So, you want to buy a bank in an emerging market and create value for your investors? Pause for a moment. The evidence of value creation is firmly against you. Yet, the wins that there have been have been great wins. How do you ensure your deal is one of the winners?
The more deals I work on, the more convinced I become of key common components of success: discipline, insight, thorough due diligence, alignment of interests, strong post-investment planning and execution; and a clear-sighted vision of the business plan.
All the above are simple mantras which are exceptionally hard to implement in practice. The pitfalls are obvious—the bank CEO who wants to crown his career with one last strategic acquisition and lets hubris outweigh value and liquidity considerations; or the buyer who cuts corners on due diligence in the excitement of a bargain. As one of our competitors found in Thailand, U.S. collateralised debt obligation exposure can crop up in the most unlikely markets. And, catching a falling knife to snare a bargain often neutralises the bargain itself. Far better to let the dust settle and pick up the pieces as Farallon did with BCA in Indonesia a decade ago. Attention to detail matters.
So why invest in emerging market banks? As Western markets crashed into systemic crisis, it was striking how many emerging financial services markets rapidly recovered. There are exceptions aplenty, but for the thoughtful investor the outlook is bright. It is no paradox that emerging markets should have proved resilient. They were lower geared, were generally not reliant on wholesale funding, and had simpler, more transparent balance sheets and products. At Actis, we turned that insight to our advantage in the summer of 2009 and made a multi-hundred million dollar investment to become the largest single shareholder in Commercial International Bank (CIB), Egypt’s largest private sector bank.
We were aware that CIB’s share price had virtually halved as international investors withdrew, but we also knew the bank had delivered exceptional growth rates and a return on equity that hovered around 30%. Additionally, the broader Egyptian banking system was in robust health with an economy growing far more strongly than most. We had tracked the bank for three years, building a strong relationship with the chairman, and the regulator. We arranged full due diligence via a team of experienced international bankers who confirmed risk management and liquidity were healthy. CIB had invested very heavily to build a market-leading capability in a fast-growth retail market that is just beginning to build results (and was significantly underestimated by market analysts). We also discovered that Egyptian GAAP (Generally Accepted Accounting Principles) offers hidden value upside for investors, compared with IFRS (International Finance Reporting Standards), because of a very cautious general provisioning policy. We executed quickly. Today, we are working with CIB to consolidate its market leadership position, executing a clearly defined strategic plan agreed upfront.
Through our global footprint we achieve compelling emerging market growth by combining local knowledge from our regional people with wide-ranging industry insight. When buying a bank, we never forget the core questions that any investor must ask:
• Shareholder value discipline—what are your criteria?
• Is the country’s regulatory system good? Are we investing in a healthy industry structure, economy and rational growth market? Is supervision tight?
• Do we understand the business and its balance sheet as well as off balance sheet make-up and market conditions?
• Due diligence—do not cut corners, and do not compromise on your needs – there is always another opportunity out there but you only have one career.
• Understand the risk position and controls, liquidity, the quality and alignment of the team you wish to back, and review the board and committee minutes – these can reveal how well governed a business is.
• Who are you backing? And who are you aligned with—your team or the existing team? (Be clear—many deals fail here). If appropriate, do co-shareholders have common goals?
• Have you a parenting advantage? Are you the logical owner of the business?
• Timing matters – where are you in the credit cycle? It is not a good idea to invest in boom markets. Is market timing on your side?
• Can you see value upside? Find the value—it might be cost/revenues synergies, accelerated growth, release of assets from the balance sheet; or accounting policy arbitrage, be clear which and how much.
• How are we paying? Cash or shares, and what’s the implication of that choice? Have you got sufficient protection from reps and warranties in the shareholder agreement?
• Once you have bought the bank, get control—set a 100-day plan, and if appropriate a full integration plan, bringing in talent as appropriate.
Rising incomes, rising product penetration, and in many cases markets which have barely scratched the surface of their potential—these are attributes that most developed markets cannot match. The satisfaction of helping to build great businesses is powerful whether you are a strategic or a financial investor. It can be done—but never forget the minefields that lurk at every turn.
Mark Richards heads the financial services team at Actis, the pan-emerging markets private equity specialist.