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Evolution of Capital Markets & Deal Activity Since the Asian Financial Crisis: Do Opportunities Outweigh Risks?
Concerns about the threats posed to Asian capital markets include stretched valuations, the potential for a slowdown in China, Japan’s demographic time bomb and India’s capacity to deliver on its economic promise. However, opportunities continue to abound throughout the region, underpinned by a range of structural, fundamental, macroeconomic and regulatory elements, all of which have the potential to support the region’s longer-term momentum.
In spite of bouts of extreme volatility, especially in China and India, each of the region’s leading stock markets has undergone a phase of impressive long-term expansion since the Asian crisis of 2007, according to Philip Lee, Head of APAC Desktop Product Operations, and Clement Ma, Senior Director of Capital Markets, APAC, at S&P Global Market Intelligence. Measured by virtually any yardstick, the most striking growth has been achieved in China, where capitalization has risen more than 300-fold, from $34 billion to well over $10 trillion over the last 20 years. Over the same period, the number of listed companies has increased from 138 to over 4,200.
India has also seen a notable increase in market capitalization since 2007, from $145 billion to over $2 trillion while there are now more than 3,800 companies listed, compared with 550 in 1997.
In more mature markets, such as Japan, Hong Kong, Australia, and Singapore, the expansion has been less dramatic, but in each case capitalization and the number of listed companies have increased materially.
Growth in capitalization of listed Chinese companies
A telling indication of the explosion in the Chinese capital market has been the growth in the capitalization of listed Chinese companies relative to those elsewhere in the region. In 2007, all but five of the 20 largest APAC companies were Japanese, with no Chinese representation in the top 20. Today, there are only two Japanese survivors in the top 20, which is now dominated by Chinese names. The largest company in APAC, China’s Alibaba, is approximately four times the size of NTT, which was the region’s largest company in 2007.
IPOs and sales by venture capital and private equity investors are projected to add to total capitalization levels, especially in sectors such as information technology, financials, and consumer discretionary.
Valuations: Still reasonable
In spite of the strong performance posted by Asian equities over the last decade, Lee and Ma demonstrate that valuations in all six leading markets other than India are lower than they were in 2007, and all but China and India now trade at lower multiples than the S&P500. The median price/earnings ratio for the S&P500 was 22.8x for the next 12 months at the end of July 2017, compared with 20x in Japan, 19.8x in Australia, 16.2x in Hong Kong, and 17.9x in Singapore.
While China traded at 33.1x and India at 24.6x, these multiples suggest that across the region as a whole, valuations remain reasonable, especially in light of economic growth prospects. This hypothesis is strengthened by price/earnings to growth (PEG) ratios in China and India, both of which are below those for the S&P500.
Among other indicators underscoring the growing maturity of Asian stock markets ex-Japan, rising brokerage coverage is one of the most notable. In 2007, fewer than half of the 1,940 listed companies in China were covered by analysts; today, this has risen to 51 percent of 4,242 stocks. In India, the corresponding shares have risen from 18 percent of 2,942 companies in 2007 to 25 percent of 3,829 companies in 2017. Only in Japan has there been a material decline in broker coverage.
The growing depth and maturity of stock markets in the region is reflected in the rise in the size and global share of IPOs in APAC. In 1997, Asia accounted for just 17 percent of global IPO activity; by 2007, this had risen to 27 percent, and in 2016 it peaked at 56 percent.
Balance sheets among Asian corporates are stronger than they were 10 years ago, with total enterprise value to EBITDA up in all six markets. The average debt to EBITDA is generally higher across the region, although it is flat in China and sharply down on 1997 levels in Japan. This reflects the growth of APAC credit markets over the last 20 years, during which time the number of S&P long-term credit ratings have more than doubled.
Cash balances among Asian corporates, meanwhile, have risen sharply over the last 20 years, and in China and Japan cash holdings across all listed companies now eclipse the cash held by those in the S&P 500. Over the last 20 years, this has created more scope for dividends and share buybacks, with the average pay-out ratio across APAC markets reaching 37.7 percent in 2016 compared with 26.6 percent in 1997, although this is well below the peaks of over 60 percent reached in 2002 and 2009 when companies in the region – especially in Japan – maintained dividends in periods of weak earnings. A more recent notable trend has been rising pay-out ratios in China, which support the overall APAC trend.
Rising liquidity in the Asian corporate sector twinned with brighter economic prospects have also fuelled a discernible rise in M&A activity in APAC as a share of the global total. This rose from negligible levels in 1997 to 17 percent in 2007, and peaked at 23 percent in 2016, turbocharged by a pronounced increase in both inbound and outbound M&A activity. Outbound M&A has increasingly been driven by Chinese companies, with ChemChina’s $46 billion acquisition of Switzerland’s Syngenta in 2017 still comfortably the largest acquisition outside the region by any APAC-based company.
The valuations of transactions completed by APAC buyers have remained broadly stable on an EV/EBITDA basis over the last two decades, as has the breakdown of cash and stock paid by Asian buyers, although this has shifted towards cash in recent years. The cash component of deal considerations reached 86 percent in 2017, its highest level since 2000.
Maintaining momentum?There will be challenges ahead for Asian equity markets. But the combination of high cash balances, the increased weighting of Asian equities (most notably from China) in global indices, sound fundamentals and credit metrics, and the emergence of more global corporate players from the region suggest that APAC markets can maintain the momentum they have gathered over the last 20 years.