Where are the Opportunities Now?

5 May 2011

A bruised and chastened business and financial world is returning with gathering pace to overseas investing. Nigel Ash asks how the opportunities have changed following a period when much of the global economy crashed into recession.

For years there was a one-way barrage of strategic investments from the First World in to developing countries. Now it is the established economies who are becoming used to the cry "Incoming!" as rising industrial powers, most obviously the BRIC countries, deploy growing cash piles for cross-border purchases, in order to enter new markets or secure natural resource supplies. In 2009, for example, the majority of the $50bn overseas investments made by Chinese firms was in natural resources deals.

Technology transfer, though still important especially in IT and perhaps also increasingly in green technology, is no longer the key driver for Indian and Chinese overseas investment. Resources aside, the search now is for brands, market share, income, products and services that can be taken back to their domestic markets.

Globally, McKinsey figures suggest that in 2010 there were in excess of 7,000 deals in which companies bought or merged with each other, the first time that M&A volumes have shown an increase since 2007. Perhaps more significantly, analysts have noted from shareholder reactions to deals that the loss of value which has classically bedevilled much M&A appears to have been reduced.

Many analyses, including that of the United Nations Conference on Trade and Development (Unctad), anticipate that 2011 will see major cross-border M&A flows, with a principal focus being on emerging markets. Unctad puts China, India and Brazil as the three top target destinations, with Russia in fifth position followed by Mexico, Vietnam, Indonesia, Thailand, Poland and Malaysia. The United States, the only developed economy in the list and once the prime investment destination, has slipped to fourth place.

A different world

First World companies emerging fit and hungry from three tough years may feel they are stepping out into a very different world of investment opportunities. Deal-making by emerging market countries currently outpaces that in Europe and North America. A netting out of the cross-border investment flows by McKinsey shows that in 2010 the Asia-Pacific region exported some $46bn in mergers and acquisition deals compared with $9bn from Europe, the Middle East and Africa.

"There are some who think the flow of capital out of India and China is odd in the light of continuing strong economic growth in their domestic markets."

After a slowdown in 2009, the Asia-Pacific region more than doubled its investments into Europe and North America, compared with flows in the opposite direction. A prime example is resource company Reliance Industries, which spent $3bn last year buying stakes in US energy producers and whose boss Mukesh Ambani has said that he wants to spend up to $12bn more on such American deals.

There are some who think the flow of capital out of India and China is odd in the light of the opportunities for returns and continuing strong economic growth in their domestic markets. Odder still since each market is still in subtle ways relatively protected. Thanks to the limitations on foreign investment in both countries, compounded in India's case by a complex and slothful bureaucracy, it remains harder for incoming companies to win contracts, not least for the upgrading of India's substandard infrastructure, or to establish their brands and services in the market. India's Business Process Outsourcing (BPO) sector has for example proved hard for strategic foreign investors to access, even though their clients include some of the world's biggest and most acquisitive multinationals. Perhaps there is a taboo about buying and repatriating business processes you had already outsourced.

General Electric CEO Jeff Immelt has accused India of stifling opportunities for investment in infrastructure and of failing to get on with large and much-needed transport and energy projects. His words echo the surprising warning from none other than India's central bank governor Duvvuri Subbarao that projected double digit growth would not be achieved unless the economy underwent a "quantum step" in investment.

Into Africa

The Indians and Chinese are not confining their purchases to the First World. One of India's biggest overseas deals so far was the $10.7bn acquisition by Bharti Airtel of the African mobile operations of Kuwait's Zain state telecoms company.

Chinese investment is flowing into Africa and Latin America, particularly Brazil and Chile. These moves demonstrate confidence and appear to underscore recourse to a growing body of home-based legal, financial and advisory services. Chinese companies have generally sought to acquire minority stakes and, often, commercial partnerships overseas.

"Chinese investment is flowing into Africa and Latin America, particularly Brazil and Chile. These moves demonstrate confidence."

Among recent high-value examples of minority deals are PetroChina's $5.4bn acquisition of a stake in a Canadian gas field and Sinopec's $4.65bn purchase from Conoco Philips of a 9% share in the Canadian oil sands giant Syncrude.

However, SinoChem would have broken the minority stake mould had it topped Australian miner BHP Billiton's $39bn hostile bid for Canada's PotashCorp, the world's biggest fertiliser maker. But, when the government in Ottawa blocked the Australian bid as being of no national benefit, it was clear that a better Chinese offer was unlikely to succeed either.

That Chinese acquirers still have some lessons to learn is illustrated by Xinmao Science and Technologies' abortive effort to crash an agreed $1.1bn cash and share buy out for Dutch specialist cable maker Drako by Italian competitor Prysmian. The Chinese interloper offered $1bn cash. However, when the European offer was improved, Xinmao was unable to respond within the available timeframe, partly because of domestic regulatory complications requiring multiple authorisations on any improved offer.

Not of course that developed country acquirers always get it right in emerging markets. The UK life assurer Prudential had to ditch a $35.5bn take-over of the Asian assets of US insurer AIG because the price was seen as too rich weighed against a risky ROI. A much-trumpeted bid in what had initially seemed a fire sale caused a shareholder revolt.

Acquisition and expansion tactics

The World Economic Forum in Davos this year agonised over the post-recessionary tip toward Asian financial and business hegemony. There seems a general awareness that the world is changing but few multinationals are yet prepared to call it.

"The climate for acquisitions is good, the climate for mergers is good. Companies are starved for growth and they are looking for opportunities to grow."

For a long-established FMCG multinational like Procter and Gamble a mix of generic and acquired growth may accelerate in developing markets. In the five years to 2009, the US giant has seen revenues from developing countries grow from 23% to 32%. Now fully 60% of the company's revenues are non-US.

P&G avoids hostile takeover bids but nevertheless is very much in the market for acquisitions. CEO Bob McDonald has asserted: "I would love to buy more brands. The climate for acquisitions is good, the climate for mergers is good. Companies are starved for growth and they are looking for opportunities to grow."

Tesco in the UK has equally involved confrontations with reluctant target managements. With the exception of India where the firm is working with a Tata subsidiary and supporting their local branding, the majority of Tesco's overseas investments has come about through clean sheet investment rather than the acquisition of a significant local retailer. With 4,800 stores in 14 countries, overseas sales principally in Asia and Europe are now approaching a full half of group sales. In Asia, Tesco has stores in South Korea, Thailand, China, Malaysia and Japan.

As this February he prepared to leave as Tesco's CEO, Sir Terry Leahy noted: "We have a strong core UK business growing well, our international businesses offer significant upside from recovery in the short term and maturity in the long term. Our performance in Asia was particularly pleasing and our business in Europe held up well, despite the obvious economic challenges." Leahy added that he believed that the start-up losses in its West Coast-focused Fresh and Easy stores would begin to reduce as the brand established itself. His successor Phil Clarke has committed himself to turning around this rare Tesco setback.

The changing outlook is encapsulated by PricewaterhouseCoopers' February report Economic Views Global: "Emerging countries are expected to present the greatest growth opportunities over the next two years, as domestic demand continues to strengthen. In this challeng-ing environment those firms that look further afield for clients and can adapt to the changing needs of customers will be best placed to prosper."