01 July 1998

If you've got it, spend it (Euromoney)

Copyright Euromoney Publications PLC Jul/Aug 1998

Once conservative Japanese securities house Nomura has been on a central European spending spree. But its acquisitions, of both banks andindustrial companies, are causing controversy among governments and competitors. Jason Bush reports

Nomura used to be a byword for caution and conservatism. For decades, the Japanese securities house shied away from risk, and built up huge capital reserves. But in recent years Nomura has been establishing a new reputation for itself. The days of parsimony are over: Nomura's new motto is spend, spend, spend.

Nomura can afford to go on a spending spree because of its large capital base and very low levels of debt. "We can do it because we've got it: we have $14bn in shareholders' equity," says Michael Boardman, head of equity new issues at Nomura International. "Our leverage is also very low. This is because of a historically conservative approach to life and the universe. But that's changing. They realized they had to use this capital base in the best interest of shareholders.

In recent months, Nomura has been investing an increasing amount of its own money in central and eastern Europe. According to Boardman, Nomura has around $lbn invested in central and eastern Europe, the middle east and Africa - most of it in emerging Europe. "There are not a lot of houses that can say that," he says.

One explanation for this exposure is Nomura's increasingly heavy proprietary trading, particularly in the Russian GKO market. According to Daniel Jackson, Nomura International's deputy managing director for emerging Europe, over the past 18 months Nomura has been heavily involved in proprietary debt trading. He says that this in turn parallels the growing interest in the market from Japanese investors. In the long term he does not think they will be put off by the current instability in emerging markets. "Japan's domestic problems will lead to a strengthening of capital exports, because domestic investment opportunities don't exist," he says.

The other reason for Nomura's growing exposure is the expansion of its corporate finance business. In the past few months Nomura has embarked on a new strategy in the region. This involves committing large amounts of the bank's own capital to direct acquisitions. In March, the firm bought the Czech bank IPB (Investicni a Postovni Bank). It has also successfully bid for the Bulgarian bank Post Bank, with signature of the deal imminent as Central European went to press.

Nomura's appetite for direct stakes has not stopped with banks. Unusually for a financial institution, it has also acquired major industrial holdings. Last year it bought a $60m direct equity stake in Romanian tyre manufacturer Tofan, as part of a $100m financing. Nomura's readiness to put its own money on the table enabled it to beat off competition from WestMerchant and Societe Generale, which were also pitching for the deal.

According to David Tate, WestMerchant's director of central and east European equities: "We were coming up with syndicated loan solutions, but we had to compete with Nomura offering a private equity partnership ... We are looking at putting $5m or $10m into deals, so we are not competing. It was a very sporty move by Nomura - but they picked an extremely good company."

Last year Nomura also acquired an $18m stake in Polish metal producer Impexmetal, and a 60% stake in Czech brewery Radegast. The purchase of IPB means it has also inherited the bank's industrial holdings, including Prazdroj, the largest brewery in the Czech Republic.

The man behind the new strategy is Randall Dillard, the managing director of central and eastern Europe group at Nomura International, Nomura's London subsidiary. He explains that the inspiration comes from Nomura's merchant banking activities in the US and Britain.

In the US, Nomura Holdings America has pioneered the so-called mega deal, which involves investing as much as $500m at a time in real estate and then securitizing these assets by issuing bonds. In Britain, the buzzwords have been principal finance. Guy Hands, ex-Goldman Sachs, and now head of Nomura International's principal finance group, has been making the news with acquisitions of a motley collection of assets, including pubs (Nomura is the biggest pub landlord in Britain), ministry of defence housing, railway rolling stock and the betting shop chain William Hill. According to Paul Heaton, a banking analyst at Deutsche Morgan Grenfell in Tokyo, since the operation was established in 1994 Nomura has invested $17bn in principal finance, mostly in Britain.

The goal of these acquisitions has been to pass them on to other investors, either through securitization, or else by finding a new buyer for the assets. So far it has been a lucrative strategy. "Nomura has been able to make returns of up to 50% in three years," says Heaton. Last year Nomura sold the railway rolling stock company Angel Trains for L1bn ($1.6bn), having paid L700m for it eleven months earlier. "It's fairly risky of course. If the economy turns down you're left with something you can't sell," he notes.

All this is a far cry from Nomura's traditional activities. Until the 1980s, Nomura stuck to the buying and selling of Japanese securities. But in recent years, the disappointing performance of the Japanese stock market has resulted in Nomura going international, and expanding the range of its operations away from its traditional brokerage activities, with largely independent subsidiaries in New York and London.

This has had impressive returns, which have contrasted with the lacklustre state of Nomura's domestic business. In 1997 Nomura's international operations accounted for 80% of the group's profit.

Given the success of its operations in Britain and the US, it is not surprising that Nomura should be looking to apply the same techniques elsewhere. Central and eastern Europe was an obvious location. Nomura International, Nomura's London arm, has been active in the region since the beginning of the 1990s. It has not been put off by recent instability. "Nomura can take a long-term view," says Boardman. "Central European markets have gone belly down. And yet since then we've acquired IPB and a stake in Bulgaria. The fact that the market has gone up or down in nine months is neither here nor there."

Nomura's strategy has involved gaining exposure to a market through fixed income advisory work, and using this experience as a basis for expansion of corporate finance activity: "We have used the fixed income business as a pathfinder. It's fair to characterize the period 1991 to 1996 in that way," says Nomura's Jackson. Nomura carved out a niche for itself in ratings advisory work (in 1992 and 1993 it had 80% of this market). It has consequently underwritten a number of debut issues, beginning with Czechoslovakia in 1991, the Czech Republic in 1993, and the Slovak National Bank in 1994.

Nomura's biggest direct investments are therefore in the Czech Republic, where it began its advisory role in the early 1990s. In March Nomura purchased a 36% stake in IPB bank, for Kr2.9bn. This was immediately followed by a capital increase of Kr6bn, funded by Nomura.

The purchase of the government's stake, together with the capital increase, gave Nomura 71% control. But this was reduced to 53% when Nomura sold part of its stake in June. Dillard says that Nomura ultimately intends to hold a stake of just below 50%. That will enable it to avoid a Czech legal requirement to make a public offer for the remaining shares.

However, Nomura's control over the bank is in practice greater. Many of the remaining shares are owned by companies owned in whole or in part by IPB itself, such as the investment find Bankovniholding. "Effectively Nomura still controls 80% to 85% of the bank," says Martin Nejedly, banking analyst at Prague brokerage Wood & Co.

As with Nomura's recent principal finance acquisitions, the plan for IPB is to sell it. "We see a holding pattern of between two and five years," says Dillard. "I imagine a strategic partner will join us and we will gradually release control through GDRs," he says.

Nomura's strategy of buying in order to sell for a profit has invited the criticism that the companies are not gaining strategic owners. There are also complaints that, if Nomura can make a quick profit, the assets must be being sold for less than they are worth. However, most analysts believe that the Czech government got a reasonable price for IPB bank and its holdings. Nomura also inherited the bank's substantial liabilities, notes Vojtech Kraus, equity analyst at ING bank in Prague. "The important point is that the government didn't strip out the bad loans;' he says. "It was not such a bad deal for the government and will be very beneficial for the bank."

Dillard remarks: "There was a lot of suspicion about IPB. We have had bad publicity. The bank has a lot of industrial holdings and people said that was the reason we bought it. But we thought this company was not as bad as the market felt." He points out that to sell for a profit it is necessary to add value for shareholders.

This raises the question of how Nomura, a securities house, can add value to companies such as retail banks, brewers or tyre factories, where it has no specific expertise. According to Dillard: "In central Europe, we like to ally ourselves with strong management. We bring outside capital. We want to avoid investing in companies where there's a substantial amount of work involved."

He admits, though, that in the case of IPB more active restructuring is required: "We can't just sit back and write cheques;' he says.

However, in IPB's case the most important restructuring is on the financial side of the bank. In the past its share price has been depressed because of concerns over its balance sheet and lack of transparency. "No foreign portfolio investors are interested because of the bad experience they've had over the last couple of years. If the bank was as transparent as Komercni or Sporitelna the price would be much higher;' says Wood & Co's Nejedly.

Nomura's first step was to wipe the bad loans off the balance sheet and invest new capital, which has addressed one major concern. Nejedly also sees improvements in transparency and the position of minority shareholders. The bank is preparing a rights issue which will enable these shareholders to purchase additional shares on favourable terms (three new shares for one old share). This addresses a complaint that when Nomura bought the government's stake, it did so for a nominal price (Kr100) below the market price (Kr140).

However, Dalibor Vavruska, banking analyst at ING in London, is not so sure. She wonders why Nomura, having committed itself to a public rights issue, unexpectedly divested itself of an 18% stake in advance of the issue. If the terms of the forthcoming rights issue are so favourable, she asks, why is Nomura only expecting to reduce its stake from 53% to 48%? "The dilution risk I see is still there. We downgraded our recommendation for IPB until these issues are resolved," she says.

On the operational side, Nejedly is optimistic about IPB's business prospects. "From the management point of view, IPB has done the best," he says. He gives the example of nonbanking activities, such as building societies and insurance, where IPB has acquired 50% shares of the market. The big growth area is retail banking. IPB has a natural advantage because, like Post Bank in Bulgaria, it has a large branch network based on its role as a bank-cum-post-office.

Although Dillard downplays the role of IPB's industrial holdings, others believe that Nomura stands to make big gains from these acquisitions. IPB bank is one of the major owners of investment funds and has, as a result, acquired substantial chunks in Czech industry. These include major stakes in the food industry and pulp and paper industry, as well as the leading tile manufacturer CHKZ and leading brewery Plzensky Prazdroj. "Nomura will either sell them off to strategic partners, or else may get corporate finance mandates," says Nejedly.

The purchase of IPB means that improbably for a Japanese securities house - Nomura now plays a leading role in the Czech brewing industry. IPB owned an 84% stake in the largest brewery, Prazdroj, which has a 28% share of the market. Nomura has also acquired 60% in the third largest brewery, Radegast, with a 14% market share.

Nomura's links with the industry go back several years. In the early 90s, when Dillard was Nomura's representative in the then Czechoslovakia, it advised the government on brewery privatization. Jackson, who joined Nomura from Citibank in 1991, remarks: "At Citibank I was doing AAA transactions, then two weeks later I was in Pilsen advising a brewer not to brew his beer in oak barrels."

Czech beer is big business. For one thing the Czech Republic has the largest beer consumption per head in the world. It also has many famous brands with potential for export. Dillard's explanation for Nomura's interest is straightforward: "The Czechs make very good beer. After all, they invented beer, back in the twelfth century"

The more immediate reason for Nomura's activity is the money-spinning potential of merging Prazdroj and Radegast. A merger would increase the combined value of the companies by at least 25%, or Kr3bn. That is more than Nomura paid for IPB bank, recouping its investment at a stroke.

The proposed merger has led to a showdown with Bass, the British brewing company. Bass owns the other leading Czech brewer, Prazske Pivovary, which has a 14% market share. Bass also wants Radegast for itself, and already owns a 33.4% stake in the company.

Graham Staley, Bass's country director for the Czech Republic, says that the merger of Prazdroj and Radegast will create a monster, with a 41% market share, which will squeeze the other brewers out of the market. He predicts it would have a 60% market share within two years.

According to Nomura's Dillard, the merger is necessary to make an internationally competitive company. Staley describes that as a "rubbish argument" He points out that brands such as Budvar have been able to compete internationally despite their small size.

Last December the Czech antimonopoly commission ruled against the merger. However, in June it revised its previous decision and announced that it will make a new judgement within 60 days. It justified this reversal with the observation that Nomura's appeal against the decision was based on "sound and founded" arguments.

Bass's Staley believes that the antimonopoly commission may now rule in favour of the merger. He puts this down to IPB's success at lobbying. "They can have meetings with cabinet ministers, while we have to wait six months," he says. How the Czech Republic's recent inconclusive elections will affect the relative lobbying strength of the two parties is unclear. But local analysts believe that the decision is likely to go Nomura's way.

Even without the merger, Bass and the smaller Czech brewers are suffering from Prazdroj's pricing policy, which has contributed to low margins for the sector. Czech beer, at between 30 cents and 60 cents per half litre, is eight times cheaper than beer in western markets. The effect of Prazdroj's aggressive pricing has been to increase its market share, which makes it a more attractive buy to an international brewing company - the ultimate goal of Nomura's interest in the company. "An international brewer wouldn't look at profitability - it would look at market share," says Staley.

Bass is suffering not only as the owner of rival brewer Prazske Pivovary, but also as a 33.4% shareholder in Radegast, which has been losing market share to Prazdroj. Staley points to the fact that, while Prazdroj has been cutting prices, Radegast has been increasing them.

He also criticises the lack of transparency within the company. Nomura's and IPB's stakes in Radegast have been sold to IMP Finance, a company registered in the Netherlands. However, at Radegast's annual general meeting on May 28, Bass's two representatives were turfed from the board and replaced by representatives from Nomura, which now has four representatives out of nine. "That tells you a lot about Nomura and IMP," says Staley. According to Wood and Company's Nejedly: "IMP Finance is a Dutch vehicle for Nomura."

IPB's 84% stake in Prazdroj has also been sold, in March, to a company called Ceske Pivo (Czech Beer), which is also registered in the Netherlands. "Who owns Ceske Pivo? It's a tangled web," says Staley. However, two out of the company's three representatives on the Prazdroj board are from Nomura.

Staley nevertheless has some backhanded compliments for his rivals. "If I was Nomura I'd do exactly the same thing ... I'd like to meet Randall Dillard - so far I've only traded insults with him at shareholders' meetings. He's a very clever man."

It is not only in the Czech Republic where Nomura has run into controversy. In Bulgaria, Nomura was selected as preferred bidder for Post Bank following a tender in February. It beat rival bids from National Bank of Greece, American Insurance Group and Bulgaria's Eurobank, having reportedly offered $24.6m. The Bulgarian Bank Consolidation Company (BCC) then established a deadline of 90 days for the completion of negotiations. Yet since then the deadline has expired, and the deal had still not been signed by the end of June, when Central European went to press. Sources at Nomura say that the deal has been finalized and is awaiting approval from the Bulgarian cabinet.

This follows tough negotiations. In May Peter Zhotev, the head of the BCC, even went so far as to announce publicly that the BCC would consider reopening negotiations with the failed bidders. He explained that Nomura would be required to hold on to a stake of at least 50% plus one share, for a period of not less than two years. This has fuelled speculation that Nomura had been aiming to sell a major part of its stake within a shorter period of time.

According to a source at Nomura, another sticking point has been access to Post Bank's distribution network. Unlike IPB, Post Bank lacks industrial holdings. The main attraction for Nomura is the potential for the development of retail banking. Like IPB it is linked to the post office. "We love post offices because they are culturally familiar places, with access to a branch network cheaply," says Dillard. But the terms of Post Bank's access to the post office network have been subject to hard bargaining.

The difficulties of the Post Bank negotiations are reminiscent of the tortuous negotiations over the sale of IPB. At one point Czech finance minister Ivan Pilip said publicly that he did not trust Nomura. He also accused it of prolonging the negotiations, as has Bulgaria's Zhotev.

Dillard makes light of the difficulties: "When the state acts as seller they need to comment a lot publicly... They have a lot of people to satisfy. We know that and are patient, but they get under pressure."

The government's tough line reflects criticisms in the domestic press about Nomura's short-term strategy. The defeated bidders are also unhappy. Hristos Katsanis, director of National Bank of Greece, the runner up in the bidding, says that two years is too short a period to hold the bank. "It's not the best strategic move. But Nomura are very good at lobbying," he says.

Nomura's involvement in Bulgaria has not followed its strategy in other countries, where it has begun with fixed income advisory work (though earlier this year it pitched unsuccessfully for Sofia's debut Eurobond). However, it is keen to stress that it is not there to make a quick buck: in June it won the mandate to advise on the privatization of Bulgartabac, the tobacco company, and according to Dillard Nomura is also interested in subsequent bank privatizations.

More generally, Dillard dismisses the charge of short-termism: "Making money is what companies are about. The question is: are you going to create more value for shareholders or someone else? Very few people have the confidence to invest their own money. The negative comments usually come from people selling advice for money, but we think providing capital is more helpful than taking money by providing advice."

by Jason Bush. Central European. London: Jul/Aug 1998. Vol. 8, Iss. 6; pg. 15

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