It is a general rule of classical economics that downturns eventually make for leaner economies: inefficient businesses fall by the wayside, while those with a competitive edge prosper. Those battle-hardened companies that survive the slump often go on to devour their weaker competitors, buying them out and applying their own successful strategies to their new acquisitions. The result is a fitter, more productive economy all round.
Such is the theory; yet what of the practice? In the UAE for example, can the guiding principle of classical economics - scarcity - be said to have applied in a monetary environment which enjoyed growth in M3 (the broad definition of money supply that includes institutional money market funds) of almost 34 per cent at one point early last year? The abrupt closing off of liquidity in the last quarter of 2008 was akin to moving an entire economy from the greenhouse to the icehouse, and the sheer velocity of the previous liquidity-fuelled growth in the UAE arguably resulted in an equally severe shock to the system for all companies operating here.
As such, it comes as no surprise to discover that merger and acquisition (M&A) activity in the Middle East, previously dominated by Gulf-based acquisitions, has slipped a staggering 86 per cent year on year, as reported recently by Mergermarket, an M&A intelligence provider. The fall is almost twice the global average of 46 per cent, and represents a slump of more than US$8 billion (Dh29.38bn) from the highs of last year. Altogether, total deals for the region in the first half of this year amounted to only $1.17bn.
The collapse is a particular blow for the region's banks, for which acting as M&A advisers was once a highly lucrative market. The number of deals on the table has fallen from 56 in the first half of last year to 22 so far this year, while the average value of deals has tumbled by two thirds, from $153 million to $53m. M&A data is hardly a bellwether for the condition of an economy (it tends to lag somewhat behind the curve at both ends of the cycle); it does however give a good picture of the extent to which both liquidity and business confidence has dropped during a downturn.
With more reliable advance indicators such as credit default swap (CDS) spreads seeming now to point toward improved confidence, particularly in Dubai, it is worth looking ahead to predict what the result of the downturn may mean for future M&A activity, and the long-term health of the economy. Given the previous high-octane growth already mentioned, it seems that, rather than acquisition, the most likely immediate result of renewed growth will be a rapid bout of consolidation in the market.
Few if any big corporations have maintained sufficient cash reserves to engage in a significant round of acquisitions, while it makes sense for some of the big beasts to profit from potential back-office synergies by merging their operations. Indeed, this already looks likely to be the pattern, with the announcement on June 28 that Emaar and Dubai Holding's property divisions are preparing for a merger, due to be completed by October.
The deal, which involves Dubai Properties, Sama Dubai and Tatweer, will create a single company with combined assets valued at an estimated Dh194bn, against total debt obligations of Dh13.4bn, according to Emaar. As the name suggests, the companies owned by Dubai Holding are not currently listed, so few financial details are available. Just as the tailing off of M&A activity during the crunch reflected its severity, so the success, and indeed the timetable, of any potential merger between Emaar and Dubai Holding will prove a good indicator for how far the Dubai market in particular has changed over the past 24 months.
A similar deal between the two, involving a land-for-shares agreement, was ditched in 2007 after objections from shareholders. A quick thumbs-up this time from both shareholders and regulators would be an indication of the new realities at play in the market, necessitating both consolidation and improved transparency among the major players. In this respect, the difference between economic theory and practice is not so far removed.
During a boom, each economy sickens on what it feeds on; yet the manner in which it sickens depends on the matter on which it feeds. Previous booms in the West, for example, have often been fed by cheap labour. Over time, a rise in the cost of labour leads to two things: at a micro level it squeezes margins; at a macro level, it creates inflation. The market response to this is improved efficiency and a reallocation of labour.
Those companies best able to achieve these results typically lead economic recovery, and go on to dominate the market. For the UAE however, the boom was to a large extent led by high liquidity, coupled with a light touch, can-do regulatory approach. The result was rapid growth, but of a type which arguably lacked adequate transparency for market signals to properly function, and hence prevent bubbles from forming.
The result has been abrupt: at the macro level, a squeeze on liquidity and a commensurate drop in prices to more sustainable levels, and at the micro level, a difficulty in bridging finances and sustaining new projects. As with other economic crises, the cure is to be found in the poison. We have already seen stage one of the market response: a raft of projects placed indefinitely on hold, coupled with a tightening of regulations.
What we are waiting for now is stage two: the business practice that will lead the economy into recovery, and go on to dominate the market. In fact, this is unlikely to be anything more spectacular than the simple act of business consolidation. Years of high liquidity have left the UAE in particular over-banked and with too many property developers. The future is likely to see fewer of both, but with more streamlined business structures in the ones that remain. Before we get there, though, expect to see fewer acquisitions, and a relative flood of mergers.
Oliver Cornock is the regional editor of the Oxford Business Group