The M&A industry can be more complex than it first appears, and is affected by a complex web of factors across the financial markets. MUJTABA KHALID provides us with an outline of the sector, before taking us through the opportunities and challenges currently available in the Shariah compliant space.
The terms ‘merger’ and ‘acquisition’ (M&A), although often used as though they were synonymous, in fact mean slightly different things. A merger implies the combination of two companies into one larger company for some economic or other strategic reasons. Acquisition is gaining effective control over the management and ownership of another company — from a legal point of view, the target company ceases to exist.
According to the MergerMarket 2013 M&A Report, global M&A was valued at US$896.1 billion in the first half of 2013 — down 12.5% compared to 2012 (US$1.02 trillion), and suffered from 12.2% fewer deals. Cross-border deals (in value) between countries in the first half of 2013 fell 19.8% from the previous year.
Some of the key reasons that a company may decide to sell a part of its business can be:
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Raising capital
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Exiting a particular sector
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Exiting a particular geography
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Competition authorities forcing sale
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Insufficient capital to drive growth.
Some of the key reasons that company may decide to acquire or takeover part (or whole) of another business can be:
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Economies of scale
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Increased revenue/market share – Acquisitions to access new customer segments
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Cross selling — a bank buying a stock broker could then sell its banking products to the stock broker’s customers
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Synergy
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Geographical or other types of diversification
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Resource transfer
Takaful industry M&A activity
According to the Ernst & Young (EY) Global Takaful Insights 2013 report, over the past five years the Takaful industry has seen considerable success, with substantial growth in gross written contributions (GWC). However, recent data shows an alarming deceleration of this fresh industry, from 22% (2007 to 2011 compound annual growth rate) to 16% in 2012. Global gross Takaful contributions were estimated to touch US$11 billion in 2012 (from US$9.4 billion in 2011).
Although growth potential is high, various strategic and political issues are dampening the available opportunities. The silver lining of the industry is the development of the Family Takaful sector, which continues to show positive growth momentum particularly in ASEAN markets.
To evolve into the next stage, the Takaful industry should look to anticipate the complex and changing needs of the public, who are no longer satisfied with having only the fit-for-all and off-the-shelf products. The demand is for Takaful products which are bespoke and match customer needs and aspirations both in product design and delivery. This need is heightened by the existing intense competition among Takaful product providers in some of the high risk insurance markets such as auto and medical insurance, which is causing harm to the natural growth of the industry and risks the integrity of the impetus of the Shariah compliance element in the Takaful business altogether.
M&As with conventional established insurance institutions can help Takaful companies learn from the vast experience of conventional insurance operators. This can enable Takaful operators to offer differentiated products and shift the focus of the Takaful operators from competing solely on price to competing on product innovation. This in turn would lead to the development of the Takaful industry, increasing not only penetration but also the size.
Issues faced by prospective international buyers
Economic and regulatory uncertainty: Assuming that the global economy continues to pick up, the growth in the insurance and Takaful space should accelerate as consumers seek to protect valuable assets such as autos and homes.
However, due to the recent economic problems in Europe as well as the Russian situation and emerging markets underperforming, there has been uncertainty in the market. Couple this with the fact that different jurisdictions have different Takaful guidelines and regulation makes the task even more daunting for potential M&A initiators. For example in Malaysia, the regulations are more inclined towards Basel, while different jurisdictions in the Middle East like Bahrain or Saudi have their own distinct guidelines.
Risk management and Shariah controls: Currently, there is an absence of standard positions in different jurisdictions on issues such as surplus sharing, the obligations for the provision of Qard to cover deficits in the participants’ fund and the rights of participants in Takaful companies. Lack of uniformity in regulatory frameworks results in reporting challenges for operators who function across jurisdictions — this also makes it challenging for conventional insurance firms looking at cross border M&A activity. In different jurisdictions, there are a number of different Takaful models in operation creating confusion among the consumers and creating a dangerous perception that Takaful is no different from insurance. This is leading to a decrease in confidence among the public. Moreover, due to a lack of global standardization, compromising of Shariah requirements might become an issue. In this respect, the challenge of convergence and harmonization becomes an urgent matter.
Deal complexity: Many a recent international M&A deals have been complex, highly structured transactions; for example companies unwinding themselves by selling subsidiaries or lines of business, joint ventures, restructurings and cross border deals subject to multi-country tax regulations. Add to this the fact that with Takaful deals having an added layer of Shariah compliance, international Takaful M&As become a very daunting task which can take longer to structure, negotiate and execute.
Capital requirements: Owing to new capital adequacy requirements, Takaful operators are required to show regulators they are well capitalized, therefore a higher investment amount is needed to strike an optimal deal. Moreover, changing European and American regulations requiring companies in those jurisdictions to demonstrate to regulators that they are well capitalized might lead to a reduction in their appetite to engage in M&A as regulators are expected to pay close attention to the capital implications of any acquisition. Also, if a company has to put more capital into the business, this may lead to a reduction in ROE and keep the organization from reaching its hurdle rate, which could also discourage M&A.
Alternative uses of capital: Many companies in the insurance segment are trading below their historic book value. Due to this discount-to-book issue, many insurance companies with excess capital have bought back stock rather than transacting M&A deals. Some companies have also been exiting certain lines of business or markets and using that capital to shore up remaining operations and older acquisitions, or pay back shareholders. These practices however, cannot be sustained for a long period as companies may be unable to meet shareholders’ and analysts’ growth expectations. Therefore, international companies might have no option but to look to newer niche segments like Takaful in high growth emerging markets where they can achieve higher returns than in saturated markets such as Europe and the US.
Conclusion
Cross-border M&A activity can be a first step towards harmonization — at least from the consumers perspective; if one firm has a capacity to operate on a larger scale, as compared to a regional (or domestic) one, the firm can apply business best practices across all the businesses. The Takaful industry can learn from conventional insurance in areas such as enhancing internal control mechanisms, risk management and governance frameworks. Emphasis on company-wide Enterprise Risk Management (ERM) systems and corporate governance is the key to operational excellence in the industry. Conventional firms which are looking to merge with or acquire Takaful businesses need to understand the importance of having a strong Shariah framework.
Mujtaba Khalid is a senior associate at the Islamic Finance Council UK (UKIFC). He can be contacted at
[email protected]
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