A busy summer for TMT

OF ALL sectors this summer, many of the largest and many of the high profile deals have originated from the TMT sector. Most recently, there was the Verizon $130 billion buyout of Vodafone's stake in Verizon Wireless. Total TMT buyouts of this past quarter amounted to $240 billion worldwide. Total M&A deals in this period reached $520 billion worldwide, surpassing many previous quarters. One recent notable M&A transaction is Microsoft's acquisition of Nokia phone business for 5.4 billion euros. 

So after a few uncertain years, it is suffice to say that the era of 'big deals' and corporate confidence are making a return. However, it is worth noting that TMT is a far more innovative and fast paced an industry than say, consumer retail. Given the speed of innovation (think how often the likes of Samsung or HTC or Blackberry release a new product/version of an existing product), strategic moves of M&A or buyouts are the easiest and quickest way to hedge against competition. Innovating organically could be too slow and ergo, useless. Further, I believe that such deals were not snap strategic decisions; in fact, they probably have been contemplated for a while. The time to execute them now is attractive because of a potential rise in interest rates, raising the cost of capital and - related to the previous point - due to the increased pace of innovation and the associated competition. 

After these strategic moves, I believe there could be more coming along. In the Vodafone and Verizon case, this deal could put pressure on competitors such as AT&T to make strategic moves, such as speeding up their plan to tap into the European market.  This transaction has also granted Vodafone with a considerable amount of cash. With this cash, it makes sense for them to enter into acquisitions. Conversely, Vodafone could be targeted themselves.  

Lenovo is looking to acquire in the area of smartphones and tablets. Blackberry is considering their sale. I don't think this would be an unlikely match as their is much synergy between the two. Much of their products are created for business but Blackberry's breakthrough to consumers in recent years coupled with Lenovo as a tech power could send more challenge to Apple/iOS or Android phones than Blackberry or Lenovo doing it alone. On a related note, Lenovo ended their interest for HTC over a year ago, blaming HTC's poor quality products. Nevertheless, Chinese firms, ZTE and Huawei, who are more equipment makers at the moment, could make a bid for HTC especially when HTC's shares are trading exceptionally low compared to two years ago. The question is when? I would say not this year. The HTC One - their flagship model - has been doing well and the company's outlook is not too weak. 

There has also been talk of Microsoft to sell its Xbox business  - now that Ballmer is leaving - as a stand alone one for around $17 billion. Xbox, despite its widespread popularity, actually produces one of the lowest margins and does not help to sell the company's core products. I think Xbox could be a successful entity by itself and there is plenty of room for growth, but only if it can access enough investment for R&D to survive competition. Microsoft's cash pot will no longer be accessible!

Meanwhile in Japan, Yahoo! Japan is also seeking out acquisitions to expand their mobile products for smartphones within Japan. I believe we can expect announcements here shortly; their hiring of former Goldman Sachs M&A VP, Ryu Hirayama, shows Yahoo! is serious.  

I think that one of the most interesting things about the current TMT sector is that it creates opportunities for other sectors. For example, apps have made digital advertising huge and we saw the $35 billion merger of Omnicom and Publicis to form one giant advertising house. 

JH

The next IPOs and M&As

THERE ARE a few companies out there I believe should/could debut on stock exchanges in 2014 or the year after. This post is a short analysis of two of them:

Dropbox (online file storage and sharing; mainly targeted for personal use)

Dropbox works by storing users' data with cloud storage and synchronising files, eradicating the need to carry portable storage devices or storing to your computer. There are now over 200 million users of Dropbox who are mostly individuals rather than enterprises, unlike Dropbox's main competitor, Box. Dropbox nevertheless in the past year has been pushing a version of its storage service for enterprise use, charging a considerable fee. In terms of other monetised/premium services,  individual users can buy more space although not many users have opted for this at the moment. Still, Dropbox have enjoyed strong revenue streams (the figure is a Dropbox secret) and also secured $250m of venture capital recently. Their valuation is around $4 billion  (to grow substantially) and I believe an IPO could help raise a huge amount, most likely to be used for expanding via further acquisition of technologies (also not to mention the acquisition of talent in this process) that are compatible with smartphones and also the technology to store music, sound. The storage of map and app data can be a further area to venture into; either to develop organically or through acquisition.  

So from this latter point, I think such opportunity is also Dropbox's number one challenge affecting valuation and stock performance after an IPO: it is really the ability to innovate storage technology so it copes as new devices, apps and platforms are changed and introduced. Another is the changing scene of cloud storage. When I started using Dropbox a few years ago, there weren't really that many 'well-known' competitors around. Now, there are several: Google, Microsoft and Amazon being the three I can think of at the top of my head. With these places giving space away for free, they could very easily snatch away Dropbox's users and eat into their profit margin. However, there is a lot of scope for growth at Dropbox which hasn't even started. Its clean-cut piece of stand alone technology giving users secure storage, a simple interface and fast software earns everyone's trust. Google and Microsoft for example, have been implicated in privacy breaching. 

Box, valued at $1.2 billion is also poised for an IPO in 2014. 

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Twitter  (microblogging/social media tool, for those unfamiliar with Twitter)

There has been a lot of talk and hype about Twitter's IPO especially in recent days. It has been reported in the financial press that initial talks between Twitter with several investment banks have started. J.P.Morgan, Goldman Sachs, Morgan Stanley, BAML, Credit Suisse and others are vying for a lead role in this prestigious IPO. The social media platform also advertised for a 'Form S-1 preparer with other financial reporting duties' for "when we go public" on Linkedin, although it was later taken down. Reasons for Twitter going public are fairly simple. Twitter is valued at $10 million with its shares valued at around $20 on the private market and increasing in an IPO. Twitter's financial performance ($350 million in revenues in 2012; estimated $500 million in revenues this year; estimated $1 billion next year) and strong user and advertising interest makes it a good time to go public. Future prospects for social media companies like Twitter are good. They can capitalise on digital advertising through its huge user base & user data and channel more links with app developers. I believe that part of the financing raised from the IPO will be spent on a further string of acquisitions, given Twitter's recent track of them. Seeing what happened to Facebook's shares after their IPO, it is no surprise that Twitter is cautious about an IPO. Indeed, there will be a lot of comparisons between the IPOs of these two social media giants. There are a few lessons from the Facebook experience that Twitter can learn from, and hopefully avoid: overvaluation, using a dutch auction and not delaying the IPO too long so that there is no inflation of the market value - ergo a bubble waiting to pop. 

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From the M&A side, I think there are currently a few potential M&As which has the synergy to work well together.

I previously talked about Blackberry's case for a joint venture with Tactus Technology to develop a microfludic keyboard for a touchscreen phone/tablet. (See here). Tactus has the technology while Blackberry already has the credentials to bring such a product to market. Such a radical innovation before anyone else on the mainstream market launches it could just be Blackberry's final life saver before it considers going private. 


TMT aside, in the food sector, I believe Krispy Kreme is a good target for acquisition by a supermarket. The doughnut chain/franchise business had been suffering from a volatile bottom line in a recent years for a number of reasons such as accounting irregularities and aggressive but often unprofitable growth in its USA franchises. Revenues have grown but this has attracted more tax, eating away at profit. Yesterday, Krispy Kreme released their financial results, missing their revenue target and causing their share price to drop 13.3%. 

Krispy Kreme doughnuts are stocked in selected Tesco stores in the UK as well as in Target and Walmart in the USA, but I believe Krispy Kreme could fare better in a supermarket for the increased consumer exposure because at the end of the day, Krispy Kreme is a highly desirable, unique and special brand. One way it has done this is through its designs of doughnuts, the packaging and the fact the chain has managed to keep itself relatively exclusive by having few stores compared to other 'occasion' confectionery and bakery retailers such as Thornton's and Millie's Cookies. 

An acquisition by an international supermarket such as Tesco, Safeway or Kroger could give Krispy Kreme far more consumer exposure through Krispy Kreme doughnuts being sold in more supermarket stores. The theme of making junk food 'healthy' is also an important thing Krispy Kreme cannot ignore. It could be useful to use the cash of a parent company (Safeway for example has considerably more cash than Krispy Kreme) for product development and marketing in this area. 

JH

In the next post: I will be discussing the future of 'Moshi Monsters' and 'Bin Wheevils'

What's next for LVMH?

Louis Vuitton Moet Hennessy (LVMH) has the greatest number of jewels in its treasure chest in that it holds more majority stakes in prestigious luxury  brands - from Marc Jacobs to Givenchy to TAG Heuer and of course Louis Vuitton -  than any of its competitors. 

Its strategy in recent years has been one of rampant acquisition and global expansion where the group has spent more than $10 billion in 27 transactions since the beginning of 2010. Notably, Bulgari, Fendi and Pucci have all joined the LVMH family in the last two years. The group's availability of cash and cash equivalents has certainly come in handy. Its latest 'big brand' acquisition occurred in early July where LVMH acquired a 80% stake in Loro Piana, an Italian cashmere clothing house for 2 billion Euros. For a small relatively unknown family owned business, this price is high. However, LVMH can benefit a lot from Loro Piana. Why? Loro Piana is a fairly unique business focussing only on cashmere clothing - there are not many similar players in the industry. It is also a company in its early stages and thus can accommodate much growth and expansion into the future.  For example, Loro Piana achieved a growth in sales revenues of 13.1% in 2012 to 630 million Euros and no doubt can they repeat a growth rate of around 10% into the next year. Loro Piana can also go more global and expand its leather+cashmere goods products. The fact that 30% of its sales come from Asia and the region's strong demand for the brand no doubt contributed to the attraction of acquisition. Perhaps this analysis is reflected by LVMH's share increase of around 2% at the time the deal was announced. In essence, there is much synergy between LVMH and Lora Piana. 

However, we can expect to see less fashion acquisitions by LVMH in the coming year or so as the business wishes to focus on organic growth, at least in some segments. For example, the group wishes to restructure and revamp its watch and jewellery business and the plan to achieve this by giving Bulgari a make over into the long term. Watches and jewellery are LVMH's lowest revenue and profit generating area, as seen on their half-year report. 

Having said this however, acquisitions and investments by LVMH are likely to increase in the luxury hospitality sector as Arnault seeks to move into high-end hotels and restaurants. Indeed, LVMH has realised that 'luxury goods' isn't just about what the consumer is wearing or possessing but more about an overall luxury experience to suit a lifestyle; from food to place of stay on holiday. It is not so much about a product anymore, but about a produce + service. Last week, LVMH bought the 5* Hotel Saint-Barth Isle de France in the Caribbean for an undisclosed sum, to be operated by LVMH's hotel business area. There are also similar opulent resort/hotel developments in Oman, the Maldives and the French riviera  In 2016, La Samaritaine in Paris, owned by the group since 2001 will be opened as a 5* hotel.  At the end of June, the luxury group purchased a majority stake in Pasticceria Confetteria Cova, a 200 year old high-end storied cafe of Milan. This was the LVMH's first acquisition of a luxury food business and Arnault wishes to replicate Cova's popularity globally, using its heritage as leverage. Again, they have been helped by their deep pool of cash resources in this area. 

LVMH isn't the only nor the first to expand into the full luxury spectrum. For example, Robert Cavalli is buying high-end cafes while Armani and Versace is designing hotels. Such brands' ability to shift into a new business area is what keeps them interesting in the eyes of their wealthy (and frequent) customers (as well as analysts at their desks!). 

The success of the hospitality acquisitions remains to be seen but I think given the brands Arnault has chosen above are fairly unique and niche, along with having the recognisable LVMH as a parent with an already established reputation for the customers, profit margins will be high. 

Acquisitions aside, LVMH's  quarter end results to June which were released on July 26th have been mixed. China is a big market for luxury brands but sales in the country have been underperforming whereby Chinese consumers are now buying overseas -in Macau, Hong Kong, Taiwan, Dubai and Europe - rather than in the mainland as attributed to tourism and weak European currencies. This, along with slowing European sales, however is being offset by demand from South-East Asia in the countries of Malaysia, Vietnam and Indonesia. Asia is the group's biggest revenue generating region - 28% of total revenues came from Asia while the US followed in second place with 23%.  

The good news is that profit margins for Louis Vuttion  - its most prized brand has increased slightly in the first half year. In recent years, profit margins for LV has fallen and operating margin has declined from 44% to 42% between 2011-2012. In line with LVMH, Louis Vuitton sales in China declined although this was compensated by optimistic sales in Japan, US and Europe suggesting that the luxury goods sector is not so down hill anymore in the West. The strategy for Louis Vuitton for the past 10-15 years has been to expand quickly and rapidly across the globe. Consequently, growth increased by 10% but the real danger of this is that such strategy for a luxury brand is not sustainable. Continued rapid expansion makes Louis Vuitton somewhat of an expensive high street retailer rather than unique, boutique and luxurious and special. Everyday, in the city where I live, I see many many Louis Vuitton monogram and canvas bags - some fake and some real. Indeed, Louis Vuttion is rather ubiquitous but regardless of the origins of the bag, this risk has been reflected by Arnault himself who is putting a halt on the opening of new Louis Vuitton stores to maintain the exclusively. 

There are signs of a rebound in the global luxury sector but China, an enormous market for luxury goods and services will certainly have retailers in the country experience a decline in sales as Xi cracks down on luxury gift-giving to battle against corruption and misuse of public funds. For example, Swiss watch imports fell by 24% in Q1 2013 although Burberry still experience soaring sales there.  Any decline within in China could be offset by Chinese tourists visiting regions outside of the country as well as by the stronger sales in Europe and the US. For the former, Chinese tourists are attracted to buy luxury goods in Europe due to the weak currency and Chinese nationals are now account for the biggest global luxury buyer market at 25% (only 0.5% in 1995) with European nationals close behind at 24%. Major luxury retailers in the West have been equipped for this for several years now with the employment of Mandarin speakers and the likes of UnionPay but there is still scope for smaller, more boutique luxury players to follow suit. 

I believe despite the recent slowdown in Asia's luxury market, the raising middle and wealthy class with their demand for status goods - not just in China but especially in South Asia (India, Bangladesh) and South East Asia (Indonesia, Philippines, Vietnam,  Thailand)  - makes Asia the most important region for luxury brands to capitalise on, for now and in the next 5 years or so. At the same time however, ongoing challenges that affect revenues aside from growth and the crackdown in China are the volatile currency market affecting exchange rates/local pricing, rising real estate prices and high import duties/taxes increasing prices by 30%-60%. This latter point nevertheless can be partially offset by tourism/spending in the West. Finally, European high street retailers of Zara and H&M have become hugely popular in Asia over the past 2-3 years. Such brands offer far more affordable fashion pieces which imitate the styles seen on catwalks. 

In Indonesia (and rest of emerging Asia) where it is happening for LVMH, Hermes, Richemont , Kering and others

JH

What's the 'deal' with Chinese internet companies?

THE AMOUNT of M&A activity and the increasing value of deals - fuelled by the money making potential in mobile platforms - in the Chinese internet scene makes the sector a very exciting place at the moment. Analysys International, an internet research firm recently reported that the value of China's mobile internet market will rise to 300 billion Yuan (£30 billion) in 2014. It was only worth 150 billion Yuan in 2012. China's internet users stands at 591 million in June 2013, an increase of 41% compared to three years ago.

M&A wise, I believe there will be continued activity here and especially in the mobile internet sector since mobile internet and applications fields are not fully developed in China. There is much scope for growth, organically or by M&A.

I have chosen a few momentous (planned) deals to blog about.

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In the past day, Qihoo, the second most popular search engine by traffic in China (after the almighty Baidu) has announced it is in early talks with Sohu to buy its search engine Sogou (meaning literally 'search dog'). I believe that the acquisition of Sogou, the third most popular search engine by traffic is a well thought out strategic decision for catching up with Baidu who is and still will be (if the acquisition goes ahead), miles ahead in terms of traffic and revenue. Internet research firms CNZZ and Alexa show that Baidu command roughly 69% of search traffic while Qihoo and Sogou only have 15% and 9% respectively. However, Qihoo has still been a serious competitor to Baidu. Their simple interface is more attractive to inexperienced users and at the same time, delivers a better smartphone/tablet experience. Further, Qihoo have an advantage over Baidu in that it is also a software company. This has enabled Qihoo to incorporate search engine bars into their software to boost traffic. 

Market share is important in the internet sector and the fastest way for Qihoo to increase market share is through M&A. With the Sogou buy, Qihoo will reach more than 20% of market share for search engines and can scale it up. This acquisition will also give the company access to the search technologies of music/MP3, videos, maps, shopping, photos, Sogou's online radio station among other features which are popular among younger internet users (who form the bulk of internet users), directly challenging Baidu's products. Further, Qihoo will reap the technology of Sogou's smart input search method which currently has 195 million users. In general, both brands have similar business models and I think there are strong synergies between Sogou and Qihoo search. Not only will they be a dominant challenger to Baidu from a second position, but they will also be dominant in the browser, internet security, software and Chinese language input markets.

Given that it is early days in talks, numbers are unclear. Sogou is valued between $1.2-$1.4 billion. As Qihoo reported $301 million of cash and cash equivalent at year end in March, any offering is more likely to be equity heavy. And since Sogou is in talks with other parties, Qihoo could potentially lose to bidders who can offer more cash, namely Baidu. However, any acquisition by Baidu could be blocked on antittrust grounds. 

The valuation of Sogou is questionable since it was only worth $237 million one year ago. A valuation of over $1 billion only makes sense if Sogou has dramatically optimised and innovated new products in its search and other software in the past year which admittedly it it has done some of...see here and here. Still, a more prudent estimate should be around $800 million maximum.

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The IPO of Alibaba in possibly this year or early next, will be one of the biggest IPOs globally. Alibaba is currently valued at up to $120 billion and could raise $15-$20 billion in this IPO. Alibaba is the biggest e-commerce firm in China and its platforms are the equivalent of eBay, Amazon, Groupon and PayPal. 

I think this IPO is likely to happen sooner than later. Alibaba achieved a profit margin of 48.4% in Q1 2013  - double than that of Apple's in the same period - boosted by the demand for e-commerce services to link businesses and consumers in China. If Alibaba can demonstrate such strong earnings growth again in Q2 2013, an IPO could be ready by the end of 2013. Other financials are also very attractive. Compared to its US counterpart, Amazon, who is the world's largest online retailer, Amazon only achieved a profit margin of 0.51% in the March quarter while it was 18.1% for eBay. Alibaba's net income in Q1 2013 was $669 million compared to only $220 million in Q1 2012. Further, Alibaba constituted 70% of parcel deliveries in China last year and sales alone on its two main platforms reached 1 trillion Yuan in 2012.  

Alibaba is also an attractive company to hold on any investor's portfolio due to the large growth market it operates in. Alibaba is still in its early days also, who has a more vertical growth curve rather than a flatter one. 

Other details of the IPO remain sketchy. But Credit Suisse is expected to take a leading role given its history of working with Alibaba on past transactions. Goldman Sachs and Morgan Stanley are also expected to play a leading role in this prestigious and highly lucrative deal. 

I believe that one problem Alibaba has however, and which could be reflected in valuations, is that Alibaba does not have a strong position in China's social media/mobile market. It is has been unable to monetise on mobile users thus far unlike other Chinese internet giants of Tencent and Baidu among others who all operate rather strong e-commerce platforms or capabilities. The other challenge is choosing which stock market to float on. With many foreign backers, Alibaba may have to float outside of Hong Kong. 

Overall, internet companies are inherently volatile, as are their valuations. I believe any valuation up to $100-120 billion of Alibaba is fair. High performers in this sector are attractive to fierce competitors and creative destruction (in the Schumperterian spirit) is not uncommon, whereby new technologies uproot even the most established ones. It therefore makes sense for Alibaba to take imminent action for an IPO. 

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A few days ago, Baidu, China's Google, has announced it will acquire 91 wireless from NetDragon Websoft for $1.9 billion to further penetrate the mobile applications market. 91 wireless is a platform that distributes Android applications and connects over 90,000 application developers. Baidu is behind the other giant internet companies, namely Tencent and Sina, in terms of targeting mobile internet. So strategically, this acquisition is the correct one for Baidu. Baidu, as a search engine, is really for desktops but since consumers are devoting more time to mobiles/tablets, Baidu cannot continue to rely on online search for revenues. Baidu really needs this acquisition as location based and real-time applications (for maps, business nearby, SatNav for traffic data) are growing popular and consumers no longer need search to find what they're looking for. Using Baidu on smartphones is not particularity user friendly either.  

This acquisition will allow Baidu to generate more traffic from mobile users. Tencent's WeChat has 400 million mobile users and Alibaba is also starting to make headway in mobile applications by investing in Sina Weibo, AutoNavi among others. It is safe to say that Baidu is falling behind in traffic from smartphones. Unlike Google, it also has few applications for smartphones but this acquisition can help Baidu to boost usage experience in mobile apps and help the company to build a mobile ecosystem faster than developing organically. As well as catching up with Alibaba among others, the 91 Wireless acquisition can also shrug off competition from Qihoo who is the market leader in mobile application distribution. 

Although Tencent is a big player in developing, operating and marketing mobile gaming applications, I believe that Baidu and also Alibaba could look into targeting gaming apps in the near future as these are hugely popular with younger Chinese users, who are willing to pay for add-ons within games. 

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All this got me thinking why Chinese internet companies are hugely successful in China but nowhere else. And why, the likes of Google, Yahoo!, eBay or Amazon are hugely successful everywhere else but not in China. So, what is the deal with these Chinese internet companies? There are several answers to my question:

• A large internet/mobile internet market (due to China's population) has been an underlying factor to all Chinese internet companies' success. 

• The rise, growth and later dominance of the main Chinese companies we know today can be attributed to first mover advantage. The companies were founded in circa 1999, a period of mass internet adoption within China. This not only provided the opportunity to enter the internet content market but internet companies also capitalised by emerging as the first movers. Later entrants fail to be as successful since the first movers capture the benefits of dynamic increasing returns, which cause rise and growth. This is true for Baidu for example, as later entrants, whether indigenous firms or foreign firms who enter the search engine market hold significantly less market share.

• Joseph Schumpeter argued that innovation drives economic growth and an organisation forward. Innovation allowed Chinese internet companies to emerge and achieve first mover status but importantly, innovation facilitated their development of new combinations, leading to rise and growth. Baidu contributed little to the general search engine technology having modelled/imitated itself after Google, but the company innovated China’s first Chinese language search engine. Similarly, Tencent QQ is imitated after Mirabilis’ ICQ but Tencent innovated the first Chinese language instant messenger and also technology to send offline messages and store chat history, rapidly increasing QQ’s popularity. Sina’s main innovation lies in being the first to provide comprehensive news and entertainment and lifestyle portals, allowing Sina to diminish its direct competitor Sohu’s market share. Innovating Chinese language platforms in particular, immediately improves ease of use for Chinese users, leading to customer loyalty, brand recognition, other dynamic increasing returns and in turn, rise and growth. Weak IP laws within China have allowed internet firms to do so without much consequence and then reap the benefits of imitating an already successful model.  Just compare: 

Or:

Spot the similarity: Facebook v RenRen; Baidu v Google v Qihoo

• Chinese internet companies' success within China can also be attributed to possessing an excellent understanding of the Chinese market. Chinese search engines' MP3 downloads and games searches are of interest to young Chinese users and Tencent’s QQ and games allow users to purchase items for customising virtual characters, meeting their entertainment needs. Sina provides region-focussed news, relevant adverts and infotainment channels such as automobile information and luxury goods which appeal to China’s ever-growing middle class. The companies also brand themselves strongly as indigenous Chinese firms, further appealing to users.

• Cooperation with the Chinese government’s censorship regulations enabled the companies to emerge and rise. Cooperation is key; Google’s refusal to censor instigated its exits from China in 2010 and several Google services became blocked, allowing Baidu’s market share to increase from 60% to 75.9%. Following Wikipedia’s block in 2005, Baidu also capitalised by developing a Chinese version of Wikipedia, Baiduknows. Sina used the opportunity to launch Weibo in 2009, after the closure of micro-blog Fanfou due to censorship disputes. Thus, censorship regulations and blocks on the main foreign internet companies from Facebook to Youtube to Google reduces competition, grants indigenous companies who comply opportunities to replicate such foreign websites and space to thrive in the Chinese market. 

• Chinese internet companies have been and will be unable to compete globally, I believe. Chinese internet companies cater only to the Chinese market and their niche models cannot succeed abroad. . Mastering an understanding of international markets can also be difficult if management have little experience of the target country. Further, competing abroad is unlikely as well-established or indigenous firms may already operate in the market; Google, Yahoo!, eBay and Amazon serve many regions outside of China. For example, Baidu, who entered the Japanese market in 2008 holds only 0.2% of the market share; the market is divided between first-movers Google and Yahoo!. Moreover, as Chinese internet companies generally will offer no markedly new products, entering foreign markets will generate little success. Similarly for these same reasons, foreign internet brands cannot be successful in China so easily. However, Baidu and Tencent currently operate small-scale foreign ventures - includes multi-language products and establishing partnerships with foreign counterparts - in emerging markets such as Brazil, India and Vietnam. Expanding into developing markets offers Chinese firms an increased chance of success as they benefit from first mover advantage and will experience little competition . Such companies will continue to expand into emerging markets, as their management have expressed a desire to invest in, or acquire foreign firms. For example, Tencent have invested substantially in FAB and KakaoTalk and Qihoo 360 have partnered with Line. 

JH

Beyond the BRICs: the 'Next 11' and even further beyond

ONE THE eve of my graduation (when I was supposed to be ironing my clothes for it), I opted to attend a talk by Jim O'Neill at my university. You probably have heard of him before, but he is the recently retired Chairman of Goldman Sachs Asset Management and the famous coiner of the BRICs acronym - the 4 emerging market giants of Brazil, Russia, India and China. Entitled ' The Changing World: an overview of dynamic and adapatable capitalism in a world beyond the BRICs', his talk of coure focussed on the BRICs but also shed substantial light on the 'Next 11' or 'N-11' - the 11 countries to watch out for as they make make their ascent towards wealth and full industrialisation, all with the potential of becoming the largest economies of the 21st century and the BRICs of tomorrow. 

These include:

The BRICs of tomorrow?

And notably, the 'MIST' (Mexico, Indonesia, South [Korea] and Turkey) nations make up 73% of the total of the N-11's GDP. 

For people my age and younger, it is all very easy to get excited about the BRICs, MISTs and the N-11 knowing that these nations will have increasing influence on our lives, no matter where we are in the world. The thing about emerging markets is that despite several commonalities, they are all different. The differ in area size, population size, rates of growth, patterns of economic reform, political, economic and legal regimes and styles of government which may pose as a threat or opportunity for investors. For example, you can probably tell from the word cloud that some N-11 members are far more industrialised than others already. 

South Korea aside (being an already highly developed nation), I believe that Nigeria, Philippines, Indonesia, Mexico, Turkey and Vietnam are the best positioned to grow into the largest economies over the next 30 years+. I have chosen a few countries to blog a some quick words about...

Nigeria, being the most populous nation in Africa and the 7th most populous country in the world, still faces huge challenges including poverty, some corruption, poor infrastructure and power supply among its 170 million people. However, for the past 6 years, the country has grown at an average 7%. Its large and young workforce means productivity won't be in short supply, attracting investment from both home and abroad. Sectors within each country grow at different rates and thus offer different opportunities for growth. Sector-wise, I know the food & beverage sector here is very vibrant at the moment and is projected to grow into the coming years, mainly driven by a wealthy middle class ready to consume with increasing disposable income. Energy is the hottest sector there (no pun intended), and still will be in the next coming decades with the oil and gas resources attracting international investments particularly as more state owned power and oil companies are set for privatisation. The banking sector is another industry ready for growth, having undergone extensive regulatory and restructuring.  

Whilst growth and attracting FDI or home investment is likely to be the top of the policy agenda for Nigeria's current and successive governments, I believe that solving the social and infrastructure related challenges faced by the country should certainly receive near equal status as part of the path to growth into an international economic force. 

Philippines, has an educated and young work force which I believe is a blessing given this characteristic cannot be replicated so easily in other countries also competing for investment and growth. Philippines is a strong exporter of electronic products, garments, petroleum products and fruits and they can continue to hold this status in the next coming years. Philippines, only very recently has become a popular destination for foreign investment given that its credit rating was raised to investment grade by Fitch and S&P not so long again. Bullish growth was a cause of this, but also due to President Aquino's rather successful bids to tackle corruption; now, there is a shift towards transparency creating more confidence among foreign investors. 

Corruption is still widespread nevertheless, and if Aquino and success governments can push for more anti-corruption measures and policies for welfare improvement, Philippines will see more investment and growth as investors tap into the work force and into the ever growing middle class. 

Indonesia, is a country I am often guilty of confusing it with the Philippines. These two countries have many commonalities but also a lot of differences. Indonesia is the world's 4th most populous country and has the largest economy in South-East Asia, with a growth rate of 6% per year. There is a thriving banking sector, with many local private equity and investor setting up, with more opportunities for growth in both banking and private equity well into the future.  The country has a large and young work force which creates an excellent source of productivity. Low wages in the country also make Indonesia an attractive destination for manufacturers  The most attractive point about the country is its 'open door' policy towards investment, where it actively welcomes investment and simplifying the legal framework (from the 1980s) to do so. Given that it is a democracy, it is also fairly easy to move money in and out of its borders (in comparison to China, for example). However, unlike the Philippines  the work force is not as educated and thus investors have trouble finding suitable management here. Therefore, should policy makers focus on improving its primary-tertiary education system, possibly modelling it on the Singapore or Filipino systems,  Indonesia could be become a serious magnetic force for attracting global investments. 


Vietnam, is an exciting place I feel as while it is a developing and generally agrarian economy, it is one which is shifting from a centrally planned economy into a more market orientated one. GDP growth is around 5%, and there is a lot of M&A activity and FDI in the country, particularly in manufacturing related sectors as suppliers seek a lower wage market as China and other Asian economies experience wage inflation. I expect Vietnam to be a major exporter of agricultural and food produce. As trade links improve with the rest of the world, the food and beverage industry could be a strong target for investors. Aside from the growth of manufacturing ( food processing, cigarettes, garments chemicals, and electronic consumer goods), I expect the tourism industry to grow as the Vietnam National Administration of Tourism is implementing a large scale diversification of the tourism industry to attract foreign exchange (as well as attracting more tourism). This sector therefore offering investment opportunities for local investors and those from further afield. Like several other N-11 members, Vietnam however faces the challenge of tackling corruption and providing experienced management due to its young population. 


With regard to Bangladesh, the country faces several large challenges that other N-11 countries do not face. Over population is the main issue which contributes to a largely uneducated country with widespread poverty. The tragedy of the garment factory incident and a general lack of regard for industrial safety reminds us that Bangladesh has a lot to do, although some action is slowly being taken. Time will tell if these actions are prolonged.  Out of all the N-11 nations however, Bangladesh has the one of the biggest opportunities to grow. Currently, although investment activity is nascent, there is growing interest in the country due to the large work force and the expanding economy (at more than 6% per annum) coupled with a growing middle class and their ever-growing disposable income. It is only ranked second to China in clothing exports, and will this industry will gain momentum into the future years as manufactures seek to move away from China into lower wage economies such as Bangladesh; it is one of the cheapest places to manufacture. 

There are high hopes of Iran and Pakistan as they are one of the largest producers of natural commodities in the world. Political and foreign policy challenges in both countries however will detract Western investors. Nevertheless, I believe we will see a thawing of relationships between the US/Europe with Iran and Pakistan over the next coming decades; Iran 's new leadership could pave a way for nuclear disarment and building a relationship with the US. As the 'war on terror' ends, Europe and USA could focus on strengthening a business and commercial partnerships with both countries. 

*****

Jim O' Neill's talk also made me think outside of the box a bit. What nations are beyond the BRICs and the N-11 to challenge the G7 of the world then? Will these nations be the emerging nations of the world when I'm spending my days playing bridge and bowling on greens?

This is very difficult to say many countries can potentially fit into this category and as for each country,  a whole host of social, political and economic factors and risks will come into force throughout my lifetime. At present however, to take a few, I believe Mongolia could fit into this category. As can Kazakhstan, Angola, Zambia, Botswana and Iraq. I've created a mind map of my thoughts as this post has been pretty wordy and long already. Take a look (click to enlarge)...

JH

M&A: a quick deal review

THIS POST is a bit different from my previous posts as I comment on and analyse a few recent M&A deals across various sectors that I've found interesting.

• June 11 2013: Google acquires Waze Inc., beating off competition from Facebook but now faces regulatory investigation.

Like a sporty kid who adds yet another trophy to their cabinet, Waze has become the latest high value internet brand to join the Google family. Waze, an Israeli real time traffic data service start-up has been acquired by Google for a cool $1.1 billion (which I think is slightly overvalued if you benchmark to something like Foursquare), beating off rival competition from Facebook. For the non-tech people among us, Waze's is an app that connects and allows its 47 million users to share information whilst on the road to alert other drivers of traffic congestion or road hazards. By doing so, Waze suggests alternative routes. But users need not to actively contribute as Waze picks up road conditions (driver speed, routes, location etc.) and alters i's maps to guide the whole Waze 'community', all in real time. There are also some social media functions on Waze, allowing users to track locations of Facebook friends or other colleagues. All-in-all, it is a GPS navigator, at the frontier of map app technology with extra frills. 

And what's in it for Google? Well, at the basic level, I would say that the acquisition of Waze and therefore its technology can help Google to enhance its already advanced mapping products with real traffic data time data. The acquisition means that Waze's services can be incorporated into Google Maps and perhaps other Google products, which do not currently have real time user traffic data. As well as this, Waze's social media functions can help Google make a stronger mark in this area; combining Google + functions into Waze is a plausible idea. Of course, Google is also an advertising company and Waze provides a huge stage for generating advertising revenues by attracting local businesses to market themselves on the map. Google's long term plans with Waze are unknown but for now, Google has stated that the two will be kept as separate units, amid regulator probing (see below). Given that consumers are increasingly adopting mobile devices and with the rise of 'phablets', location services/applications have become a primary area of focus for Google as well as other tech giants. 

Of course, the acquisition of Waze also gives Google a good wedge of the millions of consumers who already use Waze on iOS. More importantly for Google, the acquisition means that it can block competitors' use of Waze's data. For example, Facebook who is looking to develop its own mobile apps will have to use 3rd party data for any location based apps. To me, the value of this to Google is huge; maps form an integral component of the mobile ecosystem and mobile mapping heavily influences revenue generation by bringing in advertising and other social tools/apps. Google, with its huge cash reserves is playing a clever game by buying and blocking, rather than building upon Waze's technology to create its own real time mapping product. 

Waze's chief executive Noam Bardin noted that the firm explored many options (acquirers including Facebook and Apple) but found Google to be the winning choice. I would say that Google's weapon is likely to be cash, (who have a $50 billion spending power) whereas Facebook was offering stock. Terms of the transaction mean that $1.03 billion will be transferred in cash directly to Waze and its stockholders; an additional $100 million will be awarded to employees based on performance. These figures are something Facebook can probably not afford to afford. I think that Google is also a better fit for the company given that it has a large presence in Israel and therefore would not require Waze to relocate its R&D to California, as Facebook had wanted. 

This deal however is not all sweet for Google. In the last week of June, the US Federal Trade Commission (FTC) confirmed that the acquisition will be investigated to ascertain whether the deal will restrict consumer choice. It follows pressure from consumer groups that the deal should be blocked on antitrust grounds. Consumer Watchdog had raised the concern with the Department of Justice of Google becoming essentially a mapping and data monopoly.  The ruling will be made in due course but a block on the deal will be unlikely I feel since Waze and Google will remain as separate units (at least for now). The market share of Google Maps even merged with Waze is also unlikely to be astronomically high. 

All in all, both parties have got themselves a pretty good deal. Whatever Google's long term plans with Waze are, there is no doubt that into the near future, Google will add real time traffic technology onto its maps.

*****

• June 5 2013, Xerox buys LearnSomething Inc., expanding into health care.

Xerox, a company that is typically known for its photocopying machines, printers, publishing and other related equipment and consulting services, acquired LearnSomething at the beginning of the month for an undisclosed sum. LearnSomething, based in Florida, is an e-learning service provider of industry information, training and educational programs to food, drug and health care industries. I have not heard of LearnSomething previously and was surprised to find that they supply industry information and educational programs to 110,000 retail pharmacists in the US (equivalent to 85% of US retail pharmacists). The Learner Community e-learning platform is used to deliver regulatory compliance courses for food and drug retailers. 

Whilst the terms of the deal weren't disclosed, a few interesting points can still be made. 

Xerox in recent years have been working to restructure and re-brand itself as a customer focused services business providing services such as document management, bill processing and IT outsourcing in the backdrop of decreasing sales of its traditional products of copiers and printers. This deal effectively allows Xerox to build on its mark and broaden its services in the healthcare industry following the purchase of TMS Health in 2010. 

Given that 500 new over-the counter medications and health/beauty products are introduced every year, and with LearnSomething being a leading provider of educational, training and regulatory services, it seems to me that there will be no shortage of business for Xerox in this area. In turn, this will contribute to an easier re-structuring as Xerox turns away from its traditional business into a more lucrative asset-lite business of customer services. 

*****

• June 2013, Billabong troubles rumbles on. 

I am no surfer and have never lived near a surfing community but Billabong and other surfing brands like Quiksilver, Rip Curl and O'Neill managed to merge itself into the mass fashion market when I was a kid. Not only were these brands hugely popular, but they were seen as the coolest, trendiest and the most 'it' thing to have. Bus fashions of course fade and go, as do businesses. The whole Billabong trouble is something I've been following fairly closely over the past few month due to my acquaintance with the brand when I was younger. 

In developments this month, Billabong is now looking to sell its retail units separately after 2 private equity firms and Billabong did not reach an agreement to buy the company outright. The three units to sell are DaKine Hawaii Inc., RVCA, and West49, and this could be a means of raising enough capital to repay the company's $350 million syndicated debt facility. 

Billabong rejected a $903.5 million bid from TPG Capital Management in Feb 2012 but the value of the company has really plummeted: Billabong's shares closed at $0.90 on Jan. 11, when Altamont submitted a $556 million bid. By April, Billabong received a bid of $284 million from Sycamore.  

Hindsight is a wonderful thing but Billabong is not a lost cause. I feel that still at the end of the day, Billabong is a nice brand image for surfers and beachwear. What it needs to do is lower prices and appeal to the mass market once again especially for its beachwear and accessories to reverse its revenue situation since management changes and any strategic restructurings have not turned fortunes around so far. Of course, the flip side of this may be that Billabong will lose appeal to surfers as they wish sport more obscure brands to differentiate themselves from mass culture, enforcing their own sub-culture. However, since nothing else is working, and if Billabong is desperate, clever global marketing campaigns to attract the brand once again to non-surfers is the best path to boost revenue. 

Billabong: not so cool for school anymore 

JH