra effort to bridge information gaps • Assess ownership of assets, scope and validity of licenses, supply contracts and previous compliance with tax regulations • Manage authorities and utilize local resources leveraging relationships

Closing • Hedge information asymmetry by signing earn-out agreements (for example, pay lower initial price with additional payments after two years if key assumptions hold true) • Understand and anticipate Chinese regulations • Demonstrate sincerity and build relationships with target company and regulators

Integration • Identify key employees and tailor an effective retention plan • Inject expatriates sparingly; however, bring key functions (such as CFO) under control and up to Western standards rapidly • Develop a strategy to protect intellectual property rights (even in case of a full merger)

• Don‘t overpay Source: A.T. Kearney

launching new innovations targeted to meet specific market requirements within mature and emerging economies. For established firms, this means expanding the scope of their activities to assure that existing intellectual property rights (IPRs) include features such as proprietary solutions, pricing models and product upgrades. For example, we recently helped a manufacturer of specialty materials define the strategies needed to protect its business IPRs. This company was torn between ignoring the opportunities of the Chinese market and risking an IPR nightmare by moving all of its global manufacturing to China. Instead, we helped it create a strategy to discourage imitations so that it could move select manufacturing to China while still limiting its exposure to risk. By raising barriers across its entire supply chain—including tracking device technologies such as radio frequency identification (RFID)— the company distinguished its products from imi-

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tations in the market. It also alerted buyers to the potential downsides of counterfeit products by raising obstacles such as legal actions that could be taken against customers and end-users. Move quickly into emerging markets. While most M&A still takes place within developing or developed countries, the rate of M&A activity between developing and developed countries is growing by 19 percent per year. Consequently, established leaders should move quickly and more broadly into emerging markets to curb up-andcoming competitors. This can be achieved either by acquiring emerging firms or teaming up with other incumbents to conquer developing markets jointly. For example, when Vodafone purchased Hutchinson Essar in India last year, it secured its position as a global market leader and gained a foothold in the fastest-growing and second-biggest mobile market in the world. The acquisition was worth $13 billion.


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Expand M&A skill sets. As companies from emerging countries become targets of developed companies in the M&A market, the latter should redesign and expand their existing M&A skills. Transactions involving companies from countries at different stages of economic development pose unique challenges for acquirers, and require specific skills that are not necessarily available, at least not yet. Again, we can use China to illustrate this point. China is the most attractive target for established companies in developing markets, representing 19 percent of all such acquisitions. Acquirers choose China to strengthen their presence in this attractive market and benefit from its low-cost manufacturing environment. However, what Western-style companies soon learn is that conventional M&A wisdom is of limited use in China. There are specific success factors in terms of target selection, due diligence, closing and integration (see figure 6 on page 9).

For example, performing due diligence in China, as in all emerging markets, is often hampered by a lack of available information. There is little transparency in these markets, which means the acquirer must invest more time and money in identifying and assessing potential targets. Acquirers should consider making use of various arrangements, including earn-out agreements, to reduce their risk if key assumptions don’t hold true after closing.

Turning Potential Threats into Opportunity These success factors can reduce the risk and downside of making transactions in an environment that in many respects is different from the business setting established companies have traditionally enjoyed. To counter the threat of emerging competitors and benefit fully from the opportunities in these markets, leading companies will internalize their capabilities and expand their existing M&A skills.

Authors Juergen Rothenbuecher is a vice president in the Munich office, and can be reached at [email protected]. Joachim von Hoyningen-Huene is a manager in the Munich office, and can be reached at [email protected].

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A.T. Kearney

A.T. Kearney is a global strategic management consulting firm known for helping clients gain lasting results through a unique combination of strategic insight and collaborative working style. The firm was established in 1926 to provide management advice concerning issues on the CEO’s agenda. Today, we serve the largest global clients in all major industries. A.T. Kearney’s offices are located in major business centers in 34 countries.

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