As Asia Pacific managing director at U.S. company IntraLinks, Paul Rafalowski has a ringside view of the region’s mergers and acquisitions deals. His company provides the electronic data ‘clean rooms’ that prospective buyers and sellers use to conduct due diligence and exchange sensitive communications and documents.
So what’s the prognosis for M&A in Asia? “There will definitely be some uptick,” says Rafalowski (pictured). “Both China and Japan are on buying sprees right now, so they’re going to be looking at bigger assets.” Banks, insurance companies and other foreign firms will continue to shed their assets in the region to shore up their balance sheets, and Asian companies will be looking to buy as local currencies strengthen against the U.S. dollar.
Rafalowski spoke to CFO Innovation’s Cesar Bacani on M&A trends and the results of the IntraLinks study, Global Corporate M&A Survey: What Lies Ahead for Corporate Development. Below are edited excerpts from the interview.
The M&A landscape in Asia is not as developed as in the West. Will this change given the global recession?
There are two ways you can measure the depth and breadth of the M&A market in Asia compared to the rest of the world. You have the number of deals that are done and then you have the volume of the capital that’s actually transferred.
The number of deals that is actually done in Asia is comparable to EMEA (Europe, Middle East and Africa) and also the U.S. It’s definitely less, but it’s not off by a factor of two or a factor of three or a factor five. It’s actually not that far off.
But a lot of the deals are negotiated deals between small and mid-sized businesses. Someone says, ‘Would you like to buy me, and the other company says, yes, I’d like to buy you, no problem.’ It’s that easy. Versus in the West, you have a lot more larger deals that are going in terms of actual value deal in dollars or whatever the currency you want to use.
Going forward, do you see deals in Asia getting larger?
There will definitely be some uptick. Both China and Japan are on buying sprees right now, so they’re going to be looking at bigger assets. And then there will be more significant deals because a lot of those assets [bought by Asian companies] may be [non-core] assets that are sitting outside the country or outside the region, in other parts of the world where other companies with deep pockets would come along and want to go buy them.
Your research found that the sectors that are likely to see M&A activity in Asia are financial services and technology, media and telecommunications.
Financial services is the sector that has been impacted the most by the financial crisis. There’s a lot of banks, advisory firms, hedge funds and so on that just couldn’t sustain [their business] based on how leveraged they were. AIG is a great example. It has basically gotten rid of almost all of its assets in Asia. In Japan, [Citigroup subsidiary] NikkoCiti has also gotten rid of a lot of its assets. But when you look at Chinese banks, as an example, you didn’t see a whole lot going on there – except for purchasing.
But aren’t these businesses actually making money in Asia?
That’s right. But if you think of the regulations in terms of how much liquidity or how much cash these financial institutions have to have on hand, all that’s changed in the world in the last year. So as everything started to melt down, a lot of these companies started to say: well, we need more cash balance to manage the ratio of our debt to capital. That’s why financial industry groups are getting rid of a lot of their assets.
Our clients, the ones we’re working with, all of them foresee tighter regulations going forward. That means they need be making sure their debt to capital ratio is a little bit better, as part of their fiduciary duty. I think a lot of the banks out here are being proactive in doing this. We’re going to see more [M&A activity in the financial sector] coming down the road.
What about technology, media and telecommunications?
You’re definitely going to have [M&A activity in] life sciences, biotech. When you look at technology, it depends on the kind of technology you’re talking about and the intellectual property that’s actually associated with it: software vs. hardware vs. something else.
IntraLinks in Asia Pac hasn’t gotten involved in a lot of technology transactions. Most of our involvement has been in financial services and energy. The technology transactions that we’ve been involved in have been around telecom.
There’s been a number of joint ventures as well as asset sales and purchases through some of the bigger telcos in China. Some of the other telcos out in the world have assets that China’s interested in. China is making a big push to go to Africa right now on telecom and things of that nature, so I think that they’re looking at acquiring [in those places].
There’s a lot of acquisitive companies in Asia that are out there looking for deals, mostly because equity markets are still somewhat depressed in Europe and the U.S., and the currencies out here are favourable right now, especially the dollar being as weak as it is, for Asian companies to go and purchase.
So you look at China and you look at Japan, there’s a lot of acquisitions going on right now. For some of the firms that we work with, upwards of 70%-75% of their merger and acquisition activity is external buy side.
We’ve done some deals right now in China with a few of the major telecoms there, a bit around joint ventures and leveraging technology. So it’s not necessarily they’re buying a company, or selling it, they’re actually taking part ownership of an asset or licensing it, and that’s considered merger and acquisition as well.
You mentioned energy as a hot sector as well.
You look around Indonesia, you look around Australia, you look at Southeast Asia, a ton of consolidation is going on in the industry and primarily it is to service China. Sinopec and a number of the other [Chinese] companies have been buying assets or taking pieces of an asset, and entering into joint ventures for example down in Western Australia. They’ve been a big driver.
Australia has got hundreds of energy and mining materials companies. Because of what just happened in the economy, the overleveraged companies basically saw their values drop. So you have companies like Rio Tinto, BHP Billion and some of the companies that have a lot of cash in their coffers and the equity prices looking at these companies [and deciding] they’re cheap.
But that was before gold blew past US$1,100 an ounce …
Right, but if you look at publicly listed energy companies in Australia, a lot of them actually have debt-asset ratios that aren’t very good at all. So when you actually start to look at the price for their shares, regardless of whether they’re mining gold or whatever, it doesn’t make a difference, they’ve actually gone down.
The other thing in the energy industry is that there’s a lot of joint ventures that happened as well. When commodities get hot, there are certain assets that people want to take a piece of and others want to look into selling, depending on what their financial situation status is. So these aren’t necessarily outright purchases. There’s a lot of joint ventures and alliances that’s going on in energy mining.
Do you see any indications that energy companies want to get out of their traditional business because they foresee an environment where cleaner energy dominates?
That’s a good question. Truth be told, I don’t think we’ve had many conversations going down that road. Coal is obviously not the cleanest energy source in the world. Are coal miners now trying to go build solar panels? Some of these companies, especially in the energy industry that we’ve dealt with, they’re in traditional energy sources, they’re pretty big, they’re fairly monolithic and I don’t know how much they’re changing.
Are there regulatory issues?
Absolutely, depending on where you’re at. In Australia, the reporting requirements are very strict. Any type of mergers and acquisitions that [energy companies] do not only internally but also across the border has to have complete auditability, traceability, and transparency.
What this is forcing them to do, which is where we come in, is to look for more modern ways for conducting these transactions, meaning using a service like IntraLinks to allow them to satisfy these requirements. In that way, all the information is organised, it’s managed, and it’s actually accessible to the government entities that have to actually audit the deals.
How big a hindrance to M&A do regulations pose in Asia?
It depends where you’re at. The regulations in Japan are very different from regulations in China, which are very different from the regulations in Australia, Singapore and even Hong Kong. It really depends on what type of transaction you’re looking to do. If you’re looking at wholly-owned purchase of something, that’s much more difficult to do than just, say, a joint venture.
A lot of companies in China, U.S.-based and Europe-based companies that are trying to grow there, end up establishing joint ventures. They’re not outright going in and setting up by themselves or outright going in and buying assets.
It’s mostly because of Chinese regulations in terms of how much a foreign company can own. It’s the same thing in Japan. Regulations do play a very big part in terms of the size and the type of transaction and the type of M&A that goes on in Asia.
Are you seeing regulations being changed to be more M&A friendly?
There’s talk, though I haven’t seen anything specific. Japan is talking about opening up, as an example. The ability of foreign capital to come into the country is a lot easier than before. I know China has done the same thing. So, yes, I think they’re loosening up a little bit, to try and drive more cash coming in. They’ll probably continue going that way.
In terms of regulations, which markets in Asia are most open?
Singapore and Hong Kong are very open. There’s a lot more regulation in China, a lot more regulation in Japan and, especially around energy, in Australia.
Where does a service provider like IntraLinks figure in all these?
If you think about foreign company licensing technology to a Chinese telecom, they’re obviously going to want to make sure that they’re protecting their intellectual property as best as possible and that they get the best valuation for it. With our service, you’re able to organise all that information online in a secure fashion and get it distributed wherever it is around the globe. The fact that most of the companies doing that kind of work are used to using our technology makes a big difference as well.
It’s interesting how you’re expanding beyond M&A.
We’re a 12-year old company that got started helping large banks in the U.S. facilitate loan syndication. That organically grew into helping them with mergers and acquisitions. Some of people we were working with were also helping finance big M&A deals. The said: ‘Please, can you help us out?’ because some processes are just as laborious around mergers and acquisitions [as in loan syndication]. So we took our product and configured it appropriately for M&A.
That’s now manifested into companies using us for other things. Procter and Gamble, for example, owns Gillette to a number of local brands that get peddled in Indonesia, in Malaysia, Australia, everywhere in the world. There’s a lot of highly sensitive information that companies like P&G have to exchange internally and externally on a regular basis.
What these companies have done is they came to us and said: ‘We use you a lot for transactions, we use you in financing, can we use you to do other things like vendor management, intellectual property management, legal document management?’ Because they know us, they trust us and the whole community that they work with are already using our services anyway. It makes it a very easy mechanism for people to digest the technology that they’re already using to exchange the information.
Is this happening in Asia as well?
Absolutely we’re seeing that out here, especially because we’re software-as-a-service, which is a big component of why these companies are favouring us to do more than just transactions. We’re a very easy resource that can be used and instantiated very quickly to go do a number of different things.
[Japanese pharmaceutical company] Daiichi Sankyo is highly regulated and ultra-conservative, so it wants to make sure that everything is in line and in order when it comes to exchanging anything outside of the company that is potentially critical information or damaging information or whatever it might be. So they do everything from clinical trials to marketing their information to actually licensing compounds on our service.
Security is obviously a very big issue here. Have you had in your long history any breaches . . .
Any security problems? No, none at all.
The service level agreement would spell out your liability in case of security breaches?
Absolutely it does. Name the biggest deal in the world in merger and acquisition, I would more than likely bet it was done on our service. J.P. Morgan, Goldman Sachs, Bank of America, all these companies are using our service. There’s no way they are going to put a lot of that highly sensitive information, literally information that could completely change the valuation of a company in terms of hundreds of millions or billions of dollars, on a service that was not going to be reliable and secure.
We’ve had something like 85 independent audits of our product and our software. We maintain a number of certifications as well. We go through regular audits through a couple of organisations back in the U.S. So it’s not only technology but it’s our people and our process that are audited. Security is a big thing for us. And we’ve been doing it for 12 years and nobody else can say that.
I imagine there’s also concern about insider trading?
We’re bound, as employees, to confidentiality, so if there was an insider trading incident, we’d be 100% liable. And we’re not allowed to look at the data unless the client wants to disclose it to us.
SOFTWARE AS A SERVICE
Intuitively, it seems like software-as-a-service would be cheaper for a corporate user because you set up everything and so on.
If you look at traditional on-premise software versus software-as-a-service, clients can save north of 60% of the overall costs to instantiate a similar on-premise application by using our service. The fact that we are a software-as-a-service, we’re basically including everything into the package.
What we’re not doing is we’re not going in and setting up hardware, we’re not going in and having to set up software. There are no downloadables, no special things that you need to put on your system. To actually get up and running, you basically just dial us up, and once you’re in, you’re in. And what we do is we provide the appropriate account for project management, consulting services to make sure that whatever you’re using is configured the right way for you to use. So literally you have no capex and you’re able to get in the service, and we can have it up in hours versus days, weeks, months [for on-premise software].
Where are your servers located?
SunGard is our services provider for the hardware and those are in the U.S., outside of Maryland and outside of Chicago.
Have there been any instances where a client says it cannot use your service because your servers are outside its country?
We have run into situations like that, yes, absolutely. Especially when you’re looking to work with government units, they may not want to be covered by the U.S. Patriot Act and things like that.
Are there competitors in your space?
When I look at the merger and acquisition market, there’s a lot of print companies doing IPO printing for corporations that have a similar service that they offer to their clients like we do. When you get into more of the corporate use or the subscription use, you have companies like Microsoft that are out there and EMC that offer something to do internal document management or content management that we would compete with.
The thing is, on both of those fronts, we’ve invented the loan syndication market and invented the product to help facilitate that, same thing with merger and acquisition, so we’ve been doing this longer than anybody else.
How high are the barriers to entry in your space?
If you look at just being software-as-a-service or being an online entity, you can generate a website in two seconds. Anybody can do it. It’s a question of what’s in there. When you actually peel back the onion, we’ve spent 12 years building our infrastructure, refining our security and providing the services that come with the software. Plus we dump about 20% [of revenues] into R&D every year. That’s a significant amount of work that would need to get replicated to get anybody to the point where we’re at right now.
When you look at the SaaS space right now, just in general, you could be talking about Salesforce.com, you could be talking about Concur, you could be talking about us. Right now in our peer group, we’re by far the leader in terms of profitability. When I look at Salesforce.com and what their margins were exiting their 2009 [fiscal year] and compare them to what ours are, we’re almost double theirs in terms of profit. Profitability in a SaaS company is not that easy a thing.
Are you listed?
No, we’re not, we’re private still. The point here in terms of barrier of entry is that to get corporations with bigger dollars to spend, you have to have the model right, you have to have the security, you have to have the service piece, and all of that doesn’t come overnight. There’s a lot of investment to do that, as well as a lot of investment to gain the trust that, yes, this thing is going to be the service that we use vs. whatever else.