2014 H2 - Mergers and Acquisitions

The funds’ low levels of cross-border acquisitions at the beginning of 2014 can partly be explained by their need to identify new strategies that maximize what they consider to be their competitive advantages: long-term investment horizons and enormous scale. At the same time, they continued facing the M&A challenges that we observed in 2013 [link to annual report].

At the start of 2014, sovereign wealth funds continued to have difficulty competing for targets with industry buyers. Global strategic M&A surged in the first quarter. Many companies have been sitting on growing cash reserves as they’ve struggled to find attractive opportunities, but they are under pressure from shareholders to spend through acquisitions, organic growth, share buybacks or increased dividends.

This glut of industry buyers crowded out financial investors including sovereign funds, and not just by sheer volume. Strategic purchasers can bring the kind of synergies that allow them to pay more for target companies. Industry players can also take advantage of cheap financing and buoyant corporate bond markets, to help them edge out financial buyers.

Consequently, sovereign wealth funds and their partners have become less willing to compete at auctions, preferring to negotiate directly in the hope of better terms. This means deals take longer to complete. After a slow first quarter in which sovereign wealth funds sealed only ten private equity deals valued at a combined $1.6 billion, activity picked up in the second, when they concluded 19 worth a total of $7 billion.

Rebounding Purchases

In the first quarter of 2014, sovereign wealth funds were cautious about overpaying. With global interest rates remaining near historic lows, the so-called great rotation from bonds into equities continued, inflating valuations. The Dow Jones Industrial Average and the S&P 500 index nudged record highs during the first half of the year; in February, London’s FTSE 100 Index reached levels not seen since the dot-com bubble of 1999.

Share demand was fueled by plentiful and high-profile new issues on both sides of the Atlantic, but sovereign wealth funds held back, largely steering clear of well-hyped initial public offerings and participating only when they perceived exceptional deals. Some of them are now investing specifically to help companies avoid the rush to go public[link to Innovation Alliance story].

In the second quarter sovereign wealth fund acquisition volume rebounded strongly, to $16.7 billion, as funds developed strategies to navigate high valuations. One clear trend was a move into overlooked sectors and distressed companies. For example, Singapore’s GIC and the Qatar Investment Authority (QIA) bought stock in European listed real estate companies. Both funds helped raise capital for Inmobiliaria Colonial, a Barcelona-based company that owns and operates rental properties across Spain. GIC bought bonds; QIA, equity. The Qatari fund also purchased a 13.6 percent stake in Paris-based commercial property owner Société Foncière Lyonnaise alongside DIC Holding, an investment vehicle owned by Qatar’s royal family, which acquired an 8.6 percent share.

While sovereign wealth funds often strive to avoid following market trends, they have been pursuing life sciences and technology investments, where global deal volumes have been high. In the first half of 2014, sovereign wealth funds invested more than $1.5 billion in health care, nearly all of it in drug and medical technology companies — more than double their acquisitions in the sector during the previous six months. Although Asia’s funds accounted for the lion’s share, Middle Eastern sovereign wealth funds also participated. For example, the Kuwait Investment Authority made a rare direct investment by allocating $100 million to NantHealth, a healthcare information technology company based in Culver City, California.

Sovereign Wealth Fund Investments by Sector: 2013-’14

Source: Sovereign Wealth Center

Hunting for New Technologies

Asia’s sovereign wealth funds, particularly Singapore’s GIC and Temasek Holdings, were the biggest state-backed investors in e-commerce, technology and telecommunications companies in the first six months of 2014. Although this trend really gathered momentum from midyear, May saw a rush of deals from the Singaporean funds. Both funds invested in a $170 million fundraising by São Paulo–based online sports apparel retailer Netshoes. Temasek invested $17 million at the initial public offering of Beijing-based JD.com, an e-commerce website that competes head-to-head with Hangzhou, China–based Alibaba Group Holding and contributed to a $100 million funding round for Indian online retailer Snapdeal.com.

GIC backed a wider range of technologies, buying bonds issued by two Chinese technology companies and the stock of fuel cell manufacturers and software developers. In telecommunications both Singaporean funds bought into the New York listing of Cheetah Mobile, a Beijing-based mobile Internet provider. Temasek led a new, $86 million fundraising round for Virgin Mobile Latin America, an affiliate of London-based Virgin Group, which provides mobile phone services in Chile and Colombia, and will use the capital to finance new operations in Brazil and Mexico.

As these examples suggest, sovereign wealth funds looked to emerging markets in the first half of 2014. Continuing slow growth in continental Europe prompted sovereign fund acquisitions in the European Union to drop from some 60 percent ($10.9 billion) of their total foreign direct investment in the previous six-month period to just 16 percent ($3.8 billion). More than half of this investment was in the U.K. as funds bought London properties.

Go for Growth

Sovereign funds instead sought opportunities to harness Asian economic growth. The largest deal between January and June 2014 was Temasek’s HK$44 billion ($5.7 billion) investment in A.S. Watson Group, the drugstore-to-supermarket retail arm of Hong Kong–based Hutchison Whampoa, the conglomerate controlled by Hong Kong billionaire, Li Ka-shing. Temasek acquired 24.95 percent of Watson, which owns British pharmacy chain Superdrug Stores, and pushed back plans for a listing on the London Stock Exchange. But this deal was no one-off. Besides their e-commerce purchases, the two Singapore-based sovereign funds invested in several food companies in emerging markets, including São Paulo–based BRF, Brazil’s second-largest food company.

The mantra for sovereign wealth funds so far in 2014 seems to be a simple one: Go easy, but go for growth.