Kroll Quarterly M&A Newsletter – March 2012

M&A TrendsIndonesia has been lauded of late as the market continues along a solid path of growth and reform. In fact, recent months have seen Fitch Ratings and Moody’s upgrade Indonesian sovereign debt to investment grade for the first time since the Asian financial crisis nearly 15 years ago. Encouraging economic factors include low debt levels on public and corporate balance sheets, manageable inflation, a young population and domestic consumption fueling around two thirds of GDP, which keeps Indonesia relatively insulated from volatility in the world economy. As a result, Indonesia is coming into its own. Domestic companies are scaling up and overseas investors are heralding Indonesia as a rising star, with foreign direct

Successfully investing in Indonesia

We are pleased to present the latest edition of Spotlight Asia, Kroll’s quarterly M&A newsletter, produced in association with mergermarket. Contents include:

• Overview of the Indonesian M&A market from February 2011 to January 2012 including trends and exemplary deals

• Twelve months of M&A deal activity by volume, value, geography and deal size

• Interview with Kroll’s David Wildman on fraud, corruption and due diligence surrounding Indonesian M&A

Spotlight Asia Kroll Quarterly M&A NewsletterMarch 2012

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M&A trends by volume and value

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Kroll Quarterly M&A Newsletter – March 2012

investment rising to US$13.3bn in 2010, nearly a threefold increase from 2009. This growth looks set to continue, and estimates suggest FDI for 2011 will reach US$20bn.

M&A has followed suit, rising steadily over the past decade as the economy has been on a fast track toward development. Indeed, the 12 months ending 31 January 2012 saw 78 deals valued at a cumulative US$9bn, representing the highest volume of M&A activity on record for the period. The same 12 months also proved strong by value, building on the increasing inbound and domestic activity witnessed in previous years. On average, Indonesian M&A witnessed seven deals valued at a cumulative US$748m per month over the period.

Breaking down deal activity by cross-border and domestic transactions, inbound deals accounted for the lion’s share, totaling 50% of deal volume and 65% of deal value, as foreign bidders sought access to this promising market. The domestic M&A market also accounted for a significant portion of deal flow – 44% by volume and 23% by value.

The largest domestic deal for the year came in late December when oil and gas company PT Benakat Petroleum Energy acquired the coal mining infrastructure services provider, PT Astrindo Mahakarya Indonesia, for US$600m.

Bidders from near (and far)Foreign bidders have poured into Indonesia from all over the world, with most interest coming from nearby Asian countries including Japan, Singapore and South Korea. When taking both volume and value into account, Japanese bidders were the most prominent, investing US$1.1bn across six deals from February 2011 to January 2012. The largest Japanese transaction of the

year was Mitsui Sumitomo Insurance’s US$827m, 50% stake acquisition in PT Asuransi Jiwa Sinarmas (Sinarmas Life), the Indonesia-based life insurance provider.

Looking outside Asia, US bidders completed the most transactions, though largely in smaller deals. UK bidders were also active. The year’s largest deal saw UK-based Vallar Plc purchase a 75% stake in PT Bumi Resources Minerals for US$2.3bn in a particularly newsworthy transaction involving major shareholder, Bakrie Group, and a significant restructuring.

Demand driving deal flowDespite solid demographics and a homegrown economy, by many accounts Indonesia’s future rests on coal. As the world’s largest exporter of thermal coal, Indonesia sits in a strategic position as oil and gas prices rise and nuclear power remains under scrutiny. As a result, Energy, Mining & Utilities emerged as the largest M&A sector over the period, representing 19% and 54% of total volume and value respectively. The industry saw 15 deals close over the 12-month period, with a combined value of US$4.9bn.

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Bidder geography by volume of transactions

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Kroll Quarterly M&A Newsletter – March 2012

While prospects for economic growth in Indonesia remain strong, investors still have reason for caution. As with any emerging market, bidders must remain vigilant when investing in this ever-reforming but still developing country. With this in mind, mergermarket talks with Kroll’s David Wildman about fraud, corruption and due diligence in Indonesia.

Describe Indonesia’s fraud, corruption and bribery landscape and how this impacts doing business.As with many emerging markets, Indonesia has witnessed several headline-grabbing scandals over the years that have colored the perception of pervasive corruption, however the real concern lies in the day-to-day practicalities of doing business. The Indonesian public sector was decentralized in 1998, and decision-making is now administered by the local provinces. While this has made FDI easier, it has also resulted in complex bureaucracies, layers of approval and red tape. These can be breeding grounds for corrupt practices. And at the end of the day, if companies are continuously pressured to make special payments or give favors in order to obtain basic licenses, approvals and judgments, then corruption will continue to be a serious obstacle to doing business on the ground.

In your experience, how well informed are foreign investors of the potential pitfalls when transacting in Indonesia?For some, the decision to invest in Indonesia can be tainted by historical government or corporate scandals, and as a result, many companies are more concerned about protecting themselves against high-level corruption than identifying operational pitfalls that could ultimately trip them up. Faced with what can appear to be a lengthy and complex administrative process when setting up a company, establishing banking facilities or obtaining licenses and permits for example, many investors feel compelled to appoint a third-party advisor or local partner to help them “navigate the red tape”. However, these third parties may not be sufficiently aware of global anti-corruption legislation such as the Foreign Corrupt Practices Act or the UK Bribery Act, and this can lead to costly violations for investors who don’t pay close enough attention to what’s being done on their behalf.

What should investors consider when conducting due diligence in Indonesia?Due diligence must be focused in concert with the overall strategic plan, the rationale behind the investment, and understanding how the target company will fit into current operations or future plans. And while there are many factors investors should consider – from compliance with legislation to how efficient the local infrastructure is and the integrity of key members of staff – the level of importance placed on each will vary depending on the target industry. For example, when acquiring Consumer, Retail and Food & Beverage-related businesses, understanding the target’s track record of abiding by local health regulations, licensing and employment laws are key. Meanwhile in the Manufacturing sector, investors must

focus on supply-chain reliability, the efficiency of the local infrastructure and third-party suppliers, as well as any history of faults, safety violations and product recalls. That said, obtaining accurate and reliable up-to-date corporate records is one area that requires substantial attention for all companies across all sectors. Solely relying on publicly-available information could lead to inaccurate decision making.

What about corporate structures? Prior to investing, it’s crucial to gain a clear understanding of the controlling structure and the specific roles of key internal stakeholders. Private and public companies in Indonesia must have three internal governing bodies: a General Meeting of Shareholders (GMS), a Board of Commissioners (BoC) and a Board of Directors (BoD). It’s important to understand who controls the BoD and who within the organization has executive power. An investor should question the investment if this information is not clear. In a number of cases Kroll has investigated, additional research often reveals that the controlling structure an investor anticipated is not quite reality.

How should foreign investors effectively manage an acquisition in Indonesia to minimize fraud and corruption?In many situations Kroll has investigated, companies leave operational control of the foreign entity to local parties, only to later find they have become the victim of fraud, stolen intellectual property, inflated payrolls and ghost employees, among others. To avoid this situation, the target company must be fully adopted into the culture of the acquiring organization, which helps protect the key assets for which it was purchased. Investment in anti-corruption and fraud controls must be seen as any other required maintenance expenditure for valuable company assets.

These controls should include ethics reporting hotlines and where possible, be supported with the correct tone from the top as a minimum. Senior management from the head office or the investor (in the case of a private equity fund) must visit the local company ad hoc and ask the right questions to root out any wrongdoing. And you shouldn’t assume the information the investee provides you with is accurate. Investors must be proactive in high-risk environments and seek access to transactional level data at a minimum and run regular health checks over the data to identify conflicts, fraud or corruption.

David Wildman is Managing Director, Kroll Advisory Solutions Southeast Asia.

Kroll is renowned for investigations across the transaction cycle, from pre-deal investigative due diligence to post-closing dispute support and internal investigations.

For real-life examples of how Kroll has helped companies successfully invest in Indonesia, please visit www.krolladvisory.com

Understanding risk and effectively navigating Indonesian M&A

However, Indonesia is not simply an exporter of resources to energy-hungry nations. With a domestic population of nearly 250 million people with rising incomes, a number of other industries also deserve attention including Technology, Media and Telecommunications (TMT) and Financial Services. Smart phones are all the rage in Indonesia, and consumers continue to storm retailers looking to buy the newest devices. The Financial Services industry has also been particularly hot recently, due in large part to rising incomes and the increasing profitability of Indonesian banks. But ongoing policy discussions are threatening to reduce the limit of foreign ownership for Indonesian banks, which could lead to a shakeup in the future.

Budding economy, smaller dealsAs a relatively undeveloped economy and one comprised largely of family-owned and operated businesses, almost three quarters of deals with disclosed values fell below US$100m, and 32% of total deal flow was below the US$15m mark. Finding an acquisition with the right size and scale can be difficult, and bidders are often relegated to smaller deals as a result.

For example, in July Hong Kong-based private equity firm CLSA Capital Partners acquired a 20% stake in PT Sinar Mitra Sepadan Finance, an Indonesia-based multi-finance company providing retail credit for purchasing pre-owned vehicles, for a consideration of US$20m.

Great promise, but challenges remainWhile Indonesia is clearly on a path to growth, challenges remain. Comprised of numerous islands and vast coastlines, infrastructure is key to Indonesia’s ongoing development, however progress is slow and therefore threatens the growth of the local economy. Estimates indicate US$150bn is needed to develop the basic infrastructure, of which the government has dedicated one third, relying on private investment to make up the shortfall.

This leads to a ‘chicken or the egg’ scenario as the lack of infrastructure deters many foreign investors. Recent positive developments have been seen in the passage of land reform legislation, which sets out a framework for the acquisition of private land to be used in infrastructure projects. While this move has been applauded by investors, concerns remain about the implementation of the new legislation.

Further risk in this budding democratic nation can be found in the layers of bureaucracy and rife corruption that hamper much needed reform. Following several high-profile corruption cases, political moves have been made to restore confidence in the country as a welcoming destination for investment.

While the business environment is becoming more sophisticated and corporate governance has improved significantly since the turn of the century, further reform is still needed. In the public and private sectors alike, a general lack of transparency often gives pause to investors, so to ensure success, bidders must accurately manage any transaction, ensuring all bases are covered in the process.

Looking aheadLooking ahead, the Financial Services, Energy, Mining & Utilities and TMT sectors should remain hot investment targets according to mergermarket data. Among expected domestic deals, Indonesian mobile phone distributor, TiPhone Mobile Indonesia, plans to acquire three peer companies this year, and Rukun Raharja, the Indonesian energy services company, plans to acquire a gas company based in South Sumatra.

Further to continued inbound interest in previously mentioned sectors, global pharmaceutical companies such as UK-based GlaxoSmithKline could look to Indonesia to diversify regional sales portfolios. As such, domestic and inbound M&A trends in key sectors around energy and consumer-driven businesses look set to continue.

The next edition of Spotlight Asia will focus on M&A in India.

Successfully investing in Indonesia

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Deal size split by volume of transactions

The information contained herein is based on currently available sources and should be understood to be information of a general nature only. The information is not intended to be taken as advice with respect to any individual situation and cannot be relied upon as such. This document is owned by Kroll and mergermarket, and its contents or any portion thereof, may not be copied or reproduced in any form without permission of Kroll. Clients may distribute for their own internal purposes only. Kroll is a business unit of the Altegrity family of companies

All data quoted is proprietary mergermarket data unless otherwise stated. All $ symbols refer to US dollars.

Asia: David Wildman dwildman@kroll.com +65 6645 4520

Contact us EMEA: Melvin Glapion mglapion@kroll.com +44 207 029 5313

Americas: Robert Brenner rbrenner@kroll.com +1 212 833 3334

Naveet McMahonnaveet.mcmahon@mergermarket.com +852 2158 9750