Indonesia’s equity challenge

INDONESIA HAS THE largest economy in southeast Asia but its equity market is a minnow. According to Dealogic, since 2005, Indonesian companies have raised just $3.82 billion from 39 issues. Although the Philippines’ market raised marginally less over the same period, its economy is tiny compared with Indonesia’s, which has the lowest equity market valuation to GDP of any market in Asia.

This underperformance has nothing to do with a lack of enthusiasm for Indonesian equities: the Jakarta Stock Exchange Index has almost trebled in value over the same period. The answer lies in the idiosyncratic way in which Indonesian capital requirements have been funded.

"Prior to 1997/98, Indonesia was primarily a loan market," says Suresh Narang, managing director, chief country officer and head, global markets, at Deutsche Bank in Jakarta. "There was no fixed-income market, there were some equities, mainly nominal listings."

"It’s the hedge funds that have led the way in taking Indonesian risk" Fergus Edwards, UBS

"This all goes back to the crisis and the fact that almost the entire investment banking community left Jakarta," says a debt syndicate head. "Credit Suisse were the only guys not to pull out and they were mainly extending credit lines to a few select families."

It is also closely tied to the fact that Indonesian companies, invariably controlled by powerful dynastic families, have an obsession with control and would therefore much prefer to raise debt to fund development projects and capital expenditure than raise equity that might eventually dilute the family holdings.

"They don’t really need to give up control provided they can get someone to fund them," says an investment banker. "The whole concept of shareholder returns doesn’t really exist in Indonesia. It’s all about the family: it’s been like that for 50 years and it’s been more like an overgrown retail banking operation than an investment banking market ever since."

Convenient alliance

That might be a little unfair. Indonesia is not alone among Asian countries in having significant family-controlled business empires – think of Korea, the Philippines and Hong Kong – but what has certainly prolonged the influence of the family conglomerate in Indonesia perhaps more than in other markets is the ability of these businesses to secure the requisite funding on attractive terms without resorting to raising equity that would ultimately dissipate their control. And for that, they can thank the hedge funds.

"When the NPL pools dried up in Indonesia after the crisis, a lot of investors looked to see who else needed their money," says Fergus Edwards, executive director and head of debt syndicate at UBS. "It’s the hedge funds that have led the way in taking Indonesian risk for the higher return it offers compared to other markets; much of this investment has taken place through the credit market."

The advent of the carry trade led to the timely arrival of large hedge funds in Asia seeking higher-yielding returns. They found a lot of them in Indonesia.

One of the first such deals in Indonesia to be financed using significant capital from hedge funds was a $385 million 2.5-year loan for Kaltim Prima Coal (KPC) arranged by Credit Suisse effectively on behalf of the Bakrie family’s holding company, Bumi Resources, in October 2004. The deal was cut after KPC failed to raise sufficient interest for an international bond issue. The largest such loan from an Indonesian company since the crisis, the syndicate comprised 24 institutions including banks and hedge funds. The deal was refinanced a year later through a Bumi Resources securitized bond.

"Most banks couldn’t get this deal through their credit committees," says a debt banker. "That was just about the time the hedge funds arrived en masse. KPC was the first deal in the region to prove you could do it."

This alliance of convenience between yield-hungry investors and Indonesian companies seeking large sums of capital with few strings attached has persisted ever since. Highly structured loans and equity-like investments have been packaged and sold to banks and hedge funds for Indonesian resources companies such as Medco Energi, Bumi Resources and Berau Coal. Many others, say bankers, have been structured and sold "below the radar" of public scrutiny.

"These kinds of deals have worked because there’s a twist that public markets find hard to price," says Edwards, "but sophisticated accounts can properly diligence: risk associated with the name, or the owners don’t want to give up equity, or the business needs the funding right now."

So successful have these club deals been that they have even spilled over into the public high-yield debt markets.

Risky agenda

A $400 million high-yield issue from shipping company Berlian Laju Tanker in April priced at just 291 basis points over US treasuries for a seven-year non-call five bond that generated more than $4.8 billion of demand. Resource company Indika Inti Energi raised $250 million from a highly structured high-yield bond collateralized on an asset the company did not even control, a deal that many in the market regarded as best left to the private finance sector. And in August, start-up cellular operator Mobile-8 Telecom raised a $100 million bond that yielded 11.25% for 5.5-year money.