Since restructuring balance sheets post the late-1990s crisis, Asian companies have enjoyed an uninterrupted build-up of cash reserves and a corresponding reduction in debt levels. According to ABN Amro, in 1998, the nadir of the crisis, average net debt to equity was 60.5%. That ratio has fallen dramatically to around 25% now and will drop below 20% in 2006.
The lack of gearing is now suppressing returns on equity of Asian companies, says ABN Amro, an important factor in valuation. And companies face pressure to improve their capital management or return cash to shareholders. Dividend pay-out ratios have risen steadily as a result. The Asia ex-Japan dividend pay-out ratio now stands at 39%, according to research from Citigroup, the world’s second highest behind Europe. In 2000, Asia’s ratio was just 24%. In Malaysia, Singapore and Taiwan, companies are now returning more than 50% of earnings in dividends.
Citigroup has calculated another neat way to demonstrate just how much cash Asian companies are hoarding. Based on free cash flow forecasts, it reckons that 37% of Asian companies under its coverage could privatize themselves in less than five years, amounting to a return of capital of some $432 billion.
That of course begs an obvious question: Asian companies appear ripe for leveraged buy-outs and privatizations, yet buy-out activity in the region remains very much the exception. The sum of all Asian LBO activity over the past 15 years does not even equal the total for either Europe or the US alone in 1990, says Citigroup. Cultural issues, a proliferation of family-controlled businesses and restrictions in some markets have stymied the development of the buy-out market.
In the meantime, there is another use for all that cash on the balance sheets of Asian companies. While M&A activity in Asia remains low relative to western markets, one key theme to watch for is M&A from Asia to the rest of the world.
Asian companies are “asset heavy”, says Citigroup, with a higher ratio of tangible assets to enterprise value than western competitors. They also produce lower returns on equity. Higher returns justify higher valuations.
The opportunity for Asia’s companies is to use all of that free cash to transform their businesses into “asset light” models by leveraging their existing production know-how and clean balance sheets to acquire distribution channels, technology and brands.
Success in doing so would not only transform Asia’s corporate landscape, it would also fundamentally change the valuation paradigm. And that way, everyone would benefit, including international investors.