International M&A: Is A Minority Interest Worth It?
By Geoffrey Milton
In my long career as an international banker I have witnessed some common elements in expansion by both acquisition and a new start up across several continents, Asia, the Middle East and Latin America. Every time the conclusion is that a minority stake in a local bank can be a losing proposition – the international financial community believes you will stand behind your investment, yet you are unable to exercise day to day control over management decisions. The final cost can far exceed the original investment dollars.
Egypt 1979
Under Law 43 passed during the Sadat era, foreign banks could establish new Egyptian banks to handle all business in local currency, with the condition that local entities had a minimum 51% shareholding. From the United States Bank of America, Chase Manhattan and First of Chicago took advantage of this new law. Citibank decided to remain a branch and thus be restricted to foreign currency business. To protect the foreign investor and provide the necessary management expertise to a market where the existing commercial banks were state-owned, we were permitted to sign a management contract with our Egyptian partners. However all final decisions were made by a Board of Directors, majority Egyptian controlled and with an Egyptian national as Chairman.
During the boom years this structure worked reasonably well, although there would be continual pressure from the local partners and the Central Bank to favor particular projects. The concept was that, with the training provided under our management contract, we would develop proficient local management, able to assume many of the key tasks after several years. In this way “expensive” international staff would be released to the foreign partner. Technology transfer worked to a point, but to achieve the necessary economies of scale, fresh equity was required. In an unstable environment, this was not always available. Most, if not all, of the local shareholders were state-owned, so they too did not have fresh capital to inject either.
Law 43 was an interesting experiment, but it was very difficult to align the interests of all shareholders. Often the senior management team was exposed to competing pressures – it had a duty to protect the interests of all shareholders, yet it was seconded from one investor upon whose ultimate decision their career depended. In hindsight, Citibank made the better investment decision by retaining the traditional foreign branch structure, even though it probably missed out on some lucrative local currency business.
Thailand 1987
Union Bank of Bangkok, a bank that ultimately collapsed during the Asia Financial Crisis, was effectively controlled by two family shareholders. One had majority ownership, plus the positions of Chairman and Chief Executive. The other expressed the wish to unload their 25% stake; the Ministry of Finance owned 10% and would stay. My Group was approached through an existing client in Bangkok. Against my recommendation to ignore any offer of a minority position, I was instructed by my Board to negotiate secretly with the selling shareholder family, using our client as the middleman. A fair price was agreed and the Ministry of Finance was on board, as they wanted a new international partner who could inject fresh management and updated banking products into their investment.
We had anticipated resistance from the managing shareholder, but our local partners assured us they would cooperate once they could see the advantage presented by our investment. As part of the deal, I insisted we bring in a senior international banker to represent our Group on the ground. The Deputy Minister of Finance cooperated, yet never thought to advise the Central Bank before the public announcement was made. Notwithstanding our strong efforts to assure the other shareholders of our best intentions, they remained suspicious of the true objective. The Chairman was close to senior executives at the Central Bank, which could make life uncomfortable. One immediate benefit to all, was a dramatic increase in trade finance and interbank facilities, based upon the counterparty assumption that our Group would stand behind Union Bank, although we only owned 25% of the voting shares (one major downside to reputation risk when you do not have majority control).
The stalemate continued for several years. At one stage we were made an offer by the controlling group to buy us out at a substantial profit – our Board declined and the stake was worthless by 1998! One other lesson, “Never Ever Fall in Love with your Investment”.
Brazil 1997 (Or How You Structure the Perfect Deal From Lessons Learned)
As a result of one of the many Brazil financial crises in the latter part of the 20th century, my Group had ended up (via a debt/equity swap) with 50% of a small Brazilian bank license, but only a one third voting interest under the banking rules at the time. The local partner was a very prominent Brazilian firm and, after one failure with a management team comprised of executives trained at major U.S. banks, we were able to bring in a superior management team who really understood the local market.
Profits were decent, yet my Group had learnt that we would not increase our investment without majority control. Fortunately, the law was amended to allow foreign majority control of a Brazilian bank, and our partner decided to sell their interest to us so they could focus more on their core business. From my perspective book value was the only fair price but, equally as important to me, was the agreement from all sides that the management team should have a 10% stake (to be financed by my bank with the shares as collateral). In this way local management would “have skin in the game”, very important when the controlling shareholder is thousands of miles away. The Board was restructured with full agreement from the Central Bank, and the Chief Auditor reported to both this Board and the Group Head Auditor.
Ten years later we had created a very successful Brazilian bank, albeit in a favorable economic and business environment. Our Group monetized the initial investment through an IPO, the senior management had repaid their shareholder loans through a strong dividend payout policy (becoming multi-millionaires on the way!), and this subsidiary is a key element of the controlling shareholder’s international business profile. All from a renegotiated sovereign debt in the 1980s – a lot because we chose to give up 10% of the equity to protect 100% of our investment.
Conclusion:
- Minority investments are fraught with danger, you can have 100% of the pain for a comparatively small return
- Minority investments may be the only way to enter a new market – if you have to do it, protect yourself with a strong shareholders’ agreement and a management contract. Even then they can do untold damage to your reputation if shareholder interests are not aligned.
- Majority control is not the answer, unless backed up with the right management team and appropriate controls from Head Office. Always align shareholder and management interests on overseas investments.
