Turkey’s special corporate


Turkey’s Oyak Group has traditionally concentrated on being a pension fund, albeit a rather different one compared to its peers. Now, however, especially since buying out half of steel giant Erdemir, it is looking to industrial growth for its future. Justin Pugsley has the story.


Some of Turkey’s leading exporters are, ironically, owned by a military pension fund called Oyak Group, which also dubs as the country’s third largest conglomerate and its most profitable. Its recent acquisition of a controlling stake in the country’s leading steel firm, Erdemir, for example, will have profound consequences for the domestic steel market.


Indeed, Oyak is no ordinary pension fund. Its investment style is far more akin to that of a private equity group than that of a pension fund manager. Whilst the latter is generally satisfied with parking cash in listed blue chip stocks, Oyak goes out of its way to gain management control of the companies it invests in. It owns or has stakes in over 60 companies and management control over most of them.


The group also has several high profile joint ventures with foreign partners. The most well known is the one with Renault and then there’s the venture with German power generator specialist STEAG in a power station in the south of the country. The first is the market leader in passenger cars in Turkey and an exporter. The second is a power station providing 7% of the country’s electricity.


In both cases they are 49/51% ventures in favour of the foreign partner. Oyak has also left it to its partners to manage the ventures, basically leaving it to the industry experts.


Indeed, the Renault partnership has been extremely successful. According to the latest figures from the Automotive Industrial Association, it made around 40% of the country’s passenger cars, ahead of Toyota with about 30%. With low levels of car ownership per capita, the potential market growth is enormous.


There is another domestic joint venture: a 50/50 company with French insurance giant, Axa, to sell insurance products. Indeed, some have drawn comparisons between Oyak and the Korean chaebols, which have a tentacle in practically every sector of the economy. Oyak, for instance, is into steel, cement, vehicles, agro-chemicals, food processing, financial services and tourism, just to mention a few of the sectors it is vested in.




Oyak philosophy


Conglomerates are fairly common in Turkey. The two leading ones, which are family controlled and listed on the Istanbul Stock Exchange (ISE), are Koc Holdings and Sabanci Holdings. They to have fingers in many different pies and in many respects can be considered rivals to Oyak.


This is particularly the case when it comes to buying up companies and the companies they own also compete in numerous industry sectors. However, there are some differences in management approach. Most of the country’s conglomerates are focused on building market share, often at the expense of profit margins. But Oyak is different.


“We are a fund manager. We are here to get the best returns for our members,” explains Aydin Muderrisoglu, executive vice-president, new business development, with Oyak.  “Profits come first. Though we like to be a market leader, building sales for the sake of it is not our top priority.”


The evolution of the conglomerates is very much down to the fact that Turkey used to have a closed economy. Currency controls made it difficult for firms to invest abroad, therefore they were forced to invest surplus cash into other sectors of the economy instead. Years of very high inflation also made it a better bet to invest in businesses rather than holding cash or bonds.


However, under recent IMF and EU inspired reforms, which are liberalising and opening up the economy to globalisation, this business approach could change. According to analysts, many of the conglomerates could decide to streamline and become more specialised and divest out of sectors where they are not particularly strong.




Flexible evolution


However, the Oyak investment strategy evolved more out of necessity than by design.  Its investment mandate is also much more flexible than that of most pension funds. It can even invest abroad. To date, though, the lure foreign shores has not proved that big an attraction. Over 90% of the group’s assets are in Turkey. And for the time being it is likely to stay that way.


Oyak was founded in 1961 with the objective of providing a secondary or supplementary pension to members of the Turkish armed forces holding a rank. The group has some 230,000 members. Back in the 1960s there was little in the way of tradable securities for the group to invest in. It therefore either bought directly into companies or formed joint ventures with foreign partners.


Indeed, it’s an investment approach that has stuck and there are no immediate plans to change. This is despite the fact that there are now a wide range of securities on the ISE.


“We have an investment model, which works. We see no reason to change it,” says Caner Oner, executive vice-president, investment and information systems, with Oyak. But there is another reason: “If you buy shares on the stock market, you don’t have a say on how the company is run. You don’t know what is going on,” explains Oner. “If you’re a majority shareholder you control the costs and decide on the company’s investment strategy.”


Poor levels of corporate governance has been a problem, but with the economy opening up to foreign investors more companies are cleaning up their act.  They increasingly, appreciate that this will make their shares more highly valued.


Commenting on Oyak’s investment strategy, Oner says money is parked where the highest returns can be achieved. If not it is quickly moved to another investment opportunity.


Also, when selecting an investment, the group tends to be rigorous in its research. The management is particularly attracted to well established cash generative businesses where there is scope to improve performance. If they’re market leaders that’s even better. Its cement, steel, agro-chemicals and automotive interests, for instance, dominate the Turkish market. However, turnaround cases and greenfield projects are generally rejected.


Investments are expected to show a profit from year one says Oner. Other than a rise in the capital value, Oyak also seeks a rising dividend stream.


Importantly, the Oyak pensions are non-defined and the level of pay-outs is dependent on the profitability of the group. Upon retirement, members can either take a lump sum or leave funds with Oyak. They are not obliged to put the money into an annuity. Contrary to popular perception, Oyak is not owned or controlled by the military. It is a private-sector entity and operates under a special purpose law.  It is also the only remaining entity of its type left, according to Oner. Others founded around the same time eventually disappeared.


Whereas many pension funds seek to mimic or even beat a benchmark index, with Oyak it is the members who decide the level of returns management should be achieving. At the moment, this is set at 20% above inflation. Last year, the group pulled off a 26.8% return and 40.3% the year before.


Oyak receives around TL180mn (US$123mn) a year in contributions from its members, which it then has to invest for the best returns.


According to an Istanbul-based analyst who asked to remain anonymous, those solid returns where probably on the back of an upward re-rating of financial institutions, pricier cement and a general rise in real estate related assets.


“Oyak manages around US$6bn in assets, of which US$1bn is in liquid assets such as time deposits and government bonds,” says Ergun Okur, executive vice-president, member services, with Oyak Group. A certain level of liquidity has to be maintained to cover pension pay-outs and other liabilities. That amount of liquidity maintained is partly based upon actuarial forecasts, which stretch beyond a decade.


Another important step the US-educated management has taken is to make Oyak more transparent. They have implemented western standards of corporate governance for example. Indeed, the idea is to make Oyak the partner of choice when companies want to invest in Turkey. The other motive, is to be more appealing to foreign lenders.


As such Oyak has adopted IFRS reporting standards and is audited by one of the leading accountancy firms, currently Deloitte Touche. This puts Oyak on a par with most large western corporates. Oyak also insists that the companies it invests in do the same. If anything, greater transparency and using internationally recognised accounting standards, makes Oyak’s investments more valuable.


The other move, particularly important to lenders, is that it has acquired an international credit rating. Standard & Poor’s has assigned a BB- long-term foreign currency rating to Oyak with a stable outlook. Moody’s has granted a Ba2 foreign currency rating, also with a stable outlook. The credit ratings are on a par with the national one. It is actually extremely rare for a company to be rated higher than the country it is based in.  “We believe it is good for business to operate in this way,” says Muderrisoglu.


Indeed, the implementation of internationally recognised corporate standards recently paid off handsomely.




Changing steel flows


Last year Oyak won a government auction against foreign competition to buy a state-owned stake in Erdemir – one of the top 10 steel producers in Europe. The total stake, which comes to just under 50% of Erdemir, cost Oyak around US$2.96bn and the purchase was completed in February 2007.


The deal was financed with a US$1.62bn, 10-year limited-recourse loan. A further US$1bn is a corporate loan with the rest coming from Oyak. A credit rating and IFRS accounting standards make it easier and cheaper to borrow.


One of the conditions of the purchase is to see through a US$2bn investment programme to update Erdemir’s southern steel plant. An investment, which is likely to alter Turkey’s trade in steel products.


Nonetheless, the programme was originally falling behind, but Oyak is steadily bringing it back on schedule. “We’ve brought in the best talent to manage Erdemir,” says Muderrisoglu.


So far Oyak looks set to make US$100mn in savings by first half of next year in the northern plant. In terms of energy consumption, in the first nine months of 2005 this was brought down to 4,923 Mcal/tonne of crude steel, from 5,129 Mcal the year before. An important factor given that much of the country’s energy requirement has to be imported.


Indeed, this seems to be answering critics, who were openly questioning in the local press the wisdom of a pension fund running a steel company. However, the improvements don’t stop there. Another one centres on Erdemir’s procurement and sales strategies.


Most of the group’s iron ore was bought on the spot market and its steel products where sold in the same way. This left Erdemir very vulnerable to the vagaries of the markets, which can sometimes prove expensive.


An increasing percentage of that business is now done on long-term contracts, which makes planning far more predictable. But its the other measures, which will have dramatic consequences the flow of the steel trade in Turkey.


For starters, overall liquid steel capacity will rise to 8.5mn tonnes by 2008 from the present 5.2mn tonnes. At the same time, steel production is being shifted from long steel to flat steel products where domestic demand is higher. Flat steel is typically used in white goods and automotive manufacturing. By the end of the investment programme in 2008, hot rolling capacity will have increased to 8.5mn tonnes, from the current level of 4.5mn tonnes.


Also, the combined dedicated port facilities of Black Sea and Mediterranean plants will see capacity rise to 35mn tonnes a year from the present 24mn. Some of that capacity will be available to third parties.


In terms of flat steel imports, Turkey brought in 6.7mn tonnes in 2005, compared with 5.6mn in 2004 and 4.5mn the year before. Over the same period production has only increased to 4.7mn tonnes from 4.4mn, leaving a growing deficit in flat products. Indeed, Erdemir is hoping to fill some of that deficit itself.


The demand for flat steel very much reflects the rapid industrialisation of Turkey and growing incomes. More consumers can afford cars and home appliances and this is expected to escalate rapidly over the coming years.


By comparison, production of long steel products has risen to 15.2mn tonnes last year, from 13.9mn in 2005 and 12.3mn the year before.


In this area, Turkey is actually an exporter. Selling abroad 7mn tonnes last year, 6.9mn in 2004 and 5.7mn tonnes the year before. Imports meanwhile, have been a modest 0.9mn tonnes in 2005 and 2004 and 0.6mn the year before. Analysts argue that Turkey has excess supply of long products.


“Within two to three years Erdemir will be transformed and will be a much more valuable company,” says Muderrisoglu.


Currently, Erdemir supplies a local Toyota factory with flat steel products. The Oyak management is talking with the Renault management to do the same in their joint-venture plant. Currently that steel is being supplied by Arcelor on a long-term contract.


Apparently, Erdemir’s Romanian plant is fairly close to signing a deal to supply Renault’s Romanian subsidiary, Dacia, with steel.




Sceptics question price paid


Despite the good progress there has been a little scepticism among some analysts in Istanbul over the purchase. The focus of that doubt is on the premium Oyak paid over Erdemir’s share price.


The entire market capitalisation of the group is roughly around US$2.8bn, yet Oyak paid nearly US$3bn to buy around half of it. Also, it outbid other large international steel producers such as Mittal, which may have been in a better position to extract synergies. According to analysts the next highest bidder came in at US$2.7bn.


Admittedly, Oyak was originally due to make the purchase in partnership with Arcelor, which has since been taken over by Mittal. However, the Turkish authorities were apparently unhappy to see Arcelor and Erdemir linked together for competition reasons.  Yet Oyak decided to go ahead on its own, as the management felt the sums still made sense.


“They bought right at the top of the steel cycle,” says the analyst. “They also paid a very large premium of over 40% to the share price.”


He adds that Erdemir’s profitability is very much at the mercy of the steel cycle, particularly with a large investment programme in place.  “They also bought when Erdemir was making a substantial profit,” he says.


“Should a glut of steel products develop, Turkey would be one of the markets steel producers would target,” he says. Also, most of Erdemir’s raw materials have to be imported, which incurs shipping costs and to an extent currency risk.


“To get a controlling stake, paying a certain premium is normal,” says Ali Yavuz Birdal, equity analyst with Finans Invest. “Most acquisitions are going on at higher multiples. Therefore the premium shouldn’t be a surprise.” However, he concedes that Erdemir’s financial performance mainly hinges on the steel cycle.


In the six months to June, Erdemir made a net after tax profit of TL103mn (US$64.37mn) on a turnover of TL2.234bn (US$1.4bn). For the 12 months to December 2005, it made a net after-tax profit of TL193mn (US$143mn) on a turnover of TL4.167bn (US$3.09bn).




Erdemir pays off


But looking further ahead, the Erdemir purchase makes more financial sense. By the time increased capacity comes online around 2008 onwards, analysts are expecting the steel cycle to show an upturn. At which point Erdemir will not only be selling more steel, but more profitable lines.


This means the company should be a lot more profitable than now. The Oyak management also think the current consolidation in the steel sector is very good news. Not only is it lifting the value of the remaining independent steel companies, but it should also lead to more stability in prices. For decades the steel sector has been beset with chronic over-capacity as countries did their up-most to protect national champions. Now that attitude is becoming more relaxed, which is allowing much needed consolidation to take place.


Nonetheless, Oyak may at some point have to make a long-term strategic decision about Erdemir. The way to go in steel at the moment is to be either a consolidator or become consolidated. The former is definitely out, as Oyak/Erdemir do not have deep enough pockets or seemingly the desire to become an international steel giant.


So far the strategy seems to be about finding a foreign partner for Erdemir.


“Consolidation might make steel prices more stable and make remaining independent steel companies more valuable,” says the analyst, “but the other  argument is that if you are alone while global piers are consolidated and producing their own products and have their own iron ore, etc? they could have more competitive power.”


Local analysts reckon a Russian or Ukrainian player would be an ideal fit. They typically have access to cheaper energy and also raw materials. The thinking is that one of those players situated on the other side of the Black Sea can ship crude steel products to Erdemir. Indeed, Erdemir has a modern plant on the Black Sea with its own port facilities.


Erdemir could import crude steel products from a Russian or Ukrainian partner and then make them into processed steel products for shipment to the EU.


Turkey already enjoys a privileged trading relationship with the EU and Erdemir is a lower cost steel producer than its Europe competitors. That’s largely down to lower wage costs and owning its own port facilities.


Whatever the export prospects for Erdemir, the domestic market holds plenty of promise. The economy is booming with 8% growth a year with plenty of foreign investment pouring in. Much of that is going into manufacturing.


Compared to Europe, the country’s demographics are also favourable. According to the OECD, around 5.4% of the population was over 65 in 2000, by 2020 that should reach 6.7%.  The population is around 71mn people.


Inflation has also been brought down to single digits. The main worries are the current account deficit at around 7% of GDP. Another concern is the elections next year, which could lead to some political uncertainty. For instance the government may sanction too much public spending ahead of the elections. Some analysts think this could be a catalyst to triggering a correction in the Turkish lira.


What ever the short-term outlook, Oyak remains fully committed to the Turkish economy. In fact, Muderrisoglu talks of Oyak streamlining its portfolio of investments to focus more on industrial assets. Despite, strong foreign interest in the country he still sees plenty of value in industrial assets.


Power generation is one area, which is being actively explored. In the meantime, Oyak Bank is up for sale with Credit Agricole and Standard Chartered being seen as the leading contenders. It is not clear whether Oyak will sell the entire bank or just a percentage of it.


It is estimated to be worth around €2.5bn. No doubt it wants to cash in on the high value of Turkish financial institutions and seek value for money elsewhere.