Emerging Issuers Find Keys to Cheaper Funding
Cantonnet: Cross-border mergers or acquisitions are lowering thecost of capital for corporates
Experts in emerging markets corporate funding gathered at Global Finance’s offices to discuss the state of the markets.
GLOBAL FINANCE:What are the lat-est issuance trends for emerging market companies and how do you expect these to develop?
JORGE CANTONNET, senior man-aging director, Bear Stearns:Asia has be-come an increasingly important compo-nent of issuance in the international capital markets. Last year, for the first time,Asia surpassed Latin America.As of the first half of 2004 about $26 billion was issued out of Asia—33% of the total issuance.That of Latin America was close to $14 billion, only 18%.
ANDREW ZELTER, managing direc-tor,Bank of New York: Over the last four years the volume related to Asia has been quite dominant as it relates to the ADR market. It represents almost 75% of the number of transactions from emerging markets, including Latin America and EEMEA.
JOYCE CHANG, managing director, global head of FX emerging markets and commodities research, JPMorgan: In the debt market, Russian corporate bond is-suances—a trend that began last year— remains one that will be firm in 2005. We’ve seen about $9 billion in Russian corporate issuance, primarily in higher quality telcos and other industrial issuers and private sector banks. In the emerging markets debt markets all the sovereign spreads have compressed. Investors look increasingly for opportunities in corpo-rate debt. In all regions that has outper-formed the sovereign issuers this year.
CHRISTOPHER WOOD, principal, debt capital markets, Banc of America Securities: We continue to see the story of the haves and have-nots. With the haves—countries such as Mexico— we’ve seen a big trend this year towards diversifying their investor base and, both the sovereign and the blue chip corpo-rate wanting to do more in the local cap-ital markets and less in the global debt capital markets. We have not seen in-vestors concerned about the Middle East yet,but it could become a growing prob-lem and it would seem to be practical to invest more resources into our Latin American partners to hedge that risk.
Zelter: Getting stronger name
recognition helps issuers tap the
markets more effectively
SEBASTIAN CHATEL, executive di-rector, equity capital markets, UBS: For the past 18 months there has been a lot of appetite for emerging market equities. We had very good performance for Latin America equities in the secondary mar-ket last year and as a result of that this year you’ve seen for the first time since ’97 the reemergence of Latin American IPOs.That market will be propelled one, by past performance, and two, the fact that a lot of money is going into emerg-ing market equity funds.You’re seeing a lot more interest domestically as well.
GF: Emerging market companies are of-ten at a competitive disadvantage because they have higher cost of capital.What can these companies do about this?
CANTONNET: One solution is to ac-quire assets outside of the emerging mar-ket.As the company begins to be seen as a credit risk that was diversified globally, their capital structure begins to shift and their capital costs become lower. Cross-border acquisitions or mergers are lower-ing the cost of capital and making cor-porates more competitive in the global marketplace.SUSAN KAUFMAN PURCELL,vice president, Council of the Americas: Some companies are in a very bad neighbor-hood, for example a country where there is a negative attitude toward capitalism. Those companies have to try and impress upon their governments that certain kinds of behavior prevent the whole country being attractive to foreign capital.
CHATEL: Part of the reason for higher cost of equity and lower equity valua-tions was poor or less good corporate governance. In Brazil they’re trying to tackle this and the result is that compa-nies are coming to market at valuations that are a lot closer to developed market valuations.
ZELTER: Getting stronger name recog-nition and better familiarity with their story helps issuers tap the markets more effectively and at a lower cost of capital. PURCELL: There are some companies that figure that their competitive advan-tage is they don’t have corporate gover-nance.
CANTONNET: We’re having discus-sions with clients that are interested in de-listing from the New York Stock Ex-change, for example, and listing in the lo-cal markets because of the additional costs and restrictions from conforming to US standards.
WOOD: I don’t think companies would de-list because of a lack of desire for bet-ter corporate governance, but because of the cost that Sarbanes-Oxley has im-posed on those companies.
Chang:In local markets it’s
possible now to borrow on longer
: Given the strength of emerg-ing markets this year and the improving sentiment, it’s actually been much cheap-er for many corporates in the debt mar-kets to come to market in the local mar-kets or in syndicated loans rather than in the traditional bond markets.The combi-nation of the increased costs for corpo-rate governance and the fact that it’s ac-tually not saving them very much meant many corporates chose the local markets instead of international markets to issue.CANTONNET
: Local issuance will continue to be a trend and will lead to a lower cost of capital because you’re elim-inating a lot of the currency risk.
GF: The development of local capital markets has long been a goal for many emerging markets.What signs of progress are there on this front?
CANTONNET: There is apparently $500 billion held in each of Latin Amer-ica and Asia among pension funds, insur-ers,and banks that is available for issuance in local currency.This could be tapped by corporates but they are not fully taking advantage of this.
CHATEL: Chile has a well developed local pension fund system and there’s huge amounts of ability to soak up new issuance so Chilean companies don’t need to go to the international market.More recently in Mexico there has been hardly any corporate US dollar issuance because there is a good local alternative in local pesos so you don’t have the cur-rency mismatch. Brazil could be a success story, too, but local rates are so high still that it’s very difficult to find attractive lo-cal debt financing.
CHANG: In Asia we’re seeing a broaden-ing of the investor base to include insur-ance companies, pension funds and fund managers. Regulations have been passed in favor of domestic investors’ involve-ment in the markets.In 2003 regulators in Korea and Taiwan relaxed some of the in-vestment restrictions. Malaysia relaxed the reserve requirements for domestic banks for certain types of debt, and in China there is some relaxation as well.
: Does a robust local capital market affect the roles of international banks?
Wood:The costs of complying with Sarbanes-Oxley might prompt some companies to de-list
: Our fees are coming down and the competition’s getting tougher in cross-border deals, partly be-cause the local component of financing is becoming very important. International banks with a local presence can fulfill lo-cal and international financing needs, though, which will drive global banks to provide local service.
WOOD:The development of local mar-kets and the growth of global banks is not good for some of our businesses but it is making capital available to compa-nies that perhaps wouldn’t have had that access before.
PURCELL: I’ve heard many com-plaints, particularly in Argentina, that the global banks that have a local presence are still acting more global than national.
WOOD: Credit standards are still credit standards—just because it’s based locally doesn’t mean it will act differently than it does anywhere else in the world.
CHATEL:Argentina’s a very special case. In other countries, local banks that are now foreign-owned have not significant-ly changed their policies toward their lo-cal clients as a result of the change of ownership.
ZELTER: In many cases the local bank’s product offering increases when it is taken over by a global bank.
CHANG: One trend in local markets is that it’s possible now to borrow on longer maturities.That really has changed the options that local companies have to finance themselves.
Chatel:Poor corporate governance
leads to higher cost of equity and
lower equity valuations
: In Mexico, there’s been fiscal reform and an economic team that is committed to maintaining budget disci-pline and paying down debt. That’s dri-ving down rates.
GF: What’s the outlook for ADR capital raising, particularly for Asian companies?
ZELTER: We’re definitely optimistic about the opportunities for ADR capital raising. Asia is the principle driver of ADR capital raisings in the emerging market category—over the past four or five years it’s represented upwards of 70% of the transaction volume.
CHATEL: As equity markets globally have done better that’s helpful to emerg-ing market equities. Right now if you’re going to raise a significant amount of eq-uity capital, frankly you can’t do it local-ly and most investors still prefer owning ADRs than owning local shares. But as the local markets develop, companies might not feel the need to do ADRs be-cause they have sufficient demand local-ly. Specialist international investors who want to invest can just buy in the local market.
GF: How will rising US interest rates af-fect emerging market economies and bond markets.
CANTONNET:As US interest rates rise, the relative yield advantage that emerg-ing markets companies might have will be eroded. Investors will question the need to invest outside of their known market.
CHANG: The strength of emerging markets growth has been a far bigger dri-ver than even rising rates or higher oil prices. So the question is broader: what does the US recovery look like next year? Will global growth be down? If it is, emerging markets won’t do as well, even though the Fed isn’t moving aggressively.
WOOD:Typically there’s a flight to qual-ity when rates go up, but rates have been so low that we see a number of investors in many asset classes looking for yield. And Latin America,Asia,and EMEA of-fer that yield.We view that the near-term outlook as being quite favorable for emerging markets.
PURCELL: A lot has to do with the price of energy.
CHANG:The question is whether Chi-na can engineer a soft landing. And is Chinese demand for oil going to be as strong as what we’ve seen in this past year?
PURCELL: China has become an ex-tremely important market for Latin American commodity exports. Coun-tries in the region will have a very differ-ent response depending on what happens to China and other large consumers of commodities.
GF: How do executives at emerging markets companies view Sarbanes-Oxley and how will this influence their financ-ing decisions and options?
ZELTER: Compared with developed markets, Sarbanes-Oxley is less of an is-sue—or a reason to stay out of the US capital markets—within the emerging market category.
CHATEL: Most companies that have ADRs already were putting up with the cost and time and effort of being a US registered company.The additional impact of Sarbanes-Oxley is marginal. For a new company that’s thinking about an IPO it might have an impact—but not huge.
ZELTER: Even before Sarbanes-Oxley the act of listing in the US was an expensive, time consuming process.
Purcell:Some companies figure that their competitive advantage is they
don’t have corporate governance
:For big companies the addition-al costs are marginal. For smaller compa-nies the cost is enormous. But perhaps they weren’t ideally suited to listing in the US anyway.
GF: What progress are emerging market companies making with corporate gov-ernance?
ZELTER: They are making great progress. It’s a major theme of how they present themselves to an investment community.The local markets themselves are also making effort to elevate corpo-rate governance standards.
PURCELL:They’re making progress on transparency issues and the issue of inde-pendent directors and independent chairmen.
CHATEL:It’s a mixed bag, but you are seeing much more awareness—and pres-sure from institutional investors on com-panies. If a company wants to raise equi-ty they have to meet certain standards. The fact is it’s gradually happening and over time I think it’s inevitable that cor-porate governance will get better.
CHANG: Companies focus first on things like the cost efficiency, reinvesting in businesses and acquisitions—the cor-porate governance evolves alongside that. There have been improvements but of-ten they are a result of, for example, an acquisition where they’ve had to neces-sarily improve corporate governance.
WOOD: A lot of companies in Latin America are still family-owned and their board members tend to be friends and family. Going forward as the boards be-come more independent we will see higher standards of corporate gover-nance.
GF: What’s the outlook for cross-border M&A in emerging markets?
WOOD:Globally,the fear that existed for the last couple years appears to be dimin-ishing.We’ve got new players coming in-to the scene. You’re beginning to see companies from emerging markets buy-ing a company in developed market.
CHATEL:After all that happened in Asia and then in Argentina and Brazil it be-came very difficult for a US or European company to justify acquisitions in emerging markets. In the past year that’s changed. It’s inevitable that we’ll see more and more activity.
ZELTER:Will it be more corporate-to-corporate or will we see private equity funds investing? CHATEL:A lot of the private equity funds in Latin America had a pretty dis-mal experience and have been unwound. There have been very few success stories. But if equity IPO proves a viable option again as an asset, then I’m sure you’ll see interest again.
GF: How does China impact the fi-nancing of corporates in other emerg-ing markets?
CANTONNET: I believe that China will provide the hard currency flows that its corporates need to service the foreign currency banks.And that should contin-ue to improve the credit risk for the cor-porates that need to govern their coun-try’s credit risk. ZELTER Particularly in markets like Brazil and others that are strongly based on commodities, companies have aggres-sive China strategies.They call for expan-sion and expansion requires financing. That is motivating these companies to look at the capital markets fund their China strategy.
Global Finance publisher, Joseph Giarraputo
: In the current environment there’s ample liquidity so I don’t think China will affect companies’ abilities to finance themselves in the international capital markets. China’s effect will be the same as it’s having on most industries. They can produce at such low prices that they put a lot of pressure on companies. That will force a lot of manufactures to find cheaper sources of capital.
GF: What if China doesn’t have a soft landing?
WOOD:That definitely would have se-vere negative repercussions, but there’s been such pressure on commodities that there may be other parts of the world that see that as an opportunity.
CHANG:We have looked at the poten-tial impact and even under our hard landing scenario the impact was really pretty minimal. China has been a posi-tive force within Asia, with both Chi-nese investments among other Asian countries and the demand from China. The manufacturing companies in Latin America are more at risk as far as how they compete with China. But the effect of a hard landing would probably be more psychological than real.
CANTONNET: We need to think of China not as a country that only re-ceives foreign investment because it’s in-creasingly becoming a provider. It’s also been very intelligent with its invest-ments.They have access to places such as Angola and Nigeria, countries where the US quite frankly cannot do busi-ness. Those investments will help them to grow.
CHANG: One of the fears over China is that there is over-investment in cer-tain regions. It’s difficult to monitor what is going on in the different regions at the federal level.There have been a lot of success stories in China but it is actu-ally quite hard to gauge the transparen-cy of the numbers.