Highlights:

• One of the key drivers of the M&A sector in Spain in 2011 was the restructuring of the Spanish financial sector.  This process is still ongoing and represents an opportunity for foreign investors interested in acquiring strategic interests in the Spanish banking sector, entering the market on a stand-alone basis through asset purchases or acquiring non-core assets of banks and savings banks.
• There are also large privatizations in the pipeline that might be re-activated if both the markets and the political and macroeconomic environment become more stable.
• We also anticipate opportunistic and “defensive” M&A deals, corporate consolidations, along with private equity transactions (divestment of highly-leveraged acquisitions completed in the boom years of 2006 and 2007).

MAIN ARTICLE

OVERVIEW OF 2011:

Financial services M&A – financial sector restructuring

In 2011, some of the largest transactions were driven by the effects of the global financial turmoil affecting Europe and especially Spain.

As the first step of the “Basel III” financial sector restructuring in Spain, in 2010 and 2011, several regulations were enacted to facilitate the capitalisation of savings banks (cajas de ahorros) by enabling them to form an Institutional Protection Scheme (“SIP”), also known as a “cold merger”. A “cold merger” is a contractual arrangement whereby members of a group undertake to support each other in terms of liquidity and solvency. Each savings bank maintains its own brand and part of its workforce, balance sheet and branch network, but there is a single management structure. Part of the activities and business of the savings banks and some shared functions (such as the management of liquidity) are centralized.

Eventually most of the “cold mergers” led to full integration of the banking business into newly formed banks. Some of them launched initial public offerings (IPOs) which have stirred interest from investors, including sovereign wealth funds and foreign banks.

Bankia and Banca Cívica, two Spanish banks forged from “cold mergers” of several savings banks, respectively raised more than 3 billion euros and 600 million euros in two IPOs in July 2011. Both Bankia and Banca Cívica priced their shares at a strong discount to draw in shareholders amid market doubts over the health of Spain’s financial system following the collapse of the real estate industry. Bankia’s IPO was a test for the new bank and for the confidence in the Spanish economy, as well as an important step to reforming Spain’s damaged banking sector.

Also during 2011, in a very innovative corporate reorganization, the Spanish savings bank “la Caixa” transferred its banking business into its already listed industrial holding company (Criteria), while shifting real estate assets and some of its stock holdings, including stakes in Abertis and Gas Natural, into an unlisted company. This move, announced in January 2011, allowed “Caixabank” going public in July 2011 without launching an IPO.

(Failed) privatisation processes

In the second semester of 2011, Spain launched two large-scale privatisation programmes to cut deficit and to preserve market faith in turnaround plans, namely the privatisation process of the Spanish airport operator (AENA) and the Spanish lottery operator (LAE), in what would have been the largest IPOs in Spanish history. Both privatisation processes were eventually paralyzed by the Government, mainly due to the market instability and the lack of political consensus on the processes.

On top of AENA and LAE processes, there is another large privatisation programme on-hold that might be picked-up at some point in 2012 or 2013: the partial privatisation of the entity that manages the public water services in the region of Madrid, Canal de Isabel II (CYII), which was approved in 2008 but has however faced political and popular opposition since then.

Other notable M&A deals

Additionally, the following are some of the most relevant inbound M&A deals that were either announced or completed in the first semester of 2011 in Spain:

• In February 2011, a public takeover was announced for Spanish oil refinery CEPSA by IPIC, a sovereign wealth fund and investment company established by the Abu Dhabi government for €3.9 billion, one of the largest deals in 2011 so far.
• In March 2011, Qatar Holding LLC, the sovereign investment fund of the Emirate of Qatar, acquired a 6.16% stake in Iberdrola via a capital increase and the acquisition of treasury stock (€2 billion).
• In May 2011, the Brazilian Companhia Siderurgica Nacional (CSN), a worldwide leader in the steel and mining sectors listed in Sao Paulo and New York, announced an agreement for the acquisition of several steel plants in Spain and Germany from Spanish Grupo Gallardo (USD1.35 billion).
• Also in May 2011 Schneider Electric announced a tender offer on Telvent, the Spanish global technology company listed on NASDAQ (USD 1.4 billion).

In the last months we have also seen encouraging sign of the potential symbiotic relationship between cash-rich Chinese corporates and Spanish corporations with strong presence in Latin America, namely the alliance of Repsol YPF and the Sinopec in Brazil and the enhancement of the strategic alliance between the telecommunication companies Telefonica and China Unicom. On the flip side, due to the market’s volatility, the Chinese state-backed company HNA recently withdrew from a deal to buy a stake in the indebted Spanish hotel chain NH that is facing difficult negotiations with its lenders.

TRENDS AND PROSPECTS:

• The ongoing restructuring process of the Spanish financial sector (including but not limited to savings banks) will continue being essential to understand the M&A environment of the following months: banks and savings banks consolidations will continue, both as a way to meet the strict capital requirements recently set for Spanish banks, and also in order for the Spanish banks to survive in a growingly competitive environment (in which, for instance, mid-sized Banco Pastor was recently taken over by Banco Popular).

  Also, it cannot be disregarded that the Spain-based restructuring and rescue fund (FROB), controlled by the Bank of Spain, may be forced to take over more banks in trouble and subsequently offer them to private investors options (as it has been recently the case of Caja de Ahorros del Mediterráneo (CAM), eventually acquired in an auction by Banco Sabadell with partial protection from the Bank of Spain against toxic real estate assets in the balance sheet of CAM).

• On the sell-side, many Spanish banks and corporations are looking to divest non-essential assets, focus on their core businesses, strengthen their margins and rebuild their balance sheets, creating a range of M&A investment opportunities.

  A good example of this strategy is Banco Santander, whose moves often anticipate future market trends: in contrast with the shopping spree of the first semester of 2010, when Santander acquired Bank Zachodni WBK SA, the listed Poland based bank (€4.3 billion), and the remaining 24.9% stake it did not already own in Grupo Financiero Santander Serfin, the Mexico based commercial and private banking group (USD 2.5 billion), in the last months of 2011 Santander has sold its business in Colombia and a 7.8% stake of its Chilean subsidiary, and is reportedly in the process of selling a 8% stake of its Brazilian subsidiary.

• The financial distress of some companies and the continuing uncertainties over the global economy will likely pop up the deal volume in Spain, helping to bridge the valuation gap between the sellers and the purchasers.
• On the buy-side, well-capitalized acquirers may be one of the principal buy-side forces in 2012. In particular, we have already seen a number of inbound M&A investments in Spain coming from emerging countries, sovereign wealth funds and state-owned enterprises.
• Private equity firms can also be a relevant player in Spain in 2012, as some of them are coming under increasing pressure to invest the funds raised in the recent years. By the same token, other private equity funds will also be under pressure to exit portfolio companies and redistribute capital to investors as they approach the end of their divestment horizon (i.e., ending of LBO structures implemented in the “golden years” of 2006 and 2007). By way of example, the apparel retailer Cortefiel, the telecom company Ono, the amusement-park operator Parques Reunidos and the manufacturer of railway vehicles Talgo are reported to be up for sale.

  On top of this, the divestment of portfolio companies becomes a must for some private equity funds as we approach the so-called “2012 wall of debt”, i.e., maturity of the loans and bonds issued to finance the highly-leveraged deals that preceded the crisis (in addition to many other companies, whose debt matured in 2009 and 2010, but were able to extend their loans until 2012 and 2013).

  Similar difficulties have arisen for other companies which, during the same “golden years”, financed ambitious recaps out of new subordinated bank facilities. The base cases, which assumed constant growth, have been breached due to the deep crisis, and the companies are now unable to service their debt. We have even witnessed large and medium-size private equity firms that have failed to support their vehicles, leaving the financing banks with the dilemma of whether to look for a new purchaser, to swap their debt into equity, or to apply for the insolvency of the company.

• In our view, the main deal constraints for M&A transactions in 2012 will be the credit draught that the Spanish economy has been suffering over the last years, the instability of the global economy and the sovereign debt crisis.
• Finally, the privatization processes currently on-hold (AENA, LAE, CYII and maybe others) may also play an important role in the M&A activity in 2012 and 2013.