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LBO firms’ $33 bn spending sustains emerging markets rally

LBO firms’ $33 bn spending sustains emerging markets rally
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First Published: Wed, May 16 2007. 12 25 PM IST
Updated: Wed, May 16 2007. 12 25 PM IST
By Alexander Ragir, Bloomberg
New York: As if emerging-market stocks needed another boost: Buyouts and takeover speculation are pushing up shares from Taiwan to South Africa.
Private-equity investors are looking to spend the record $33 billion (Rs13,479 crore) they raised last year to buy companies in the developing world. Johannesburg-based Edgars Consolidated Stores Ltd. and Advanced Semiconductor Engineering of Kaohsiung, Taiwan, are among companies whose shares have soared after takeover bids. Potential targets range from South Korea’s Daeduck Electronics Co. Ltd. to Egyptian International Pharmaceutical Industries Co., according to Morgan Stanley.
“The conditions are ripe,” said Greg Lesko, head of equity at Deltec Asset Management in New York. “Valuations are cheap, cash flows are strong and debt levels are low. It’s a very good recipe for private equity.” His $900 million hedge fund owned stock in Edgars when it climbed 11% on 8 February on a takeover bid by Bain Capital LLC of the US.
Private equity funds increased the amount raised for emerging market investment 10-fold over the past four years, according to the Emerging Markets Private Equity Association. That war chest will help boost share prices for two reasons, according to Lesko: Firms will make takeover bids, and potential targets will distribute cash to shareholders in the form of increased dividends to deter buyers.
A pickup in deals may help extend the four-year rally in emerging markets. Morgan Stanley Capital International’s Emerging Markets Index has risen 8.7 percent this year, after surging an average of 36 percent annually from 2003 to 2006. Emerging markets are beating developed markets this year for the seventh straight year, MSCI indexes show.
Debt Loads
Buyout firms are lured by the low debt levels and profitability of emerging markets companies, said Vinicius Silva, Morgan Stanley’s New York-based emerging market strategist who helped compile a report on potential buyout targets.
Buyers typically load up the target companies with debt to pay for the acquisitions. They can then boost profitability by cutting costs or increasing revenue, ensuring that there are enough earnings to pay off the debt.
Regulators approved Bain Capital’s $3.5 billion leveraged buyout, the biggest ever in South Africa, of Edgars last month. Shares of South African retailers Foschini Ltd., Ellerine Holdings Ltd. and Truworths International Ltd., all potential buyout targets according to Merrill Lynch & Co., have gained 14% or more since the bid for Edgars was announced.
Gone Fishing
Investors interest in Asian semiconductor companies perked up after Washington-based Carlyle Group’s $5.7 billion bid in November for Advanced Semiconductor, which tests and packages chips. Shares of other Taiwanese chip-related companies, including Siliconware Precision Industries Co. and United Microelectronics Corp., jumped.
Billionaire Warren Buffett, whose Berkshire Hathaway Inc. has about $46 billion in cash and bought its first non-US company in Israel last year, is becoming more comfortable investing internationally, he said at a 6 May news conference in Omaha, Nebraska. He said he’s considering a purchase in South Africa.
“If we can bring in a fish, and preferably a whale, in South Africa, we would love to do it,” Buffett said in response to a question from a South African journalist. He said he’s looking for acquisitions of $40 billion to $60 billion.
Beating the Index
The 20 largest emerging-markets companies that Morgan Stanley picked as likely private equity targets outperformed the MSCI Emerging Markets Index since 15 February. The investment firm’s list included South Korean steelmaker Posco, Thailand’s PTT Chemical Pcl, Taiwanese chipmaker Nanya Technology Corp., and Polish oil refiner PKN Orlen SA.
Price-earnings ratios of those companies are lower than the average on the MSCI Emerging Markets benchmark. Posco trades at 10 times earnings for the past year, PTT is at 6.8, Nanya Technology at 6.1 and PKN at 10. The MSCI index has a PE of 15.1.
Debt as proportion of equity for the MSCI emerging markets index, excluding financial shares, fell to a record low of 35% in 2005, the latest figures available, according to Morgan Stanley. That’s half the level of debt to equity in the MSCI World Index of developed market shares, excluding financial stocks, according to Morgan Stanley.
Oaktree’s Bid
Buyout firm Oaktree Capital Management said on 9 May that it plans to buy Fu Sheng Industrial, a Taiwanese maker of golf-club heads. Fu Sheng shares surged by 6.9%.
Those kinds of gains don’t always last, said Jesper Madsen, who helps manage $9.1 billion in stocks in the Asia-Pacific region at Matthews International Capital Management in San Francisco.
Carlyle, for example, dropped its bid last month for Advanced Semiconductor, and chip stocks in Taiwan pared their gains.
“It’s always a mixed scenario,” Madsen said in an interview. Regulators in emerging markets probably will block some private equity deals because many companies are perceived as having “strategic importance” for developing nations, Madsen said.
Even so, private equity funds have made a “distinct” move toward emerging markets in the past three years, said Sarah Alexander, president of the Washington-based Emerging Markets Private Equity Association.
Valuation Signal
Asia-dedicated funds garnered $19.4 billion last year. The amount set aside for Latin America, $2.65 billion, doubled from a year earlier, while money for sub-Saharan Africa-dedicated funds, $2.35 billion, almost tripled, according to the association. The funds are mostly buying closely held companies, Alexander said.
Private equity interest is a good indicator that stocks in a particular market may be undervalued, said Audrey Kaplan, who manages $2.3 billion in global stocks at Rochdale Investment Management in New York.
“They have experts on the ground and they won’t invest in a place that is too risky,” said Kaplan. “It’s a good indication of future stock market performance.”
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First Published: Wed, May 16 2007. 12 25 PM IST
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