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Markaz Research identifies potential acquisition targets using a proprietary methodology Kuwait Financial Centre “Markaz”, in its recently released research note titled “Banking Sweet Spots” highlights that sustenance of current earnings growth for the GCC companies will be a key question for 2008. GCC companies have been posting record growth in earnings.
However, there comes a tipping point after which growth will have to be bought. This is where the potential of mergers and acquisitions in the region takes a center stage state M.R. Raghu, Head of Research and Amrith Mukkamala, Research Analyst. The report states that the impetus to this nascent but burgeoning industry comes from internal pressure on companies to buy growth as well as keenness of foreign companies to have serious Middle East exposure. M&A the high growth industry Over the past five years, the GCC M&A total deal value has increased to a staggering USD 55 billion from a modest USD 812 million. Robust economic growth has forced companies to purse inorganic growth strategies and may explain this phenomenal growth. The growth has also been aided by opening up of markets thanks to WTO requirements. However, the growth has not been orderly and is in fact extremely erratic. For example, year 2005 recorded a near 1000% growth while year 2006 witnessed a 0% growth. This clearly shows that the industry is highly deal dependent and hence any exercise to forecast the likely size of the industry in the short-term will be rendered fruitless. Despite this growth, the value as a percentage of the global deal value is still a minuscule 1% providing adequate upside. In terms of market capitalization, GCC M&A deal value is at 4%, as against the global average of 7%. Higher liquidity in the system increasing the number of cash financed deals It is interesting to note that nearly 77% of all deals were financed by cash, a trend in line with global average of 74%. This indicates high levels of liquidity in the system and willingness on the part of companies to commit this cash for acquisition purposes. In terms of the value of deals, of the USD 55.7 Bn worth of deals in 2007, USD 43 Bn worth of deals were cash deals. The growth in the proportion of cash deals has increased from 31% in 2003 to 77% in 2007. Among the GCC countries, UAE leads the highest amount of deals closed in cash during 2007 at 74% followed by Saudi Arabia at 31%. In the case of Saudi Arabia, it can be mainly attributed to the USD 11.6 Bn deal between SABIC and GE Plastics. Ex-GCC Focus adopted till now – A shift in geographical focus underway The number of foreign companies acquired by GCC companies had historically formed the majority of the total acquisitions. By foreign companies are those that are domiciled outside the GCC region. UAE has recorded higher than GCC average value of deals in the last three years in acquiring foreign (Ex-GCC) companies. This can be mainly attributed to global expansion by GCC companies. However, in the last two years, the level of foreign acquisition has reduced significantly and has been substituted by an increase in companies targeting acquisitions within the region. It is significant to note that the local acquisitions form the least share implying regulatory and other hurdles to cede control to groups within a country. Increasing diversification – Cross sectoral acquisitions on a rise Companies in GCC were seen pursuing opportunities outside their sectors (defined as cross-sectors) though its share has been declining recently. As of 2007, cross sectoral acquisitions accounted for 24% of all transactions, a level more or less in comparison with China & India (Figure 5). In 2007, UAE led the GCC in closing the highest number of deals across sectors worth USD 8.2 Bn. Of this, more than USD 4 bn worth of deals were closed by Dubai Holding and Dubai World put together. Financial services segment in the limelight Financial Services, especially banking, dominate GCC in terms of market cap and hence dominates the M&A activity in the region. Average deal size for financial services at USD 11 billion is significantly higher than other sectors. The competitive environment within the banking space has intensified, as cross-border barriers are gradually lowered. GCC Monetary Union and WTO requirements will eventually lead to opening of the banking sector. The bigger banks will benefit from the economies of scale, using their larger balance sheets to compete more aggressively, both domestically and regionally. The pressure of competition among the GCC banks is expected to lead to consolidation in the industry. The UAE banking sector is one of the least concentrated in GCC region with 46 commercial banks, 25 of which are foreign. The top bank of UAE, Emirates NBD accounts for 19.2% of total assets, while in other GCC markets the concentration level is much higher at the top banks. The UAE banking sector is already witnessing the consolidation, as indicated by the recent merger between the National Bank of Dubai and Emirates Bank. The deal valued at USD 3.7 Bn is also one of the largest in the banking M&A history in the region. The combined entity is the largest in GCC in terms of total assets, which may lead to competition among other GCC countries to match the size. Process to Identify companies which can attract greater M&A attention –Markaz M&A Potential Score “MMAPS” approach Markaz has in the report unveiled a proprietary quantitative methodology to identify companies which can be potential acquisition targets in the future. The model is based on evaluation of banks on four dimensions - Performance, Valuation, Management policy & Ease of execution. The dimensions are broken down to financial parameters and weighted. (Detailed in the table below) MMAPS Scoring Process & Parameters Parameter Interpretation Weight Return on Equity (%) Higher RoE preferred to lower RoE 22% Return on Assets (%) Higher RoA preferred to lower RoA 22% Normalized Price to Earnings per share Lower P/E preferred to higher P/E 16% Price to Book value per share Lower P/B preferred to higher P/B 16% Dividend payout Higher dividend payout preferred to lower dividend payout 13% Size (as measured by market cap) Lower sized companies preferred to higher sized 6% Free Float Lower free float companies preferred to higher free float as it eases the process of strategic negotiations with few shareholder blocks 6% Source: Markaz Research The results of the model, depict contrasting characteristics of banking scenario within each of the six GCC markets. On the whole 13 banks appear attractive out of a universe of 50 banks, with UAE offering adequate potential. As the model is based on quantitative screening criteria the results of the same are highly dynamic. Attractiveness also includes other qualitative factors that will influence the final decision. While companies that are screened as sweet spots may look attractive from a quantitative point of view, there may be other hurdles including shareholding structure that my inhibit any prospective bidder. ### About Markaz Kuwait Financial Centre 'Markaz', with total assets under management of over KD1.3 billion as of December 31, 2007, was established in 1974 has become one of the leading asset management and investment banking institutions in the Arabian Gulf Region. Markaz was listed on the Kuwait Stock Exchange (KSE) in 1997; and was recently awarded a BBB+ corporate rating by Capital Intelligence Ltd.