Maximizing shareholders value through inorganic growth is no longer a theoretical discussion in boardrooms of Saudi corporates. Mergers and acquisitions have become an increasingly important tool deployed by senior management and board members to expand aggressively.
As a result, a healthy M&A deal pipeline is expected in 2013 on the backdrop of rising growth expectations of shareholders, availability of financing, reduced bid-ask spreads, openness to creative deal structuring, as well as cross border targets and a favorable regulatory environment.
This could also be an opportune time to analyze the key trends that are shaping today's Saudi M&A landscape and highlight some important considerations in such transactions.
There has been a gradual institutionalization of the investor base in the Saudi Arabian stock market, led by a significant increase in assets under management (AUM) with the fund managers, the emergence of new institutional investors as well as business families building up in-house investment capabilities.
Following the 2008 stock market decline, sophisticated investors shifted their focus on fundamentals and future outlook of the underlying companies from trend-based trading in stocks.
Mid-sized listed companies with attractive growth prospects and strong fundamentals have attracted these investors. With a regulatory environment that is conducive to minority shareholders' participation in the boards and assemblies, investors are becoming more and more active and vocal in shaping the future of these companies.
Growing beyond the home market
As growth choices become limited within the core business and geography of Saudi companies, decision-makers consistently look for alternatives to domestic organic growth outside their traditional scope. Organic and inorganic expansion within the GCC and wider MENA region come across as a natural choice.
More importantly, acquiring an established platform is the preferred option for regional expansion or product portfolio growth. This has been attributed to the fact that acquisitions significantly reduce time to market entry and offer synergies in the form of cost savings and cross selling opportunities to a new customer base.
The lack of or limited liquidity options has driven down the valuations in most regional economies. That, coupled with readily available cheaper financing, makes most of these deals accretive at inception and fuels cross border M&A activity.
An example of this trend is Almarai, which used joint ventures and acquisitions to fuel its growth engine across the Middle East. In 2010, it partnered with Mead Johnson to enter the baby formula market. A year before that, it acquired Hadco and rebranded its products as AlYoum to jump-start its poultry business.
Also in 2009, the company entered into a venture with PepsiCo to expand its dairy and juice business outside of the core GCC markets by buying out Beyti in Egypt and purchasing a majority stake in Teeba in Jordan.
Shift in market dynamics
Traditionally, Saudi banks have limited or no appetite for acquisition financing. However in recent years, many banks are opening up to provide funding for both onshore and cross border acquisitions.
A recent example was Saudi Printing and Packaging Company's (SPPC) acquisition of Emirates National Plastic Industries (ENPI), wherein Riyadh-based Bank Alinma provided almost half a billion Saudi riyals in acquisition finance.
In a number of transactions including Almarai's landmark acquisition of Hadco, consideration is paid through equity in the form of newly issued shares of the acquirer. The Capital Market Authority (CMA) has played a critical role in encouraging such share swap transactions as it introduced a formal takeover code in 2007 and built a team of professionals dedicated to facilitating M&A transactions.
Going forward, corporates are highly likely to tap into the debt and equity capital markets to finance or refinance acquisitions and diversify their funding sources. In recent years, a number of large corporates (such as Savola, Sipchem and Almarai) have successfully completed sukuk issues at attractive pricing, which encouraged more issuance.
The process for raising equity capital is also expected to be further streamlined this year making it more efficient to use equity as source of financing.
A number of deals in the past could not be concluded as the principals were generally averse to complex transaction structures. As corporate executives gear up for the second, third or fourth transactions, their willingness to use more sophisticated deal structures is evident whether it relates to consideration adjustments to mitigate certain risks or to bridge the valuation gap through earn out mechanisms.
SPPC in its acquisition of ENPI structured the purchase of equity interest of the managing shareholder on a deferred payment mechanism, which is linked to future business performance. This creative deal structure enabled SPPC to offer an attractive valuation that excited the seller while at the same time reduced risks, improved returns and created a buffer to ensure a smooth transition and integration of the acquired entity.
Due diligence and the regulatory framework
As M&A transactions become more complex, the role of advisors and their involvement from an early stage is vital to the success of a transaction. The financial advisor plays a crucial role in coordinating with the management and legal advisor, implementing the deal and overseeing the work of other consultants during the due diligence phase.
In addition to being a critical part of the acquisition process, the due diligence findings can provide the necessary ammunition in price negotiations. Therefore, selecting the right partners that are capable of looking beneath the surface for in-depth understanding of the business and identifying key transaction risks is absolutely critical.
Generally, there are issues related to underestimated working capital provisions, unrecorded or capitalized expenses, outstanding tax and zakat liabilities, non-recurring or non-operating revenues or expenses, deviation from accounting standards and related party transactions.
It is always advisable to assess the quality and reliability of the underlying financial data provided by the management and audited statements, and the buyers should not shy away from conducting a full re-audit or insist on a closing audit for their satisfaction.
The regulatory regime in Saudi Arabia is relatively well defined and straight forward as transactions are generally governed under the M&A regulations, listing rules, companies law and competition law.
The CMA approval is required for any transaction by a listed company, which will significantly alter the underlying business of acquirer. Such transactions also have to be approved by the shareholders, and in case of related party transaction, all parties are to abstain from voting on the transaction.
An important consideration for cross-border transactions is the difference in the foreign ownership laws within the GCC, which in some situations can significantly impact the transaction particularly if one of the shareholders is a non-GCC national. However, it is widely expected that a unified regime on foreign ownership will be in place in the future.
In summary, a strong desire from management as well as a push from shareholders for inorganic growth, a favorable regulatory regime, attractive valuations and readily available financing is expected to fuel the growth of M&A activity in Saudi Arabia in general and regional cross border deals in particular.
Sajid Riaz is currently the managing director in investment banking at Jadwa Investment, a Riyadh-based company that offers investment services for individual and corporate investors.
© Zawya 2013
