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Western EuropeJune 1 2011

Breakthrough year for Istanbul's international financial centre ambitions

High valuations, rising equity issuance and plentiful financing in a growing variety of formats all point to Istanbul making progress toward its goal of becoming an international financial centre.
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Breakthrough year for Istanbul's international financial centre ambitionsMetin Ar, CEO, Garanti Securities

Metin Ar, the CEO of Garanti Securities, has been busy. The investment banking arm of Garanti Bank, Turkey’s third largest private bank by capital, has historically been the country's number two player in the local equity capital market, and usually handles one or two large initial public offerings (IPOs) per year.

Already in 2011, the bank has been a bookrunner for a $250m IPO for consumer goods wholesaler Bizim Toptan and a smaller float for Bimeks, the first Turkish electronics retailer to list its shares. Real-estate developer Ronesans should follow with a deal for Tl310m ($195.5m) by the end of the first half of 2011 and in the second half Garanti looks set to handle three other offerings, including a float of about $300m for Gama Enerji, the infrastructure joint venture of local conglomerate Gama and US giant General Electric.

“There are also other deals in the pipeline managed by other banks. If all of the transactions around in the market take place, we will certainly have a record year in Turkish capital markets in terms of equity fund-raising,” says Mr Ar.

Little wonder that even some of the smaller players in the local market are looking to expand their investment banking activities. Finansbank CEO Omer Aras says his bank hopes to increase the share of its investment banking arm Finans Yatirim in the group’s overall revenues.

“Our M&A [mergers and acquisitions] and advisory business has started picking up a bit, returns on a risk-adjusted basis are very high quality because this is mostly fees income, but compared with commercial banking, our investment banking activities are still limited. We feel that Finans Yatirim will become more significant in the future,” says Mr Aras.

Buoyant market

High valuations, fuelled by 8.9% economic growth in 2010, go a long way to explain the enthusiasm for equity issuance. Even after a sell-off in the lira and the Istanbul Stock Exchange (ISE) in early 2011, the benchmark ISE 100 was up more than 30% year on year in dollar terms, as of May 2011. Mr Ar says favourable peer group valuation comparisons encourage owners to monetise their assets.

The Turkish government can add to stock market activity with privatisations or secondary public offerings of its stakes in companies that are already listed. Secondary public offerings of the three largest state-owned banks, Halk, Vakif and Ziraat are all slated, along with one for Turkish Airlines. These are likely to await the outcome of parliamentary elections in June 2011, at which the current AK Party government is expected to retain its majority. Bankers also expect the government to keep majority control over these four companies.

Two of the largest private sector IPOs on the cards are also tied to the aviation sector – airline Pegasus and infrastructure firm Limak Yatirim, which operates many of Turkey’s airports. However, stock market jitters over political risk in the Middle East and northern Africa, and eurozone sovereign debt, plus a round of monetary tightening expected later this year, may dampen issuer enthusiasm for these deals unless markets show resilience.

Relative value

The strength of Turkish company valuations is also significant for M&A activity. Attila Penbeci, the CEO of Akbank’s investment banking arm Ak Investment, says private equity firms in the immediate aftermath of the crisis were looking for distressed assets at suitably discounted valuations. “Since Turkey suffered very little financial distress, there was a price expectations gap between buyers and sellers,” he says.

But that has certainly changed over the past year. Interest has been sparked by a highly successful exit for Texas Pacific Group and Actera in early 2011 from their investment in leading Turkish distiller Mey Icki. The sponsors were preparing for an IPO, but trade buyer Diageo stepped in with an offer of $2.1bn that met their target valuation.

Sergun Okur, a former deputy CEO at local brokerage Global Securities, now wears two hats, having started raising a private equity fund for €100m in mid-2010 and founded boutique advisory firm Atlas Corporate Finance in early 2011. When he started looking for private equity investments, he was valuing typical Turkish mid-cap manufacturing firms at 6.5 times earnings before interest, taxes, depreciation and amortisation (EBITDA). By the time he began advising on M&A deals, clients were pushing for valuations of eight times EBITDA and he says he already has so much potential deal flow that Atlas was forced to turn away business after just two months in existence.

Foreign buyers

“Turkish consortia are interested in the energy production and distribution assets that are being privatised by the government, but local trade and private equity buyers tend to think the healthcare market is saturated, and valuations for retail and consumer goods are very high. On the other hand, foreign buyers still like healthcare and retail, mostly trade buyers who feel that they need to be present in Turkey, that it is a vital market to operate in,” says Mr Okur.

But he adds that even foreign buyers are beginning to baulk, with some investment bankers suggesting that Turkish valuations are excessive compared with those in other major emerging European markets such as Russia. This could affect the appetite of Gulf sovereign wealth funds, which have taken a growing interest in Turkey thanks to its geographical proximity but have a global investment mandate to seek relative value.

This has not stopped Time Warner, along with Texas Pacific Group and another private equity giant, KKR, expressing an interest in the television assets of Turkey’s dominant media holding company Dogan. The group sold two daily newspapers in early 2011 for $74m, after being hit with a $2.5bn back-tax claim, but has so far appeared reluctant to sell off its prize broadcasting assets.

KKR already has an office in Turkey, with Carlyle and Apax apparently looking at opening soon. Gulnaz Aricanli, head of Turkey investment banking at Nomura, says there has been an influx of foreign private equity firms hiring whole teams in Turkey, and they want their investment banking partners to have relationships on the ground as well.

“These funds have gone well beyond a decision to invest in Turkey, they are looking in detail at which companies to invest in,” says Ms Aricanli.

Two-way traffic

And the M&A traffic is increasingly two-way. With Turkish banks enjoying very high capital and liquidity levels, and credit default swap spreads for Turkey now tighter than those on many peripheral eurozone sovereigns, Turkish companies can finance cross-border acquisitions at competitive rates. 

Mustafa Bagriacik, the head of Turkey investment banking for Deutsche Bank, says Turkish companies do not need to buy overseas to access export markets or improve productivity. Exports, mainly to the EU, already account for about 50% of sales at many Turkish firms aside from domestic-focused consumer goods companies. But it is still possible for Turkish manufacturers to boost profits through acquisitions in western Europe.

“Turkish companies are competing with the rest of the world in the EU, they have low manufacturing costs and quality industrial stock so that their goods comply with EU standards. But what they lack is branding outside Turkey. Many branded goods in Europe are actually produced here, but someone else puts their name on it and sells it at a significant premium. Turkish corporates have now accumulated the sophistication and the capital to buy brands in Europe, to enhance their margin,” says Mr Bagriacik.

He adds that Turkish companies are providing some of the only up-to-date industrial stock for producing building materials in areas such as Russia, central Asia, Syria and Iraq. Turkish contractors are increasing market share in the construction business in these regions.

IFC ambitions

If Turkish companies have the confidence and the capital to step out on the world stage, this is a promising sign for the government’s stated ambition of making Istanbul an international financial centre (IFC). There are some bold numbers being discussed. The Turkish State Planning Office estimates that an IFC in Istanbul could add 8% to the country's GDP by 2025, increasing output by $20bn.

Ziya Akkurt, who heads the IFC committee of the Turkish Banks Association, says Istanbul needs to learn from China in setting a clear timetable for the establishment of its IFC. This will then create the momentum to make the necessary regulatory arrangements.

“The government can act as a regulatory facilitator and coordinating body, but we must not leave everything to the authorities, the private sector must also participate, because we will benefit from this initiative,” says Mr Akkurt.

Caglan Mursaloglu, the deputy CEO of Is Investment, and a member of the Turkish-American Business Council, says that while the importance of Istanbul as a regional financial centre is growing all the time, the aim is not to compete with London or New York, but to provide a link between Europe and Asia. It has a traditional role as a trading centre since the creation of the first great bazaars about 500 years ago.

“If you fly from London or Frankfurt to Hong Kong or Singapore, the only financial centres inbetween the European and Asian time zones that might compete with Istanbul are Moscow and Dubai. Istanbul lies right in the centre of a geographic region that has 40% of the world population and 50% of the world’s income within a three-hour flight time,” she says.

Pension reform needed

The retail brokerage industry is relatively developed – Isbank even allows customers to buy shares through its 'Bankamatic' ATM machines. Almost all the global investment banks are already present in Istanbul, together with about 100 local players. Ms Mursaloglu believes the next step is to persuade the global asset management industry to follow suit, and begin basing regional offices in Istanbul.

“If these companies believe the Middle East or the CIS [Commonwealth of Independent States] are attractive markets in which to invest, we need to encourage them to run their operations from Istanbul as the crossroads between the two,” she says.

First of all, however, Mr Bagriacik says the government needs to think about the domestic asset management industry. Turkey has not yet embarked on creating the kind of private pension system undertaken in Poland in the late 1990s or Kazakhstan in the past decade, and local insurers have a small capital base.

“We even see Polish pension funds participating in Turkish IPOs. But in Turkey, the lack of a significant professional money management industry is limiting the growth of capital markets, and the issuance from Turkey is much lower than from Poland, Russia, South Africa or Brazil. Foreign funds own up to 70% of the ISE, which means Turkish capital markets are very exposed to any challenges that global players may face in other parts of the world,” says Mr Bagriacik.

Liquidity on the ISE was good enough to encourage catering company Do&Co, which had listed 19% of its stock in Vienna, to undertake an additional 30% float in Istanbul, the first foreign company to dual-list on the ISE. However, bankers note this is something of a special case: one of the company’s largest founding shareholders is Turkish, and it has a contract with Turkish Airlines.

Istanbul Stock Exchange ISE -100 Index

Debt markets catch up

Turkey's government has begun to address some of the legal impediments to capital markets growth. A commercial code planned for 2012 looks set to create the legal basis to prevent minority squeeze-outs in takeover situations and facilitate the issuance of new instruments, such as treasury stock (which is gradually bought back by the issuer instead of paying dividends) and convertible bonds.

The authorities are also beginning to tackle the constraints created by withholding tax levied on Turkish Eurobond issuance. The tax has been cut from 15% to 10%, and tapers down to zero on longer-term issuance, to encourage banks and companies to establish a long maturity profile on their debt. Debt capital markets have historically been the poor relation in Turkey, not only because of taxation, but also because government debt crowded out private issuers, and local banks had plentiful liquidity for corporate lending.

“At the peak of the market, 60% to 70% of Eurobond issuance from Russia was private sector, compared to only 0% to 10% in Turkey,” says Muge Eksi, head of Turkish capital markets for UniCredit.

That is starting to change. Low interest rates mean that investors seeking yield are looking beyond government securities, creating greater appetite for private sector debt. Turkish banks themselves are leading the way, says Gaurav Arora, who is responsible for Turkey debt capital markets at BNP Paribas. The banks are diversifying their funding sources to finance Turkey’s growing infrastructure investment needs and as such are moving away from the traditional deposit base that remains relatively short-term, and the advent ofBasel III could stimulate the market further.

“The Turkish market has traditionally been driven by relationship lending, but the Basel III liquidity coverage requirements are likely to put pressure on international banks’ balance sheets and lending capabilities. We are already seeing a number of Turkish issuers filing with the Capital Markets Board and talking to ratings agencies to access the debt capital markets,” says Mr Arora.

Turkey’s prudent bank regulators have over the past year given the go-ahead for local lira bond issuance, while recent changes to the tax legislation have paved the way for direct Eurobond issuance. The four largest private banks have either tapped both markets, or are preparing to do so. Ms Eksi says the banks are likely to focus their fund-raising on lira-denominated paper, tapping the Eurobond market only when the pricing suits them.

DPR securitisation

Prior to the crisis, Turkey was also the largest emerging market issuer of diversified payment rights (DPR) securitisations, in which banks securitised future receivables flows from their portfolios. However, only the major multilateral lenders remain active as investors in that market.

“There have been no downgrades among the Turkish DPR securitisations, and one Yapi Kredi Bank deal that had been monoline-wrapped was even exchanged for an unwrapped issue. So there is confidence in Turkish assets, but the structured finance investor base is still resolving its own problems,” says Ms Eksi.

Covered bonds may step up to fill the gap. Four years after the government passed enabling legislation, UniCredit is managing the first Turkish covered bond deal in 2011. Sekerbank will issue a medium sized covered bond backed by a pool of SME loans, even though the original legislation had envisaged that banks would use mortgage assets. Although development banks are set to be anchor investors, one tranche is to be sold to private investors. 

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