An uncertain future

Author: | Published: 1 Oct 2013
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HSBC’s Asia-Pacific leveraged and acquisition finance head, Lyndon Hsu, explains why the outlook is unclear for regional markets

Lending activity in Asia Pacific reached record levels in the first six months of 2013, with syndicated loans (excluding Japan) totaling $164.5 billion.

This marks a year-on-year increase of 15.5%, and is thanks primarily to a slew of large M&A financings. Indeed, M&A lending made up 18.5% of Asia Pacific's total loan volume in the first half of 2013, putting this year on track to be the region's second biggest for M&A in a decade.

But is such growth sustainable? HSBC's Lyndon Hsu explains what's next for the region.

Earlier this year, there were predictions of a pick-up in Asian leveraged finance, as activity resumed after a subdued 2012. To what extent has this come to fruition?

Asia's M&A debt financing market received a boost in April with the provision of an $8 billion loan to Alibaba Group. The facility was intended to refinance the Chinese e-commerce company's existing debts and raise additional funds. It was comprised of three tranches: a $2.5 billion three-year term loan, a $4 billion five-year term loan and a $1.5 billion three-year revolving credit facility.

That transaction – and particularly the fact that it incorporated nine banks as lead underwriters – made clear the level of goodwill prevailing in this space. It's thanks in part to the intial public offering (IPO) connotations that follow such deals; banks are happy to pursue such transactions on the basis they get to play significant roles in the ensuing IPO outcome.

Certainly in the months surrounding the Alibaba refinancing, we've seen a slew of fairly large deals that would suggest much higher activity this year as compared to the same period in 2012. These include the $6.6 billion acquisition of Thai cash-and-carry wholesaler Siam Makro by Thailand's CP All; the $1.5 billion takeover of Canadian oil and gas company, Nexen, by Chinese state-owned entity (SOE) CNOOC; and the proposed $4.7 billion acquisition of the US's Smithfield Foods by China's Shanghui International.

But activity is not just focused on the headline transactions; in the first half of 2013 there have also been a number of smaller deals further fuelling liquidity in this space. Australia's APA Group's $2 billion unsolicited all-share merger with Envestra is a good example here.

We've also seen a rush of leveraged buyouts this year. Highlight transactions include KKR's April purchase of a controlling stake in Alliance Tire Group, from an affiliate of Warburg Pincus; Baring Private Equity Asia's acquisition of a 14% stake in Lafarge India in June; and the $3.8 billion buyout of China's digital advertiser Focus Media Holding by management and a Carlyle Group-led private equity consortium.

In the last quarter of 2012, it became evident that regional equity markets were starting to recover and Asia's bond markets were beginning to reliquify, with yields being chased down as global interest rates fell to record lows. That created a very attractive environment for issuers to raise funds and high-yield investors to tap new markets.

As we move further into the third quarter of 2013, it will become increasingly difficult to assess how sustainable this rebound is. Asia's high-yield and equity markets are already starting to fall back, although there remains a lot of available liquidity at higher pricing and less attractive terms for those issues wishing to tap the US capital markets. This could worsen as a result of the QE taper out of the US.

We're already seeing evidence of a mini-crisis in emerging markets, with a number of investors pulling out of Asia exposures or Asia-domiciled assets. That may well temper the final deal tally for 2013 and negatively affect the deal pipeline for 2014.

Private equity buyouts, particularly leveraged buyouts, have been popular in the US and Europe, but less so in Asia. Why?

There's certainly been more focus on LBO activity recently, and we are beginning to see sponsors spending more time selectively making controlled or buy-out investments.

That said, other more established markets, such as those in the US, Europe or Australia benefit from one very important factor – homogeneity. For example, take the US: it has a very deep loan market, it has creditor-friendly laws, it has a single currency and everyone respects the rule of law, including the country's government authorities.

Across the Atlantic, LBOs were historically just a feature of the UK sterling market. However, with the advent of the EU and the introduction of its common currency, we began to see more investors extend their geographic mandate from the US, through to the UK and into the EU. That trend remained from 2003 through to the onset of the global financial crisis.

In contrast, Asia is a much more disparate region with a diverse array of markets. They range from the mature or maturing, such as Australia, New Zealand and Hong Kong, through to jurisdictions with codified laws, like Japan and Korea, and emerging markets operating under ancient or locally-adapted colonial laws, such as Indonesia and Malaysia.

Then there's China, which has its own legal framework. India is a highly idiosyncratic market too – it's relatively insular and restricted, but remains attractive to sponsors hopeful its current downtown will create lucrative investment profits when market confidence returns. Southeast Asia is yet another mix of different laws, cultures, languages, currencies and regulatory regimes to control those currencies.

Add to this inconsistency the region's strong preference for family-owned or private enterprises passed through generations, and you have an environment in which there simply aren't enough opportunities in the LBO space to create substantial deal flow. That could change as the next generation of Asia's professionally educated high-net-worth individuals come to inherit these large businesses. Many may not wish to adopt a managerial role, and that could free up more businesses for sponsors and private equity houses.

How has the bond markets' increasing role in the provision of leverage finance affected the market?

We only have to look at deals done from January to July this year to note the bond markets' increasing activity.

"China will continue to anchor Asia’s leveraged loan market"

Deals are primarily being placed in countries that have a demonstrable and codified legal regime in place and are typically better received by US investors.

Indeed, a mixture of US-listed and Chinese domestic corporate issuers and sponsor-backed LBOs have tapped or intend to tap the US term loan B and high-yield markets to secure long-term financing. The decision by Australia's Nine Entertainment to obtain a $700 million term loan B facility earlier this year to refinance debt is a good example here. The deal successfully demonstrated that for the right credit, in the right circumstances, the economics of a high-yield bond or term loan B facility may be worthwhile, notwithstanding the absence of US dollar revenues.

We've seen favourable conditions in Asian markets recently, with QE and the corresponding low interest rate environment prompting issuers to take advantage of improved borrower terms and liquidity.

I'd expect more Chinese deals in the pipeline. For example, the Focus Media LBO is bridged at the moment, but media reports expect it to tap the US capital market. The same can be said for AsiaInfo-Linkage, following the close of its $330 million leveraged buyout loan in August.

To what extent did the Focus Media LBO loan attest to China's potential for leveraged finance?

Focus Media's LBO loan was successful in terms of size, challenges and the response from lenders. But it is important to remember there were several previous similarly successful deals in China's leveraged finance market. For example, Unitas Capital's May 2011 purchase of Netherlands-based hydraulics firm, Hyva Holdings, set a structural standard for future acquisitions in the region. The $723 million acquisition from 3i was the first sponsor-backed acquisition in Asia to be fully-financed by a high-yield bond.

People also forget these deals are structured as holdco offshore loans, hence servicing of debt obligations is reliant upon dividends expatriated from China onshore profits. These are therefore high-risk transactions that rely on approval from China's regulators or government entities for the offshore issuance of dividends. We only have to look back to the acrimonious debt restructuring of Asia Aluminum in 2009 to ascertain the risks associated with these kinds of structure. When these deals go wrong, they go very wrong.

My point is that the pricing on these transactions, whether from the bank or bond market, has been similar to that offered on LBO loans originating from codified-law countries, like Australia, which have onshore OpCo security. There's clearly a risk/return disconnect here.

Which other countries in the region stand out as potential growthmarkets for leveraged financing?

China will continue to anchor Asia's leveraged loan market over the next couple of years. Its size alone means that it has a much higher-volume market than others in the region.

But I wouldn't rule out Australia as a source of activity in the foreseeable future. The election of a majority government will help to restore investor confidence and I expect strong investment to follow, with a lot more leveraged financings as a result.

Hong Kong might offer some opportunities in the wholesale retail and healthcare sectors. India and Japan will offer opportunities as well, depending on the economic climates in those two jurisdictions and sponsors' appetite to buy into their corresponding risk profiles.

Indonesia and Malaysia may be somewhat overvalued presently so there's a market view that activity may fall in those markets accordingly. Singapore will continue to offer up the occasional large transaction, such as ThaiBev's acquisition of Fraser & Neave.

In truth, it's hard to predict. A lot will depend on the impact of QE tapering and China's economic performance, because of the potential knock-on effect on so many countries. The mere threat of that impact recently changed the mentality of emerging market investors, so we might see more jitters ahead as the effects of the tapering come to fruition later this year.

How do you expect use of the US's term loan B and high-yield market to develop in Asia?

So long as the prevailing low interest rate environment continues, and we don't have setbacks with major financial shocks, like the 1997/1998 crisis, or any extraneous factors like the avian flu crisis, I expect those markets to develop and mature. However, I expect that development to occur in a much slower fashion than previously seen. It goes back to one fundamental issue – the need for homogeneity in terms of a regional currency and legal frameworks.

Without that in place, it's harder to create liquidity. Funds will not mandate the region or the geography over and above a far more developed market. Investors need to be able to mark-to-market their investment; they need to see a price on an exchange. However, exchange-traded Asian debt is not commonly available anywhere in Asia.

Until we achieve some level of homogeneity – by, for example, removing investment restrictions, removing exchange controls and introducing more creditor-friendly laws, as seen in Europe and the US – these factors will continue to retard the growth of the Asian financial markets.

How are covenant packages differing between Asia's private company and sponsor-led borrowers?

In the bank market, covenant packages for US loans or high-yield financing tend to conform, in that the transaction's terms and conditions are driven by US counsel and tend to match those on offer elsewhere in the market. The underwriting banks see it as a distribution game as much as a risk game.

In light of that, there's a growing need to properly test these packages in the Asian market, given the markedly different geographies in which these deals are taking place. For example, it's questionable whether applying US terms and conditions to a Chinese transaction is appropriate for the country's investment thesis.

How are international developments affecting Asia's leveraged and acquisition financing markets?

In aggregate, Basel I, II and III have resulted in banks ramping up their capital base. That has created a more expensive lending environment. Combined with QE, and historic crises in the US and EU, it has also helped to significantly bolster the regional bond market.

"Asia is likely to be hit first by a large-scale capital withdrawal"

Of course, banks will always have a role to play, but while the cost of capital remains relatively high, their involvement will be constrained – especially for capital allocations outside of a bank's home region.

Certainly, it is critical that Asia's bond markets stay open in order to satisfy the funding gap that banks can no longer fill. After the widespread retrenchment of western banks post-crisis, we are starting to see some of the French banks reinvest in the region.

Even so, if Asian bond markets were to close down or contract significantly, it would have a notable impact on event-driven transactions, refinancing, and companies' abilities to conduct liability management.

Some non-bank entities, such as ICG and Fortress, are active in the loan market. We are also seeing some increased activity from Australian pension funds, but this is limited typically to investment-grade rated assets or small deals that barely affect LBO volumes. There are not enough debt funds looking to Asia at present in the LBO market.

Are there any other opportunities in terms of structural trends and deal flow that might be of interest to foreign investors looking to do business in the region?

At present, there's a notable uptick in foriegn direct investment with a China nexus. As part of this continuing trend, and given the slightly more austere environment in China, I expect the country's SOEs will begin to refine their approach to offshore purchases. That may well be offset by a more focused investment strategy from China's privately-owned entities. But deal volumes will depend on the liquidity of the market and the related impact of QE tapering in the US. That could well prompt a sharp pull-back from western investors to home markets. In just the same way that a homeowner would sell a holiday home first when times get tough, Asia is likely to be hit first by a large-scale capital withdrawal.

About the contributor

Lyndon Hsu
Head of leveraged and acquisition financing, Asia-Pacific, HSBC
Hong Kong, Hong Kong SAR

Lyndon Hsu joined HSBC in 2010 as leveraged and acquisition finance head for Asia-Pacific.

Based in Hong Kong, he previously spent 14 years with Credit Suisse, as the bank's head of leveraged finance (non-Japan) Asia and prior to that Australia head of leveraged finance.

Hsu has worked for ANZ Banking Group in its institutional banking division.

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