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Wednesday, July 25, 2007

Investing in Turkey

From the Financial Times:

INVESTING IN TURKEY: Polls unlikely to deter investors

By Vincent Boland, Financial Times
Published: Jul 18, 2007

As it heads into a general election on July 22, Turkey's government might have been forgiven for taking its foot off the privatisation pedal for a few months.

Selling state assets has been a passion of the ruling, centre-right Justice and Development party (AKP), even if the public is either indifferent or hostile to the idea.

Foreigners own two-thirds of the Istanbul stock market, and fewer than 1m of Turkey's 73m people own shares, according to Mehmet Sami, an investment banker in Istanbul.

But election fever did not halt the sale in early July of a 50 per cent stake in Petkim, Turkey's leading chemicals group. It provided confirmation - if any were needed - that one of this government's guiding principles in selling state assets is that he who offers the most money gets the prize. With a current account deficit hovering around 8 per cent of gross domestic product, this might be understandable.

Petkim paid off handsomely. The transaction raised more cash - just over $2bn - than expected, valuing the group at three times its stock market capitalisation.

Such is the apparent demand for Turkish assets that investors are prepared to pay ever-higher multiples for them. The winning consortium comprised Troika Dialog, a Russian investment bank, the Investment Production Group Eurasia, a real estate investment company controlled by Kazakh investors, and Caspi Neft, a Kazakh oil exploration business. They said they would make significant investments in their new asset.

But that has not stopped the transaction being controversial, electoral considerations aside, for two reasons.

A trade union has threatened to go to court to block the sale of the Petkim stake. Previous efforts by Turkey's trades unions to halt privatisation deals have proved disruptive though not conclusive, and this is likely to be no different.

And Fitch Ratings, a credit rating agency, said it would have a negative effect on Petkim's creditworthiness if, as seems possible, the new owners seek to recover their investment by leveraging Petkim. That would have the effect of "turning the transaction into a leveraged buy-out," according to Oguz Bardak, a director in Fitch's industrials team.

The government tried to sell 80 per cent of Petkim in 2003, but nobody wanted to buy it except Cem Uzan, a controversial businessman. The transaction fell through. The group was making heavy losses at the time.

Now it has been restructured and is profitable. The turnround, and the value it created, are evidence of the wider improvement in the Turkish economy, which has grown by an average of 7.4 per cent in each of the past five years, creating a lot of value along the way.

Regardless of the details of any particular transaction, the bigger picture is what matters for investors, and there is no doubt that the investment climate in Turkey is better than it has been for a generation.

The combination of a stable government, structural reforms, the prospect of eventual membership of the European Union (even if it is receding somewhat), a new openness to foreign direct investment, and vast amounts of global liquidity for investment in emerging markets, has transformed Turkey's prospects as a destination for FDI and as a manufacturing and industrial base.

It has also increased the competitiveness of the $400bn economy, although many analysts say there is a need for more thorough microeconomic reforms.

Mustafa Boydak, chairman of Boydak Holding, a cables-to-furniture conglomerate in Kayseri with revenues of $1.8bn last year, says: "We do a lot more business now than we did in 2000, although the environment is more competitive."

According to figures from Garanti Securities, the sale of Petkim will put Turkey on course to attract about $25bn of FDI this year, compared with less than $1bn a year six years ago. Much of this investment has consisted of foreign companies buying mature Turkish assets, especially in the banking, telecommunications, media, and consumer goods sectors.

It seems certain that this will continue: some family-controlled conglomerates, which tend to dominate the corporate landscape, are experiencing generational change or seeking to shift their strategic interests.

At the same time, the small and medium-sized business sector is booming. Although its family-owned multinationals such as Koc and Sabanci are the best known faces of corporate Turkey, its SMEs are the lifeblood of the economy.

They are becoming as numerous in Anatolia as in Istanbul and its hinterland, the traditional hub of the economy. Cities such as Kayseri, Gaziantep and Konya are contributing an ever larger share to GDP. They are also growing in political importance - the AKP is strong in these centres.

One of the most active seekers after returns in the Turkish market is the private equity industry. "It's the busiest after strategic investors," says Michael Schilling, a lawyer at Linklaters who has advised on many Turkish private equity transactions.

"In the past three years, private equity investors have gone from talking about investing in Turkey to actually doing it." It is a one-way street that can get crowded: some private equity firms bid against their rivals for the most prized assets, such as retail and pharmaceuticals companies, sending multiples soaring.

Mr Schilling says an added attraction of the Turkish market for foreign investors, including the private equity industry, is that its capital markets are deep enough to allow financing for deals to be raised and syndicated locally.

Still, Turkey remains an emerging market, with many of the long-term obstacles to investment and to sustained economic growth that such status entails.

Yased, the association of foreign investors that has recently come under new leadership, is drawing up a list of priorities for reform. First is the issue of addressing the enormous unregistered economy - "the mother of all our problems", according to Tahir Uysal, Yased's new chairman. The unregistered sector, by some estimates, accounts for half of economic activity.

The association is also pushing for a review of corporate taxes and incentives for foreign investors, for measures to address the shortage of skilled labour, for more support for research and development, for reform of property rights, for an improvement in the climate for green-field investments, and for Yased itself to play a more active role in the debate surrounding possible EU membership.

Unless steps are taken on all these pressing issues, Yased argues, it will continue to lag behind its competitors in attracting FDI. "In 2006, there was $1,300bn of foreign direct investment seeking a home worldwide, and Turkey got only $20bn of it," Mr Uysal points out. Despite the surge in FDI inflows in the past two years, the country is actually slipping down the league table of FDI destinations, he says.

Whether the political environment changes after the election is also a consideration. Although the AKP is expected to retain power, perhaps with a smaller majority, the constitutional crisis that precipitated the July 22 poll could have long-term reverberations.

One effect of the crisis over the appointment of the next president - which set the army, the opposition, the courts, the parliament, and the government at loggerheads - is that it has severely dented the image of Turkey's governing institutions in the eyes of the public. It may take more than a general election to restore their credibility.

The other issue hovering over the economy is whether it will have a hard or a soft landing if - or perhaps when - global liquidity begins to shift away from emerging markets.

As Kristin Lindow, a senior credit officer in the sovereign risk unit at Moody's Investors Service, observed at a recent conference in Istanbul: "The question is whether the effect of global liquidity has changed the rules of the game [permanently for the better] in Turkey, or whether the party will stop. The answer is that I don't know."

An area of vulnerability is the high value of the lira against a sagging US dollar, which has made imports cheap. Much of the import bill is spent on goods that are used in the manufacture of Turkish goods that are then exported.

The economy is export-dependent and exports are booming, partly because companies have become much more efficient as a result of the economic turnround and are shedding jobs as they become more profitable and technologically sophisticated.

Ms Lindow estimates the import content of exports at above 80 per cent, however. Whether this can continue if the lira retreats at some point is another question dogging the economy.

It seems unlikely that the new government, regardless of its political stripe, will want to interfere excessively with the economy, which is growing at its fastest ever pace.

But for a variety of domestic factors, the past four years of relative stability may be over, at least until Turkey decides on the political direction it wants to take in the next five years.

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