Turkey debate: A good time for Turkish business

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Three leading companies and Garanti Bank discuss the country’s corporate performance and access to finance. Growth is steady and firms are expanding, but there are wider macro issues that won’t go away.

Turkey debate: Learn more about the participants

EXECUTIVE SUMMARY

• Turkish companies are growing, with growth in the home markets much better than in the regional markets, where macro difficulties are hindering performance

• Turkish companies have good access to finance, especially from local banking groups, which can provide long-term finance in size

• International banks are more selective in which companies they are banking and have reduced their overall exposure to Turkish risk

• Macro factors such as the current account deficit and the fall in the value of the Turkish lira are having an affect on corporate results

• Tax requests from the government are the biggest concern for Turkish companies

Nick Lord, Euromoney What is your outlook for growth in your respective sectors?

MU, TAV In the past 11 years since we began operations as an airport operator, we have seen many ups and downs. First there was the devastating earthquake in Turkey, and then the 2001 crisis in Turkey, which was a small-scale version of what happened globally in 2008, then 9/11, then Sars disease, avian flu, Gulf wars, ash cloud, revolutions in North Africa... But when we look at our sector, we see double-digit growth in the number of passengers each year. Our compound average annual growth rate has been around 11% to 12% in the past 11 years. We are expecting the same growth rate for the next three to five years at least.

ME, Turkcell Our sector is growing and will continue to grow, thanks to several factors. In the Turkish market, from which we get close to 90% of our revenues, penetration is still low, around 85%. Mobile internet revenues are growing through 3G and smartphone devices and application downloads. Mobile internet revenues of Turkcell Turkey grew by 74% in 2010. More than 23% of our revenues are coming from mobile internet and service usage, whereas a few years ago it was around the 10% level. Another factor is the usage of smartphones. There are close to 3 million smartphones in Turkcell’s network, and lots of growth is still expected from there. Then there is the fixed-broadband business. We are selectively building the latest technology fibre-optic network throughout Turkey.

BB, Erdemir All related industries such as construction, automotive and general manufacturing are projecting healthy growth – between 9% and 14% for 2012. We will see industry growth of around 10% for next year and overall steel consumption will reach about 35 million tonnes in Turkey by 2015. Turkey is a deficit market for flat-steel products and we were the sole flat-steel producer in Turkey until three years ago. With the additional local production facilities that have started production since 2009 this deficit is narrowing. And supply and demand will be in equilibrium by 2014 or 2015. Because of the increase in competition for certain qualities of flat steel with new local producers, our objective is to increase our export level. Exporting flat-steel products will not only be our company’s objective but also the whole industry’s.

Euromoney Does that picture sound familiar? You’re a regional company and the majority of your revenues are from Turkey but you’re growing very quickly outside Turkey as well. Does it look that way for TAV?

MU, TAV The Turkish market will still continue to grow, especially Istanbul, because it’s the hub of Turkey in a superb location between Europe, Asia and Africa. In the world, there are about 4.5 billion passengers travelling by air a year, carried by 20,000 commercial aircraft. In 10 to 15 years, depending on aircraft manufacturers and sector estimates, these numbers are going to double. At the moment, people constantly complain about the delays at airports and how crowded they are, so there’ll be huge investment needed in the airports: trillions of dollars around the world. Plus, in countries like Turkey, as people’s wealth increases, they’ll spend more leisure time in remote locations, and hence use airports even more, together with business travel.

ME, Turkcell We’re not just looking at Turkish markets. In terms of international expansion, we have operations in the CIS countries, Ukraine, Belarus and Germany. We would have made the investments before 2007 when there was significant liquidity. However, the crisis hit and all the asset prices went down and all the liquidity dried up. Right now, I believe the liquidity window is here. The global economy is still under some stress, but when you look at the growth opportunities in the region, there are much more reasonable opportunities in the emerging markets.

Euromoney Tolga, perhaps I can bring you in here and we can move on to the financing aspect. What is Garanti’s appetite for helping to finance the growth of Turkish companies, both domestically and internationally?

TE, Garanti At least in the past six or seven years, we have had a very strong, liquid, well-capitalized, aggressive banking sector. Until five or six years ago, if these three corporations had a big investment, they would have needed to be able to attract the investment from the foreign banks. In the past five or six years, however, most such investments by these corporations have been funded by local banks, even projects as long term as 12 years. That, combined with domestic demand, is why these three corporations, as well as all the other leading corporations in Turkey, are much stronger than their competitors in some other markets. But having said that, knowing their investors and the expectations of their shareholders, for them, I’m sure it’s not sufficient to benefit from the local market. Now they are all trying to generate more revenues from non-Turkish customers. Turkish banks will be happy to support them on this as well, obviously. So as long as we’re well capitalized, liquid and happy to lend, it’s a big plus for the corporations.

Euromoney Can I ask the corporate representatives here if they agree with that? Are the banks open to funding your expansion?

ME, Turkcell There has been a comfort zone with respect to support from the banking sector. But the comfort zone might be a delusion in regions where there are always problems going on. Just after the crisis, we had an operation in Ukraine, which had just been hit by devaluation and the contraction of the economy reached close to 20%. We were almost out of the crisis by 2011, but in Belarus, where we also have operations, we have experienced 73% devaluation. So for the regions where we are investing, and I believe it’s the same for TAV as well, there are regional long-term opportunities, it might be possible that there isn’t a financial market ready.

MU, TAV Airports are a very capital-intensive business. The initial required capital and leverage are very high, so we of course need the support of the banks. Even in 2009, we had the support of Turkish banks through the global crisis. So we are very thankful to Turkish banks for that. But in terms of regional growth, in Tunisia, the former Yugoslav Republic of Macedonia (FYRoM), or Georgia, since every international bank has its market focus, we work with many different banks throughout the world.

TE, Garanti In these difficult markets, FYRoM, Georgia, Belarus, or Ukraine, wherever, any corporation that is expecting to get financing for their investment will be disappointed. Without their strength in the local Turkish market, they cannot expand in the region, so their expansion relies on the success of their operations in their home countries.

Euromoney So in terms of the capital structure, local Turkish banks prefer to provide money at the top and then it’s invested internally into subsidiaries.

TE, Garanti In general, yes, in these difficult markets.

MU, TAV In the past 11 years, the growth has always been there with new airports. But that organic growth, when you’re a young company, is not that easy to finance. We borrowed capital at the parent-company level. There again we have had the support of Turkish banks because they trust us. And now that we are getting more mature, we are beginning to collect the fruits from our subsidiaries as well, which we’d promised to our lenders and which we are now delivering. So trust is very much involved.

Project finance

TE, Garanti It’s a good example. As a bank, we can provide a long-term project finance loan to a company in three ways. We can either take the risk of the project on, in a non-recourse loan to the operating company, or lend to the balance sheet of that operating company, or lend to the SPV or shareholder that controls the operating company. In the case of Bülent, the SPV that owns Erdemir is controlled by one of the biggest groups in Turkey, and the operating company is also extremely credible, so he has the luxury of being able to get any financing from any bank.

BB, Erdemir For heavy industry, our leverage level is assumed to be normal in my point of view. But unfortunately, rating agencies don’t like this level. Although our $3.5 billion investment projects sourced by foreign contractors has in large part also been financed by foreign banks and ECAs, half of it has still been financed by Turkish banks. In the past 18 months, we restructured a $1.2 billion loan from local banks very successfully. We felt that local banks were highly motivated and committed during our restructuring process to achieve the transaction. Since 2001, all developments in the banking sector in Turkey seem to be improving the value and support that local banks can provide on future projects. But we are still working with many multinational banks.

Euromoney Would you agree with that, Murat? How do you see foreign banks?

ME, Turkcell They are much more selective than local banks. Dealing with local banks is more about building a long-term relationship so they support your company from all angles without being so selective, whereas the international banks are becoming much more concentrated on different areas of funding. On the positive side, there are newcomers. There are important Asian banks, important US and European banks in the market. I believe we have increased the number of international banks in the market in the past two years, but the usual local players who fund us are much less selective on a project basis.

MU, TAV With a highly capital-intensive business with lots of regional growth opportunities, you have to work with many different names. Banks have different appetites for different markets and different countries. With international banks you work on a case-by-case basis; you go to them with a project, and if the cashflow is good, then they lend to you. But with local banks, it’s about reciprocity, which means Turkish banks enjoy more of our cross-selling opportunities. So it’s a win-win for both corporations.

TE, Garanti We have an advantage over the foreign banks in their efforts to penetrate into these top corporations in Turkey. Since we get their local business, we manage to cross-sell to generate of non-credit business, thanks to which we can provide better terms for them. Which is why the foreign banks sometimes cannot compete with us.

Euromoney Let’s move on to some of the bigger-picture macroeconomic forces that are affecting Turkey at the moment. A lot is being said and written about the risk of the current account deficit getting too wide. At a specific corporate level, has the deficit affected your ability to raise finance in any way? Has it affected liquidity from a foreign financing point of view, or your own desire to raise money?

ME, Turkcell It’s at the top of the agenda for the foreign investor base and for the government itself. Bottom line, current account deficit is drying the excess liquidity in the system, increasing the demand for hard currency, hence leading local currency to depreciate. Moreover, if you have domestic liquidity, which is the case for Turkey, the cost to access liquidity is settling at a higher level as the central bank or regulatory bodies take new measures to fight against the current account deficit and credit growth expansion. The rating agencies are now penalizing the Turkish economy for the current account deficit. That’s why we are paying higher costs, sub-investment-grade premiums, and we are also missing the liquidity window that can come from an investment-grade investor base. We are uncomfortable about their unfair attitude about our rating. It’s not fair to Turkish corporations and to the Turkish economy.

TE, Garanti I fully agree with Murat, obviously, but the good news is that markets don’t look at ratings that much. The relatively high cost of funding that we’ve been exposed to is still much better than what our ratings would normally correspond to. I mean, Turkey is double-B-minus, but look at the Turkish Eurobonds, look at the Turkish banks’ spreads. Almost all of them indicate an A-plus spread.

ME, Turkcell Since more than a year ago, we have fully deserved a higher investment grade, but we didn’t get it. We are still paying sub-investment-grade premiums, and we are also missing the liquidity window, which is going to be a first for Turkish corporations. There are a few Turkish corporations like ours who are in the investment grade, but apparently there aren’t enough, because we still don’t get the premium awarded to higher investment-grade corporations. When you look at Turkish growth, everything is superb. When you look at the region, everyone is in consensus, including international banks and domestic banks. It’s just this rating that is keeping us down.

Euromoney Where are you trading at the moment?

TE, Garanti The [sovereign] five-year Eurobonds, are around 180 basis points, 190 over mid-swaps. In Turkish banks, they’re a little lower, 300 over mid-swaps. This is the widened version of the Eurobonds. One or two months ago, for example, we did a 10-year fixed-rate Eurobond issue from 279 over mid-swaps. So he’s right, ratings are extremely unfair. However, the good news is that markets don’t only look at the ratings.

ME, Turkcell I can also include the regional competition in this. Right now we are paying a much higher premium compared with the Russian market, despite the transparency differences. So I believe very strongly that we are receiving unfair treatment because of the current account deficit. We know the root causes, and we know how to address them, and we have the political will that you can’t find in most countries right now. Look at how the European nations have tried to handle a rescue package six times in the past 18 months: there is no consensus. So I believe, yes, it is 8% or 10%, but it can still be financed, and if it is financed...

TE, Garanti It is good. Even if it is not financed, the exchange rate is going to go up, which will balance the whole thing, as we saw in the first quarter of 2009, and after Lehman collapsed. Liquidity dried up, the exchange rate went up, but in February 2009, the current account gave a surplus. So even in the worst-case scenario, there won’t be a crisis in Turkey.

However, it’s very important for the Turkish corporations to start abandoning their foreign-currency-using habits for working capital purposes, and switch over to Turkish lira, which is what most people are doing at the moment. Long-term project finance still might need to be in foreign currency. But working-capital loans, in the new environment in Turkey, should start to be in local currency.

Euromoney Bülent, you looked a bit sceptical when he was talking, is that because your sales are linked to hard currency?

BB, Erdemir Actually this is not directly our case because our sales and purchases are denominated in US dollars. But our reporting currency for the consolidated financial statement is Turkish lira, so in the short term this kind of fluctuation affects the bottom line of our financial statements a lot for our reporting purposes. However, there is no actual cash effect of short-term fluctuations in our financial statements.

Euromoney How do you hedge your FX risks? Is that on the balance sheet? Do you use derivatives?

BB, Erdemir We do make some transactions, but as I said, our sales and purchases are denominated in US dollars. Apart from reporting in Turkish lira and the effect of short-term FX fluctuations to the bottom line of our financial statements as a consequence of Turkish lira reporting currency, we don’t face a foreign-currency risk.

TE, Garanti The price of your product is in dollars?

BB, Erdemir The price is in dollars, all receivables are in dollars, payables are in dollars, borrowings are also in dollars. But any kind of impacts that may threaten our end users and producers due to FX fluctuations shall affect our demand. So if the demand for our products goes down rapidly, although we are not facing that kind of currency risk, we still face a commercial risk.

TE, Garanti You cannot sell.

BB, Erdemir We always have to keep producing as we are in heavy industry. We can’t fully stop our production in certain factories, no matter what happens. Therefore we have to sell our product without waiting for any kind of self adjustments in the markets.

Euromoney Murat, you mentioned the local corporate bond market. How interested are you in the development of Turkish lira corporate bonds, taking your local financing and local funding structure out by a number of years, say five? Are you actively considering that market?

ME, Turkcell We are considering that market. I believe that should be the priority, like Tolga said. In Brazil, the reason they are successful right now is because they developed a significant local funding market. Everything’s OK in Turkey’s debt market, but the profile on the debt market has to be completely restructured. At Turkcell, we are a cash-rich company compared with other Turkish corporations. Not only are we cash-rich, but our ebitda is positive, which minimizes our need to enter the corporate bond market.

TE, Garanti They don’t have working-capital loans. They don’t need it.

ME, Turkcell We are supporting all the corporations to move in that direction. At Turkcell, at the group level, we’d like to raise that local funding for our subsidiaries where they need working capital.

Euromoney So for the roll-out for the fibre-optic network, and things like that?

ME, Turkcell Yes. Though we have a centralized approach, we guide our subsidiaries to fund themselves when they reach a certain financial performance level, meaning when they produce at least a positive ebitda. Right now we are in the second stage in our funding strategy to support our group companies to source funds on a non-recourse basis from the debt and capital markets and if possible in local currency.

MU, TAV Yes, well I’m an ex-banker as well, like Murat, but we are not financial institutions. We want to earn from the operations side, not from financial speculation. Cash is accumulating in our operating companies. Naturally, a fixed inflow enables us to borrow in FX as well, but we don’t take any financial risk on the borrowing or lending side.

Euromoney There has been a general weakening of the lira over the past two months. Has that improved your balance sheet or your earnings?

BB, Erdemir Actually, our balance sheet position is open. Our US dollar borrowing is much higher than our assets. On the reporting side, unfortunately, the high exchange rate hit us in our monthly accounts. But it doesn’t mean the end of our world; after five to six months, it will recover on Turkish lira terms, because all receivables, payables and borrowings are denominated in US dollars.

ME, Turkcell We have to distinguish between the corporations that, on a reporting basis, might record those losses or gains, versus the corporations that are in the same position but do not generate cashflow. These are the ones that are under threat in the Turkish system. The ones that cannot generate cashflow in hard currency and even cannot generate any positive free cashflow numbers. But for the corporations like us, this is just a reporting outcome and is a non-cash issue.

Euromoney The Turkish Industrialists’ and Businessmen’s Association [Tusiad] has released a survey of leading chief executives in Turkey, asking what their main concerns were in the coming year, and one of the main concerns they had was legal uncertainty. Now that the new commercial code is coming into effect in 2012, how are you looking at the way your company’s structured, from a legal point of view, and are there any concerns of yours about how it affects your operating environment?

BB, Erdemir Because we are a quite big corporation in Turkey, we have already been subject to whatever has changed in the commercial code. So from our point of view, the world hasn’t changed. Only the regulation has changed, and their approach to us.

MU, TAV The commercial code might bring some more transparency, which we have actually met. We have a corporate governance rating that is the highest in Turkey. So all the transparency is already there. Thus I don’t believe we’ll be negatively affected by the new code.

Euromoney As a company with important foreign shareholders, Murat, do you think the extra transparency that the commercial code will bring will help Turkey’s overall investability for foreign equity investors?

ME, Turkcell I believe so. But not for the corporations like us that have already been listed in various stock exchanges, that have already achieved corporate governance levels and certain levels of transparency. It is just a governance issue, to which we are used to adapting over the years. If they adapt quickly enough, the rest of the companies in our ecosystem will become much more bankable, which is going to help us as well.

TE, Garanti The commercial code is going to bring much more transparency, which is good, but most businessmen are probably more concerned about the tax side. Some big corporate groups have received big tax penalties, which have arisen from differing interpretations of tax law, so they want more transparency on that as well.

Euromoney We’ve spoken about how positive the financing environment is, how new transparency levels are going to increase foreign participation, how domestic demand is strong, and how regional expansion, though it will take some time, is looking good. But what concerns do you still have? What keeps you awake at night about the outlook, from a financing and a balance-sheet perspective?

MU, TAV I’ve been asked this question a lot in the last four-and-a-half years, since we quoted TAV on the Istanbul stock exchange, and as I said at the very beginning of this conversation, the company has experienced a series of crises since its establishment. Despite all those, the growth has always been there. So if you’re asking me what keeps me awake, I really don’t know.

Not so positive

BB, Erdemir I am not as positive. First of all, due to being in a cyclical industry, our future prospects are not so foreseeable as they once were. We don’t have any kind of solid projections regarding the timing of cycles. Apart from this, from a short-term perspective, if the current account deficits continue to be financed, I don’t think there will be too much of a problem. But I do worry about the long-term demand side and another uncertainty is Europe. Twenty percent of our sales are exports, and almost 90% of our exports go to Europe. So any kind of crash in Europe that affects demand of our products will hit us.

ME, Turkcell We should not exclude the global investment climate. There is no solid recipe for world growth. I believe we are part of it, although we are much more immune compared with other countries in the region. Let’s not forget that half of the banking sector shareholders are from the international side, so we will be affected by whatever goes on globally.

Euromoney How is Garanti looking to support Turkish companies to overcome the risks they face?

TE, Garanti It’s a pleasure for us to provide consumer loans to your customers to boost demand. It’s a fact that consumer loans are increasing, which is helping local demand be even stronger. And as long as I see a strong capitalization in Turkish banking, despite the efforts by the government to stop us, we continue to grow. I think the most important concern is the global markets, as Murat said. There appears to be no solution on the European side. It’s impossible for us to stay completely immune, but don’t forget what we demonstrated in 2010, when the whole world’s growth was very slow but Turkey grew by 10%. We can, for a number of years, sustain high growth in our country in the absence of demand for our exports. Finally, Turkey should not take the overheating economy in the country for granted. We can’t forget the importance of encouraging manufacturing and production investment in the country, which is the only way to achieve a more balanced economy.