Doing deals in growth economies remains challenging

​HO CHI MINH CITY, 10 Aug 2018 – Thanks to stable macroeconomics, an attractive demographic window with a rising middle-class, and strong potential capital investment growth, the Vietnamese real estate market continues showing irresistible appeal to foreign investors, mostly through mergers and acquisitions (M&A). The enquiries come from a variety of investment purposes, such as capital deployment from established funds, private equity firms, real estate developers, Real Estate Investment Trust  (REITs), business expansion requirements, apart from local Vietnamese groups who are actively expanding their footprint.

The common structure that most foreign companies prefer is investing in a majority shareholding in the project company to join the development. Otherwise, investors might take a minority share as a capital investor or an equal share to co-develop. For illustration, Frasers Property entered into a conditional share purchase agreement with Tran Thai Lands Company Limited to acquire 75 per cent in a residential development in District 2.

CRE Asia has invested 30 per cent into SembCorp Infra Services with Sembcorp Development holding the remaining 70 per cent. Similarly, Nam Long Corporation continues co-operating with Japanese partners at a 50-50 joint venture to develop Nam Long residential projects.

In spite of high M&A records in recent years, striking deals in growing markets like Vietnam remains incredibly challenging. From our observations, though a transaction is set to be completed within three to six months, it can be a lengthy process and the majority of the deals might take a year—sometimes they even drag out for two or three years. There are plenty of reasons for this.

Firstly, deal sourcing to identify the best opportunities that meet the requirements of major investors is always a key challenge. In particular, in a growing market which lacks transparency and adequate information, it is a challenge to reach the right target. The right target encompasses the following criteria:  a feasible project, a reasonable and trustworthy vendor, and a capable investor that fits the transaction.

Secondly, the pricing gap between the seller and the buyer can make negotiations longer and more fraught as the parties are farther away from a compromise. This is mainly subject to market perceptions, expected growth in capital investment, and the potential upside if both parties share a vision. There are a number of reasons why valuation and the expectations of vendors are inflated. Supply and demand imbalance is one of the primary influencers, as there are too many buyers, particularly with the emergence of numerous local Vietnamese groups who are now competing for deals. The scarcity of qualified projects in some 'hot' real estate areas, such as the East and South of Ho Chi Minh City, notably the Thu Thiem New Urban Area, District 2, 9 and 7, or the central business district (CBD) of District 1, also drives up the prices. Therefore, investors now negotiate with local partners that expect higher valuations and are facing pressure from bidding rivals, while more available sources of capital might also push up prices.

Additionally, an appropriate deal structure can be proposed by the seller if it can meet the conditions of the purchaser. The deal structure is particularly important from a tax perspective. Depending on how the transaction is set up, the payable taxes for the seller and the purchaser will vary considerably. This can have a significant impact on the final price of the transaction. The most preferred structure is buying the shares of the project company, known as a special purpose vehicle (SPV), as most investors require a clean and clear company with no hidden obligations. Also, it is a popular choice to include a warranty clause for a certain period to ensure tax or finance obligations.

In some cases, the purchaser may require a project transfer instead of company transfer to mitigate the risk of hidden obligations in the project company, particularly those companies with a long history of operation. Corporate governance is always strictly scrutinized. Therefore, the investor would require a thorough due diligence on both the project and the project company in all aspects of legal, financial, and tax matters before entering a binding sales and purchase agreement.

Lastly, the process could be prolonged and transaction costs could be driven up by the long list of conditions that needs to be satisfied, the taxation system or the lack of regulation. Unfortunately, in many circumstances, the deal might fall through as the parties fail to reach a final agreement at the closing stage after a great deal of effort and resources from all related parties. Therefore, the crucial factor to the success of a transaction is always identifying the right investor for the right opportunity. Thus, the key question is how to identify them?

The right investment opportunity could be defined as a feasible project owned by a reasonable and trustworthy partner. Before entering a deal, building trust in each other is considerably important. Investors rely on the preliminary information and the commitments made by the vendor, while the vendor relies on the track record, financial background, and expertise of the investor. Given the lack of transparency in the market, listed companies are more preferable for both sides because there is transparent and accessible information available on the company as well as its financial and legal status.

In most transactions, investment advisors with in-depth local knowledge and market understanding play an important role in helping the parties agree on the commercial terms and complying with each other's strict requirements during the negotiation process. With a plethora of experience in M&A activity, JLL had been recognized by both investors and sellers for our involvement and contribution in successfully executing transactions.

Meanwhile, the right investors are those who understand the nature of an emerging market with a certain appetite for risk, reasonable expectations on the returns on investment, and strong commitment to completing deals. Cultural differences can sometimes make it impossible to close a deal. Therefore, our recommendations to investors in growing markets are:

• Be flexible, patient, and persistent throughout the negotiation process. Sometimes, it might take a long time to close the first deal, however, when there is trust between partners, subsequent deals will come with fewer complications. This can be particularly seen in the case of Japanese investors. For instance, Nishi Nippon Railroad has invested their 5th residential project with the same local group, Nam Long Corporation. Creed Group and An Gia Investment is also a typical example.

• Perform thorough due diligence to identify all potential risks, measure them, and determine your level of acceptance.

• Work with experienced and professional local advisors to leverage their local knowledge and manage key deal challenges, as well as assist with negotiations and resolve issues.

The real estate market in 2018 continues to witness a record number of M&A transactions. JLL observes that there are hundreds of millions of dollars waiting to be poured into the market in most segments, including residential, office, retail, hospitality, and industrial property projects. Investors hail from countries such as Japan, South Korea, and Singapore, with an increasing number of groups from mainland China. Therefore, despite the typical challenges in conducting deals in growing economies, great success is still within reach if one comes with the right combination of patience, flexibility, and proper planning.