The US and Turkey have had a mixed and sophisticated relationship for the last 150 years. It has never gotten as bad as today. However, there is an important saying for Turkey - you should never be too optimistic or pessimistic about Turkey as things can and do change quite fast. The US has $60 billion worth of direct investments in Turkey, along with an annual $20 billion trade.
Turkey’s financing needs remain sizeable, and Turkey is now facing a more challenging external environment with tightening global liquidity. However, macroeconomic theory does not explain where we are today. Currencies can, and often do, overshoot vehemently.
Turkey’s public debt-to-GDP is currently around 36-37 percent - you have EU countries which with three times that level. Our budget deficit-to-GDP of about 2 percent is an important evidence of discipline, and our current account deficit (CAD)-to-GDP is about 5.7 percent.
Turkey was not exposed to any similar currency attack when the CAD-to-GDP was at near-double digits or when oil prices were above $120. Yet the currency attack happens now? There are so many financially-troubled countries in the world which are in a worse shape than Turkey but currently trade and are rated better. This just does not technically make sense to me.
The Turkish banking sector is solid with no short currency position. The banks actually are long. Yes, private sector companies with FX loans will face difficulty, but this will not morph into something much bigger.
Growth and profitability levels will go down, while inflation will go up. Importer companies and FX-levered companies will have a much more difficult time. There will be asset revaluations all across the board, especially on the real estate side, along with restructurings and even some corporate debt defaults.
But keep in mind that Turkey is the 17th largest economy in the world, and has a clear competitive advantage in certain manufacturing industries. Turkish companies can manufacture products in as small batches as necessary and deliver them abroad in a much shorter time that a low-cost Chinese player can match.
I do not expect this downturn evolve into full-blown country-wide crisis, recession or default. I do not think there is even a remote possibility for run on banks, implementing capital controls or Turkey needing the IMF. However, it is becoming less and less likely that the government will be able to avoid higher interest rates.
2) How do you see the macro picture and M&A evolving in the Gulf?
In answer to the relatively weak economy and challenging geopolitical conditions prevailing in the Gulf Cooperation Council (GCC) over the past few years, there have been serious structural reforms adopted by governments (especially Saudi Arabia and the United Arab Emirates) to control an economic slowdown, increase liberalisation, incentivise foreign direct ownership and diminish oil’s weight on the economy. It is no secret that the M&A, IPO and private equity (PE) markets closely follow economic activity and political stability. So things have had faded in that respect as well.
However, I would not be surprised to see the region’s economic take-off in the next 2-3 years, to be followed by a jump in M&A and IPOs. Such FDI will not only bring in capital but also increased corporate governance standards and global best practices. The newcomers will bring increased competition – for customers, suppliers and qualified talent, and will challenge existing companies even more. But overall, it will be very good for the economy.
3) What are the industries of interest in Turkey to GCC investors and vice versa?
Historically, Turkey has been one of the top investment destinations for Gulf investors with the total value of investments in Turkey reaching nearly $20 billion over the last 15 years, according to the Foreign Investment Agency of Turkey and the number of GCC companies operating in Turkey reaching nearly 2,000. In the past, there was a lot of interest in financial services, real estate, media and retail. Going forward, I expect to see more interest in B2B services, export-oriented industrials and e-commerce. From the Turkish perspective, especially KSA and UAE are interesting. Education, healthcare, food & beverages and logistics have been mentioned to us recently. Take Saudi Arabia, for example. Yes, the economy is not currently doing very well, with disposable income falling and unemployment climbing, but how can you not look at a market (KSA) where more than 50% of the 33 million population is under the age of 25?
4) How do you see international private equity interest evolving in GCC? How will the Abraaj saga impact on the region’s private equity market?
Even before judging the possible adverse long-term impact of the Abraaj saga, I should note that the PE industry in the Gulf was already facing some difficulties - just look at the number of active local PEs in the market (20-25, vis-à-vis 100-plus before 2008).
Firstly, the Gulf has been lacking institutional capital for the last decade. Most of the current $5 billion dry powder is coming from SWFs, family offices and banks.
Secondly, it has been relatively difficult to consummate transactions for many international funds who have shown ambition to do that. It is not enough to identify a high quality potential target. There is sometimes a valuation gap, and even if there isn’t, there are other impediments.
I know for a fact that there is a certain international PE fund working towards signing the same deal for the past three years. The GCC is not an easy market.
5) If we go back to the Abraaj situation, how will this impact the GCC and emerging markets private equity scene?
I do not believe that this will have a marginal adverse impact on the Gulf private equity scene as the LPs (limited partners) investing in local funds have mostly been from the region anyway, and this will remain the modus operandi.
On the emerging market (EM) front, a recent survey showed nearly 50 percent of LPs expect to increase their level of new commitments to emerging markets over the next two years. So there will be no serious marginal adverse impact there in the short- and mid-term.
Having said that, the Abraaj situation is likely to have a long-term impact on how non-EM LPs view and evaluate EM GPs (the general partners who run the funds). These EM GPs/funds - whether from Turkey, China or India - may now all face additional challenges and scrutiny over corporate governance, team composition and credibility.
6) What would be your recommendations for potential asset buyers and sellers looking at the region?
Investors should understand that the GCC may be a longer but more interesting journey. Part of the problem is that there are not so many seasoned investment bankers.
It really depends on the specifics of the situation at hand, but I recommend investors in general should seek controlling equity stakes in companies; resilient founder/management teams who wants to stay with a business; relatively local-but-profitable, high-growth companies with the potential to become regional or international players; and business models which use a cash injection for organic and inorganic growth, as opposed to taking money out.
Sellers should understand that both strategic and financial investors work with a 20-year vision. Financial investors may appear to have a ten-year lifecycle based on their funding commitments, but they have to think of the value to a potential buyer of their assets over the long term.
We often come across successful GCC corporates who are clueless about their strategic options - including M&A - or who have not looked at their direct investment portfolio with a critical eye. So they can just decide to sell one of their companies, but they are not equipped to run the sale process and the target company is not ready to be put on the block.
As a result of this, more than once have I seen an acquirer client quickly losing interest after preliminary discussions.
7) How do you think an investment portfolio should be managed?
I have seen more than once a GCC group hesitate over divesting a business even when it clearly no longer fits its overall strategic portfolio and the group can use the proceeds in much higher-growth investments. Despite state efforts to have economies and the private sector diversify from oil, sticking to the status quo has been the modus operandi for most.
There is a clear link between asset reallocation and value creation. Deciding which businesses to sell and which to keep at the right time can make more difference to a group’s long-term value creation than which new businesses to acquire and add to a portfolio. Hence, GCC shareholders should put their personal bias or ego aside and proactively and systematically evaluate their direct investment portfolios. They should not worry about growth but focus on profitability and return on invested capital.
8) What is the key to success when making or thinking about a potential acquisition?
I am not a fan of passively waiting for ad-hoc opportunities to emerge or going after a single target as a tactical necessity. I cannot stress enough that the worst possible mistake a seller (or a buyer) can make is talking to a single potential suitor (or target). Companies that become more successful at deal-making are those who apply the same focus and consistency to this process year after year, developing a pipeline of potential acquisitions around various scenarios and business plans.
9) What can a potential acquirer do to put themselves in the strongest position?
Few companies consider how they are perceived by targets or how their value proposition as a partner is better. They can unknowingly earn a reputation as opportunistic, tactical, ruthless, or process heavy. Keep in mind that people like to do business with those they like.
Even if you are a multi-billion dollar conglomerate, you can still be perceived well by a much smaller target, depending on how you or your advisors initiate conversations, develop relationships and manage the process. Believe it or not, most of the time, 100 percent sellers of a business care about what will happen to their company, employees and brand post-sale. So tell them. Be transparent, predictable and credible.
10) Let’s put aside M&A for a moment. What are the major risks for GCC companies in an era of liberalisation?
If you look at the GCC, some of the largest family businesses were incorporated half a century ago, with many businesses being built around oil & gas and shipping. In time, although they have grown both in footprint and scale, nearly 90 percent of all private sector businesses still remain family-owned. These companies collectively contribute more than 50 percent of regional GDP.
In the GCC, it seems to me that the most critical factor of success in the past has been political ties and blood relationships, where businesses were practically ‘assigned’ to certain families who have had enjoyed limited competition and inside access to information for decades.
Although most GCC family companies today are being managed by first- or second-generation owners, over the next decade you can expect to see around three-quarters passing over of $1 trillion worth of wealth to the next generation.
Hence, the biggest threat lies with that transition. Family businesses have already been put to the test over the past few years due to economic slowdowns, trade barrier and subsidy removals, and increasing competition, but I expect things to get more intense.
It will not be as easy to continue to manage investments and liquidity as it was in the past as governments push through privatisation, liberalisation and reform agendas further. Family companies will need to cope with increasing foreign direct investment and more competition over the next five years.
(Editing by Gerard Aoun and Michael Fahy)
Any opinions expressed here are the author’s own.
If you would like to participate in the Zawya Markets Weekly Q&A please email firstname.lastname@example.org.
Our Standards: The Thomson Reuters Trust Principles
Disclaimer: This article is provided for informational purposes only. The content does not provide tax, legal or investment advice or opinion regarding the suitability, value or profitability of any particular security, portfolio or investment strategy. Read our full disclaimer policy here.
© ZAWYA 2018