Even though there are still opportunities for mergers and acquisitions (M&As) in the UAE's real estate sector, industry experts believe "absence of finance" and "lack of value creation" have hampered the initiative.
In a round table discussion with Emirates Business, Andrew Charlesworth, Head of Capital Markets, Jones Lang LaSalle Mena; Ahmad Saidali, Vice-President, Investment & Fund Advisory CBRE Middle East; Sana Kapadia, Vice-President, Equity Research, EFG-Hermes, UAE; Mike Atwell, Head of Middle East Operations, Cushman & Wakefield and Andrew Goodwin, Director, DTZ, said there are good prospects of M&As, but these are likely to happen only when merger makes sense and the market is ready for it.
Asked about the chances of cross border M&As, most of the experts said possibilities were limited since real estate was a local domain, in terms of supply-demand and other market dynamics.
Excerpts:
Where do you think companies have failed when it comes to mergers and acquisitions in the UAE's real estate sector?
Charlesworth: Limited acquisitions can be partially attributed to lack of finance and buyers not willing to take a risk in stretching their company balance sheets in the current environment. Mergers will only succeed if there is a clear business case and proper corporate fit in terms of savings, efficiencies and value creation.
Saidali: M&As are very complex operations which require many conditions to be fulfilled in order to make them. There was a lot of speculation about M&As in the UAE's real estate sector. However, so far we have not seen any high-profile M&A taking place.
Many experts wonder why these talks failed. In most cases, these operations did not go through because either the numbers did not work or the market was not ready and ultimately there was not proven visible benefit from M&A of those companies. But even if these conditions are fulfilled, M&As can still fail after their conclusion.
In reality, and the economic literature shows that most often the problems can arise from when it comes to the integration of cultures, staff, processes, best practices and philosophies. As a result, retention of key employees at all levels is compromised, and fear increases among staff and other stakeholders. And when communication becomes dysfunctional, internal conflicts grow while morale, and thus productivity within the new company/entity, decreases which can really jeopardise business continuity.
Kapadia: It has been a mixture of waiting it out and letting natural market forces allow things to shape the fate of companies, and also recognising that companies that were being meant to be combined may have been less able to derive operational/financial synergies than first presumed.
Atwell: The real estate sector in the UAE, and more specifically Dubai, has gone through well-documented changes over the past 12-18 months, facing in particular the challenge of significant oversupply and the saturation that continues to hamper the market.
The softening of the real estate market, and access to financing, which has affected all the key players, has, therefore, meant that in reality nobody is really in a position to be doing deals – most are adopting a "wait and see" approach.
Goodwin: The sudden impact of the financial crisis led to a significant shortfall of interim and end revenues for developers and the cutting off of the "exit" led to the failures.
Unlike other downturns, the impact of the crises has been across all property sectors and development bodies, including government-related organisations. So there have not been any "winners" capable of taking advantage.
Do you still believe there are opportunities for M&As within the UAE?
Charlesworth: One would expect the real estate sector will need to rationalise but in the absence of development/development financing, simply merging entities with large land banks, for example, may not achieve much value creation as new construction generally is going to be constrained in the near term. We would expect some potential for the merger or the creation of spin-off businesses particularly where assets can be grouped that are revenue generating.
Pooling income-generating assets into an asset management business and creating efficiencies around that would have some logic.
Saidali: There are definitely opportunities for M&As within the UAE since the real estate sector needs to consolidate. It happened in many other sectors where after a boom market some adjustment is needed.
However, I would stress once again that the main rationale behind any M&A activity is that one plus one makes three: this equation is the special alchemy of a merger or an acquisition.
The key principle behind buying a company is to create shareholder value over and above that of the sum of the two companies.
Two companies together should, therefore, have to be more valuable than two separate companies, at least from a theoretical point of view. If not, the operation can prove very costly with disastrous results.
Kapadia: Absolutely. There continues to be a case for consolidation, as some entities are still in need of financial/operational assistance.
Atwell: From our activities in the market, we would think this is unlikely in the short term, although there is a possibility for those focussed on the specialist locations and sectors that have proved to be resilient in this market. For example, companies active in areas such as the DIFC, or the retail sector in Qatar, where low-level vacancy levels have remained attractive.
Goodwin: We can see the situation changing as confidence in property begins to improve from the financial sector's poin of view. The beginning of this will initially see an increase in land trading – for which there is some evidence – before M&As become the more economic way for companies to scale up their activities.
Should regional governments play a more active part to get state-owned companies to merge?
Charlesworth: Generally, markets will find their own level and governments are best at providing support in terms of legislation and the right business framework.
I think most governments would not want to force the issue of saddling strong businesses with weaker ones.
Many of the GCC governments control the major real estate players in their market (through either direct ownership or controlling stakes in listed developers), this provides them with an opportunity to push through mergers in those circumstances where they will create stronger entities.
The Qatari government has been particularly active in this space recently. In Dubai, the decision not to proceed with the proposed merger of Emaar and Dubai Properties shows that mergers of government-related entities may not always be appropriate.
Saidali: M&A is not the only option for companies. There has to be good reasons behind any merger in order to make sure that the outcome will be positive for the two merged entities and ultimately for the society.
Therefore, M&A within the government-owned companies should answer and comply with the same economic imperatives as merger between private companies.
Kapadia: To some extent, but such consolidation needs to stem from an intrinsic need as well.
Atwell: No comment
Goodwin: There has been a consolidation of organisations within umbrella groups and a number of unsuccessful merger attempts which is to be expected. However, there is evidence of increased M&A activity outside the real estate sector. We firmly believe that any transaction should have good economic grounding rather than political motivation.
Do you see chances of cross-border M&As happening in the region?
Charlesworth: I am not sure M&A is the right answer to such situations. I think what we can expect is more co-operation across borders initially as real estate groups focus on new markets. In such cases, developers may tie up with qualified and experienced local partners often through the creation of joint ventures to develop or invest in something specific.
Over time, this might lead to an acquisition but this does not necessarily have to happen straight away if at all. The most successful developers tend to be quite lean and work in partnerships in different markets and thus remain flexible and adaptable as circumstances change. Real estate is in many ways a local industry and there are relatively few global brands.
One of JLL's Top 10 of 2010 trends was that the Mena market will become more localised and this will restrict the opportunities for successful cross-border M&As.
Saidali: There are good chances of seeing M&As in the region, but these will only happen when the merger makes sense and the market is ready for it.
The new company's strategy is the magic force that allows for enhanced cost efficiencies of the new business and makes it appealing investment opportunity for the market.
Kapadia: Not necessarily, as real estate remains a local domain, in terms of supply-demand and other market dynamics.
Atwell: Cross-border M&As in the real estate sector are probably most likely to occur – but we are talking about companies already working regionally rather than those focussed solely on specific markets.
Goodwin: We see this as unlikely due to the structure of companies having regional allegiances but there may be individual opportunities in emerging regional markets such as Egypt and Syria.
Do you believe private developers should merge so that they have the financial capabilities to complete projects?
Charlesworth: I think it is possible but likely to be very complicated and could take time. You would need to be clear about where the value would be in merging numerous developers who are all facing the same problem.
It all depends on what the benefit would be through such a merger and how that, in turn, would work and how it might benefit the various stakeholders.
Saidali: The first condition to make an M&A a success story is that all parties have an interest, financial or otherwise in the merger of two different entities.
Stakeholders include first the firm-stock holders, the creditors, bondholders, employees, customers, management and finally the government.
Once again the merger has to make sense from an economic point of view, for example by economies of scale, access to new markets or new products, and create value for shareholders of both companies. On the other side of the equation, if two financially distressed developers merge, the result will only be a new big distressed developer and not a strong one.
Kapadia: Could be likely… on one hand if it makes good business sense, but some smaller ones could continue struggling.
Atwell: Again, this is one of the more likely possibilities but there must be a clear benefit of working together. As well as combined financial capabilities, there is also the benefit of offering alternative investments/units in place of delayed deliveries.
Goodwin: Again this is linked to increasing confidence from the financial sector. We hope that this will be seen in the fourth quarter this year.
Mergers will only succeed if there is a clear business case and proper corporate fit Andrew Charlesworth, Jones Lang LaSalle
The first condition to make an M&A a success story is that all parties have an interest Ahmad Saidali, CBRE
There continues to be a case for consolidation, as some entities are still in need of assistance Sana Kapadia, EFG-Hermes
Cross-border M&As in the real estate sector are probably most likely to occur Mike Atwell, Cushman & Wakefield
A transaction should have good economic grounding rather than political motivation Andrew Goodwin, DTZ