Business, EUROMONEY, Turkey - Wed March 6, 2013

Istanbul’s invisible IPO market

Turkey has grown by leaps and bounds for more than a decade. Yet its stock market remains dependent on foreign capital and successful IPOs are rare. Can the country finally succeed in adding depth to its capital markets?

Stock market performance is supposed to dovetail with industrial growth. When one does well so, in theory, does the other – witness the outperformance of US equities during the economically golden late 1990s. Likewise, stock market crashes are expected to stem from, or herald, broader economic recession.

That doesn’t always happen in practice, particularly in fast-growing emerging markets. India’s Sensex, a weighted index covering the largest 30 Mumbai-listed stocks, gained 28% in 2012, while the Indian economy sputtered. China’s red-hot economy masks a stock market stuck in first gear: the Shanghai Composite, an index of all A and B shares listed in the nation’s financial capital, is down 14% over the 24 months ending on February 8.

Even more strikingly contrarian figures can be found in Turkey, an economy that has performed magnificently since a crippling financial crisis around the turn of the century. Only over the past 12 months has this success story started to fray: Turkey’s economy expanded by just 2.5% in 2012, down from 8.5% the previous year, according to data from the CIA World Factbook.

Yet resisting all logic, the benchmark ISE Index, covering Turkey’s leading equities, had its best year in living memory. In the 12 months to December 31 2012, the index gained 61% in dollar terms, making it the world’s best-performing major emerging market bourse.

More weirdness can be found in the contradictory world of the initial public offering. While Turkish securities have soared over the past two years, primary stock sales have been almost universally disastrous. Of the 13 IPOs completed in 2012, fewer than half are selling above their issue price as of February 15. Just five of the 26 initial stock sales completed in 2011 are now trading in positive territory, statistics from Dealogic show: the average IPO from that year has lost 23.8% of its value between issue date and February 15 this year.

More Dealogic data show the unusually poor after-market performance of Turkish IPOs. Chinese initial stock sales completed in 2012 gained an average of 21% between issue date and February 15 this year, the latest figures available. Indian and Brazilian IPOs completed in 2012 have gained an average of 51.6% and 7% respectively from issue date. Turkish IPOs, by contrast, have fizzled, losing 5.3% on average.

Nor is it easy to determine which sales will fly and which will flop. Size seems not to matter much. The $2.5 billion November 2012 secondary stock sale by Halkbank, Turkey’s seventh-largest lender by revenues, has outpaced expectations: its shares are trading 11% above their issue price. Compare that with the troubles at Migros Ticaret. Shares in the Turkish supermarket chain were trading at north of TL35 ($19.83) before a much-heralded $508 million follow-on sale completed in April 2011. Its stock is now trading at around 60% of its previous level.

Understanding why this happens in a country with a strong, forceful financial regulator, the Banking Regulation and Supervision Agency (BRSA), isn’t easy. Investment bankers interviewed by Euromoney in Istanbul were wary of publicly criticizing either the quality of companies listing shares on the Istanbul Stock Exchange, recently renamed the Istanbul Borsasi, or the BRSA itself. Yet this is clearly how many feel in private.

“There is just an awful lot of rubbish entering the system,” says one banker working at a leading European institution. He scrolls down a list of completed IPOs from 2012, prodding his finger at the names of companies as he goes: “No good, no good, good but badly sold, no good, too big to fail, terrible story,” – and so on.

He sits back and offers one, compelling reason. “Most IPOs here are penny stocks even before they start trading. The market doesn’t want to see $20 million, $30 million deals. It’s hard here to find credible, sizeable issuers, which is a real weakness for [Turkey’s] capital markets.”

It’s hard to argue with this point. The largest local IPO completed over the past 24 months was a $105 million April 2011 sale by second-tier real estate firm Kiler Gayrimenkul Yatirim Ortakligi. Kiler’s shares have fallen ever since, from an offer price of TL4 a share to TL1.84 by February 15 this year.

Of the 38 share sales – IPOs and follow-ons – completed since the start of 2011, just seven have raised more than $100 million. Moreover, this list contains some real stinkers: note the $19 million June 2011 IPO of construction firm Atac Insaat ye Sanayi. Investors who bought Atac at TL7.90 a share on issuance are now holding shares worth barely one Turkish lira apiece.

Many of these small-ticket IPOs draw criticism from across the investor community. “They do irreparable harm,” says one banker. “A lot of people who have never bought shares in anything hear a name from a friend, and buy a few shares, just to test the market, then watch as their money drains away. This is instilling a sense of distrust in a generation of investors. The regulator needs to find a way to create more confidence. We need stocks with size, scale and quality.”

This chimes with a glaring need to educate most Turks about the potential long-term benefits of investing in local securities rather than sinking all their savings into inflation-proof commodities such as gold and land. “Turks don’t have the culture of investing in equities as we have had such high rates of inflation for so long, and interest rates have only recently come down,” notes Gonca Gürsoy Artunkal, chief executive of UBS Turkey.

Many in the banking community are in two minds about the BRSA. Turkey’s financial regulator is a highly respected institution that reacted to one localized financial crisis, in 2000/01, by imposing sensibly heavy regulation that curbed the impact of a global crisis several years later.

Yet few here are happy about basic oversight involving primary stock sales. “Too many companies are looking just to complete [an IPO] and make a killing,” says a leading Turkish banker. “You can see what is happening on these [types of sales], yet the financial regulator hasn’t tightened up on it. If an issuance [sees its price go] down 50% in a short amount of time, the regulator should haul people in and ask questions.”

Kaan Basaran, head of origination and sales, Turkey, at Nomura, praises the regulator, but adds that the country needs “discipline in terms of the companies that are being brought to market”.

There is one final and compelling reason why the domestic market for IPOs remains so small, and why daily volumes on the stock exchange are so thin. For all of Turkey’s economic progress in recent years, it’s easy to forget that until recently this was a country hobbled by sky-high inflation and interest rates. Turkey’s local institutional investor base simply isn’t deep enough.

A leading local investment banker outlines what he describes as the “crap-shoot” involved in selling a local IPO. “I’ve done 12 of the largest IPOs ever done in Turkey,” he says, reeling off an impressively long list of big-ticket initial stock sales stretching back nearly two decades. “And I’ll tell you one thing for free. You need a good day in Europe and the US for any sale to go well. If you have a bad day in either, your IPO gets the big fat finger from the markets.”

This dependency on outside institutional capital – around four-fifths of all stocks in important new listings are typically bought by foreign investors – is described by Dimitris Tsitsiragos, vice-president, Europe, Middle East and North Africa, at the International Finance Corporation, the private sector arm of the World Bank, as Turkey’s clear “problem at the moment”. He adds: “If [inward capital flows] dry up, it’s a problem; hence the importance of building strong, vibrant capital markets. If you have that [in place] you’re less dependent on external foreign funding flows.”

Mike Davey, country director at the European Bank for Reconstruction and Development, adds: “A major constraint in Turkey is that domestic capital formation is insufficient to meet strong investment needs.”

Turkey’s leaders recognize this problem. On the first day of 2013, legislators in Ankara pushed through a series of pension reforms designed to deepen the capital markets and to boost a stubbornly low savings rate. Individuals can now claim a tax deduction of up to 15% on pension contributions, while the government boosts any contribution of up to TL799.50 – the national minimum wage – with a matching contribution of 25%.

These reforms are designed to deal with several ingrained Turkish problems at a stroke. They will boost a gross domestic savings rate that, at end-November 2012, stood at just 16.3%, according to Fitch Ratings, one of the lowest rates in the emerging world. They should, if all goes to plan, create a deep new well of domestic investable capital, held within powerful local institutional funds and insurance firms, reducing the country’s dependency on foreign capital flows. They will also create a deep pool of new liquidity, allowing the state to channel capital into badly needed new infrastructure projects that tap both public and private funding sources.

Ilhami Koc, deputy chief executive of Turkish lender IS Bank Ilhami Koc, deputy chief executive of Turkish lender IS Bank These reforms, says Ilhami Koc, deputy chief executive of Turkish lender IS Bank, will “motivate [consumers] to save for the long term. In the past, we have seen people going into the system but withdrawing their money in a short period when they need to spend. This will help to improve the savings in the country while also deepening the capital markets.”

Whether or not this works will depend largely on the extent to which the country’s 75 million people trust their government’s fiscal plans. Right now the answer is overwhelmingly positive. Turkey’s prime minister, Recep Tayyip Erdogan, in power since 2003, has brought political stability and economic diversity to a country once ruled by an entrenched military and its corrupt cronies.

Only in recent years have prices and interest rates fallen to manageable levels, instilling in Turkish citizens and foreign investors alike a measure of confidence in the nation’s long-term growth story. “Achieving sustainable growth remains our biggest challenge,” says Turalay Kenc, deputy governor at the Central Bank of the Republic of Turkey (CBRT). “Our aim is ‘5-5-5’” – 5% inflation and interest rates, and a 5% current account deficit. We can only reach that equilibrium through structural reforms, and that is why we have introduced the private pension scheme, among other measures.” Kenc predicts that GDP growth, after bottoming out last year, will rise to 4% in 2013, and to 5% in 2014.

It will take perhaps up to two years fully to gauge whether or not January’s reform process works. All the ingredients appear to be in place. Previous attempts to persuade a largely young and spendthrift populace to save more faltered, largely because of the paucity of long-term incentives. “Before, people were putting money away and taking it out two years later to spend on themselves or their kids,” notes a local fund manager. This year’s reforms vest fully at retirement: anyone withdrawing capital beforehand loses out on up to 60% of the state’s matching contribution.

Key financial figures are generally bullish on the reforms’ long-term potential. “Sixty-five percent of the Turkish stock market is foreign owned,” says one leading investment banker. “We need to turn that figure around. It will take two or three years to create [a savings pool worth] $30 billion to $40 billion, and that’s when the stock exchange will really come into its own.”

Many here compare Turkey’s future with Poland’s past and present. Far-sighted and far-reaching decisions in the late 1990s turned Warsaw into a regional financial powerhouse built atop a solid domestic investor base and a strong supporting cast of loyal, embedded foreign institutional investors.

Many in Turkey are understandably seeking not only to emulate but also in some ways to supplant Warsaw as a more attractive and dynamic financial centre, sucking in new IPOs from across the Middle East and north Africa, as well as eastern Europe and central Asia. “We expect more IPOs [to come into the country] in the future,” says UBS’s Artunkal. “Some of them [will come from] regional companies from the likes of Ukraine, Iraq and the Caspian region.”

These plans are slowly taking shape. Witness continuing attempts by Ibrahim Turhan, chief executive and chairman of the Istanbul Borsasi, to draw all of Turkey’s numerous securities exchanges together under a single roof. Or premier Erdogan’s long-standing plans to build a new, $2.6 billion financial hub on the Asian side of the Bosporus over the next four years. In mid-February, Halkbank raised just shy of $150 million by selling shares in a real estate unit, Halk GYO; the capital will be used partly to fund and build the new Istanbul International Financial Centre.

Turalay Kenc, deputy governor at the Central Bank of the Republic of Turkey Turalay Kenc, deputy governor at the Central Bank of the Republic of Turkey Realizing both these ambitions – creating a deep pool of domestic institutional capital while replacing Warsaw as the local IPO market of choice – won’t be easy. Istanbul needs effectively to pull a few rabbits out of its hat: namely, a series of big IPOs attractive to local and foreign investors alike. This shouldn’t be too hard. Politicians and regulators are working to sell down stakes in several publicly owned lenders.

An initial stock sale of Ziraat Bank, the country’s second-largest lender after IS Bank, is set to be completed by the end of 2014. Two big follow-on issuances are expected in the second half of the current year: a $2 billion sale by Turkey’s fifth-largest lender, VakifBank; and the divestment of a 6.68% stake in Turk Telekomunikasyon, cutting the government’s stake in the country’s largest carrier to 25%.

Polish politicians turned Warsaw into a regional financial hub by taking a long-term view on state assets. Publicly owned institutions, following the collapse of the Soviet Union, were systematically sold down, putting ownership of banks, highways, utilities and insurers in the hands of the investing public. State assets were deliberately undervalued in the 1990s, dragging in little revenue but lots of goodwill. This allowed regulators to fully value and even overvalue remaining state assets over the past decade.

Bankers in Turkey are rightfully hopeful that privatization will boost fees and deepen local capital markets. UBS’s Artunkal describes the process as a theme that will continue over “the next three to five years”. If all goes well, the sale of government stakes in everything from banks and ports to power firms, highways, and even the national lottery, should net the country at least $30 billion over the next few years. “We are only at the very start of the privatization process,” says one leading investment banker. “There’s so much still in public hands. Get the process right, and Turkey could be the financial heart of the whole region in 10 years’ time.”

But that relies on the government pricing state assets at reasonable levels. Istanbul has set out aggressive plans to build over the next four years the world’s largest airport, with a capacity of 90 million passengers a year. Transport minister Binali Yildirim said in late January that licences to build and run the new airport, set to be issued in May 2013, could net the government more than $5.6 billion. Banks warned that the price tag was overly optimistic. “I’d be surprised to see any bid come in at [north of] $5 billion,” noted an investment banker at a big US lender.

Most bankers concur with that view, although many also warned that a big privatization deal completed in December 2012 was even more overvalued. That deal was ultimately secured by Turkish conglomerate Koç Holding and a consortium of local and Malaysian investors, who paid $5.72 billion to run and manage 2,000 kilometres of national highways over the next 25 years. Even now, bankers grumble that fair value might have been closer to $4 billion.

This matters. An investment banker who advised a client on last year’s roads deal says: “The government runs a risk of overpricing state assets. It might get lucky on one or two deals, but there has to consistency here: you have to leave something on the table [for investors].”

There is a sense here that Turkey is still catching up with the rest of the world. A country that led the world for millennia in science and invention, straddling the eastern and western world through three dynasties, had a dreadful 20th century. Hemmed in by the Soviet empire and Middle Eastern neighbours, Turkey withdrew into itself, battered by internal political crises and military coups, emerging again only as the new millennium dawned.

The country still faces manifold challenges if it is to meet Erdogan’s stated aim of becoming a top-10 global economy by 2023. Officials need to contain corruption, stiffen up the country’s rambling legal framework, and restrain the need to fiddle with industry regulations every few months. Capital markets need to be deepened and initial public offerings more tightly regulated; privatization deals must be consensually priced.

However, the country that represents what Jim O’Neill, the retiring chairman of Goldman Sachs Asset Management, described to Euromoney as the “acceptable face of Middle East capitalism”, is certainly on the right track. The next few years will be critical. Get it right, and almost anything is possible.

Read the article online at EuroMoney.

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