Frontier for corporate growth-

While Indonesia has not been immune to the chill that has taken hold of emerging markets (EMs), the country has attracted significant merger and acquisition (M&A) activity. Overall, 29 inbound M&A deals took place in Indonesia in 2013. While this was lower than 2012’s 41 transactions, the value has skyrocketed. Mergermarket data shows that the average deal value in 2013 reached $264 million, compared to $86 million in 2012, with one of 2013’s most notable announced deals being the $1.6  billion purchase of a 40 per cent stake in Bank Tabungan Pensiunan Nasional by Japan’s Sumitomo Mitsui. M&As slowed in the second half of 2013 and into 2014, reflecting the wider sell-off in EMs.

The biggest challenges since summer 2013 have been the devaluation of the rupiah, from about IDR 9,000 to the US dollar to IDR 12,000, and the presidential election in 2014. Because of these, a lot of people did not go for M&As.

However, this does not appear to have affected foreign direct investment (FDI) volumes. According to investment agency BPKM, FDI in Indonesia has quadrupled in the last seven years although the pace of M&A activity has slackened.

Buyers want more certainty on the currency and political situation. The continuing risk of a further fall in the exchange rate of the rupiah and changes in policies will mean that M&A activity will remain subdued.

Indonesian GDP grows

According to Oxford Economics, Indonesia should enjoy an annual GDP growth rate of nearly 6 per cent for the next two years, reflecting a broad consensus among analysts that, despite pressure on EMs, Indonesia’s macro position is positive.

The long-term picture is encouraging. Indonesia is currently the 16th largest economy in the world. It is expected to become a G10 country by 2026 and the seventh and fifth largest economy by 2030 and 2045, respectively. This is on the back of a growing middle class and higher per capita disposable income.

Indonesia – An investment haven

Indonesia’s prime location in Southeast Asia is proving attractive for blue-chip foreign investors. In November 2013, German logistics company Dachser announced the formation of an Indonesian joint venture (JV).

Indonesia has the fourth largest population in the world and, according to the World Bank, 45 per cent are aged 24 or under.

Indonesia’s reliance on domestic consumption was one reason why it weathered the financial crisis of 2008–09. Middle-class consumers, combined with industrialisation and urbanisation, offer significant prospects for companies.

As productivity continues to rise, both per capita income and per capita spend have increased.

Indonesia’s natural resource bounty remains compelling. The country is the world’s largest producer of crude palm oil and coal, and the fifth largest exporter of copper. It is also home to 40 per cent of the world’s geothermal resources.

Indonesian inbound M&A

Unsurprisingly, given Indonesia’s resource endowment, the energy, mining, and utilities (EMU) sectors saw the most deals in 2013, with 17 transactions worth a total of $4.8 billion. With 12 deals each, the industrial and financial services sectors ranked next.

The population’s growing wealth has also attracted retail investment, with Swedish furniture giant IKEA currently building its first store spread over 5 hectares in the country with an investment of roughly $100 million. In consumer goods, Unilever, Procter & Gamble, and Johnson & Johnson are well positioned in the market.

In tandem with this, a growing middle class means more appetite for personal financial services – a market that is substantially underpenetrated. A 50–50 JV announced in January 2014 by Aviva, the UK’s largest insurer, and Astra International, Indonesia’s largest publicly listed company, illustrates this untapped potential. Astra Aviva Life will sell and distribute life insurance products in Indonesia through a variety of digital, agency, and partner channels.

Astra, a $25 billion market cap company serving more than 10 million customers a year across a variety of sectors, will afford Aviva access to Indonesia’s burgeoning middle-class segment.

Indonesia’s shifting demographics is playing a big part in Indonesia’s attraction to corporates in the insurance sector. A recent EY study, “Waves of Change: The Shifting Insurance Landscape in Rapid-Growth Markets”, developed in collaboration with Oxford Economics, identifies a number of markets providing real growth opportunities for insurance companies over the next few years. Indonesia is specifically identified as presenting an extremely strong economic growth picture – second only to China and Vietnam in the report’s forecasts.

Manufacturing is another growing target for foreign investors, thanks to Indonesia’s abundant resources and young workforce. For example, in February 2014, Taiwanese technology giant Foxconn Group announced that it intended to invest up to $1 billion in Indonesia as it seeks to diversify production away from China.

Some prominent foreign investors are already reaping the rewards of establishing manufacturing footholds in Indonesia. Astra International became a subsidiary of Bermuda-registered conglomerate Jardine Cycle & Carriage in 2005. Indonesia now represents 52 per cent of the Jardine group’s total profits.

A 2013 EY Indonesia report for the US Chamber of Commerce, “Partners in Prosperity: US Investment in Indonesia”, shows that the manufacturing sector is increasing in size rapidly. The compound annual growth rate for the extractive sector between 2004 and 2012 was 11 per cent; for manufacturing, it was 21 per cent.

Challenges to business

Despite its potential, Indonesia still has fundamental challenges that corporates would like to see addressed. For example, in EY’s Globalisation Index, Indonesia ranks 57th in the world – far behind neighbours such as Thailand (32nd), the Philippines (34th), and Vietnam (36th).

Infrastructure is frequently cited as the biggest weakness, with underdeveloped road networks and congested seaports. Complex regulations, political and cultural issues, and bureaucracy are also prominent challenges.

“Congestion at Jakarta terminal is significant and, over the next two decades, Indonesia will need four new container ports,” says Anne Booth, Professor of Economics, with reference to Asia at London University’s School of Oriental and African Studies.

Meanwhile, according to Goldman Sachs, the country needs more of a sense of commercial purpose beyond commodities and has to improve its infrastructure.

Several US mining companies have criticised the government’s imposition of a tax on the export of raw ores. Miners say that the tax breaches their long-standing contracts. Although the companies have permission to export their partially processed copper concentrate for the next three years, they will have to pay a progressive export tax, starting at 25 per cent and rising to 60 per cent by 2017.

Government takes action

In the wake of this, the country is working hard to improve its corporate image. For instance, in December 2013, the government announced easing of foreign investment rules, with plans to dismantle the barriers that currently surround advertising, power plants, and pharmaceuticals.

The 2010 Negative Investment List is also under revision. The government is considering allowing foreign companies to invest up to 100 per cent in power plants built under public–private partnerships and with capacity of more than 10 MW. The government may also allow investment of up to 49 per cent in airports and up to 95 per cent in seaports and toll roads. Under the plans, foreigners will also be allowed to take stakes of up to 85 per cent in pharmaceutical companies.

This proposed liberalisation programme is accompanied by a concerted effort to tackle corruption. Indonesia ranks 114 out of 177 countries in the Transparency International Corruption Index.

The government’s anti-corruption agency, KPK, is working to apprehend individuals alleged to have engaged in corrupt practices, with an impressive 100 per cent prosecution success rate. The gusto with which KPK has gone after people provides evidence that things are being done, even if it will take a long time to fully wipe out corruption in a paternalistic society like Indonesia.

Corporates looking to do deals in Indonesia should follow the following steps to success.

Four steps to success in Indonesia

  • Know who’s on the other side of the deal. Get a clear picture of who you are dealing with. Family businesses dominate the corporate landscape in Indonesia, with nine of the top 10 listed companies controlled by families. This invariably shapes deal structures. Family businesses tend to want to maintain control.
  • Take proper advice and enter into partnership. Conduct proper legal due diligence, and do not attempt it yourself. Foreign corporates are using JVs to get a foothold in the market, as exemplified by Dachser.
  • Allow time. Dealing with different layers of bureaucracy, at both the central and local government levels, can attract much of your attention. Trying to engineer a quick M&A deal in order to boost your share price for the next quarter is not likely to work out.
  • Understand the legal context. In Indonesia, the law tends to be an umbrella instrument. The real detail comes when the government issues regulations. Whatever the legislation says, corporates would be wise to wait for the regulations to kick in before making a decision that is based on a promised reform measure.

The result of the recent presidential election has been well received by the market and the investor community, as testified by the Jakarta Composite Index consistently scaling new records in recent weeks. There is a great deal of expectation from the president-elect, who is seen to be market friendly, results orientated, and as having the popular mandate to effect the necessary structural reforms. If the government can ensure that the investment climate can match the sizeable market opportunities that are available, there is no reason why Indonesia cannot continue its impressive M&A track record and emerge as one of Asia’s most vibrant acquisition markets.

David Rimbo has been involved in many transactional-based due diligence and M&A advisory roles for both acquisition and divestment transactions. He is an accredited Valuation and Business Modelling (V&BM) and Project Finance Advisory Partner. His V&BM experience includes business and goodwill and brand valuation, financial projection reviews, purchase price allocation and IFRS 3 valuation, and capital market-based independent review. Rimbo has a Master of Business Administration and Bachelor of Business from the University of Technology in Sydney.

Teh Seng Leong has been with EY Indonesia and Singapore for more than 15 years. Seng Leong’s industry experience covers technology, utilities, real estate, retail, food and beverage, life sciences, and mining. Seng Leong has a Bachelor of Accounting (Merit) from the Nanyang Technological University in Singapore and is a non-practising member of the Institute of Singapore Chartered Accountants.