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Hong Kong/Jakarta. The departure of Sri Mulyani Indrawati as Indonesia’s finance minister nearly two years ago seemed to sum up much that is both right and wrong in one of Asia’s fastest growing economies. Her reformist modernizing zeal was lauded by international banks and investors, and she won plaudits at home for overhauling corrupt tax and customs departments.

But she made enemies along the way, particularly among the powerful tycoons and politicians who run the world’s fourth-most populous nation. The reformer may be gone, but the business opportunities remain. 

Ratings agencies have upgraded Indonesia’s debt, the stock market is up by a fifth since October, the IPO pipeline is well stocked, and investment banking fees are growing far faster than elsewhere in Asia. Little wonder that Morgan Stanley is beating a path to the country, elbowing out rival Goldman Sachs in a race to buy a brokerage seat in one of the world’s hottest emerging markets. 

Southeast Asia’s largest economy is a big draw for global investment banks chasing fee revenue on deals and fund raisings, but which are well aware of the dangers — from corruption and a lack of transparency to market volatility.

“I’ve read the Indonesian takeover rules and they’re brilliant. They’re better than nearly every other country in Asia, better than a lot of countries in Europe, and definitely better than the US in terms of minority protection,” said the manager of a large, Asia-based hedge fund, who did not want to be named because he trades in Indonesia.

“But you don’t apply them.”

While still a relatively small piece of the Asia fee pie, revenues from investment banking operations in Indonesia have soared in the past decade.  

Fast Growth

Fee income is up seven-fold, rising every year since 2000 to $391.4 million last year, Thomson Reuters fee estimates show.

Over the same period, fee income trebled across Southeast Asia.

While total estimated investment banking fees earned over the decade, at $2.1 billion, are just a seventh of the Southeast Asia total, and a mere fraction of the overall Asia total, it’s the pace of growth that is a magnet for global banks to compete in a market where the likes of Credit Suisse, Deutsche Bank and Citigroup set up shop some time ago.

In the last 10 years, Credit Suisse has earned an estimated $250 million in Indonesia fees, on 121 deals, according to Thomson Reuters data, more than double the deals and fees of its nearest rival UBS, while third-ranked JP Morgan is credited with 63 deals and $100 million in fees.

The growth opportunity is overshadowed, however, by a lack of strict market checks and balances that make for an unpredictable business climate, and a heightened risk of losing money in a system where it can be difficult to exit investments.     

Banks and dealmakers looking for long-term investments in Indonesia must tread carefully around the powerful conglomerate heads, as UK financier Nat Rothschild has found in the boardroom of London-listed coal miner Bumi. 

Nonetheless, lured by the money to be made, banks and funds are increasingly hiring onshore in Indonesia rather than jetting in and out, according to Charles Gunawan, co-head of Indonesia investment banking at Credit Suisse.

“Unless you’re on the ground here all the time it’s impossible to do business in a meaningful way,” he said. “The model of covering the market from a hub like Singapore no longer works, both for securities firms and for private equity funds.”

Gunawan reckons investment banking opportunities will grow faster than current GDP growth of 6.5 percent, and his co-head, Rizal Gozali, sees banks and funds zeroing in on two sectors driving Indonesia’s growth.

“The main sector focus will be on natural resources, and then anything related to consumers: so retail, manufacturing and consumer banking products,” Gozali said.

Indonesia is rich in oil, gas, thermal coal, tin and palm oil.

The fee pool in the domestic equities market is also growing, explaining why Morgan Stanley pushed so hard to buy the brokerage seat from Jakarta securities firm Tiga Pilar Sekuritas, allowing the US bank to cover the secondary side of sales and trading, as well as research in a country where the stock index is nearing its record levels of last August.

Morgan Stanley needs regulatory approval before it can buy and sell stocks directly with the Jakarta exchange.

The investment climate has been boosted by both Fitch and Moody’s approving Indonesia’s debt as investment grade, allowing its bonds to be added to benchmark global indexes.
 
Announcing plans in November to set up an onshore brokerage business, Morgan Stanley CEO James Gorman said Indonesia was a “strategic priority” and cited “favorable ... demographics, low debt levels, stable government and abundance of natural resources” as reasons to be optimistic about the country.

These factors increase investor interest and corporate expansion, and mean opportunities for banks.

“We’re seeing much more willingness from investors to get exposure to Indonesia, either through direct investment, as with BAT’s acquisition of Bentoel; through the increasing number of corporate bonds; or through equity deals, which often take the form of a re-IPO of a company that has undergone a technical listing,” said Matt Hanning, head of investment banking Asia Pacific at UBS.

British American Tobacco bought a majority stake in Bentoel for close to $500 million in mid-2009.

Possibly bruised at being outmuscled by Morgan Stanley, or possibly smart to sit it out awhile, Goldman is talking to other Indonesian brokerages, though is not expected to sign a deal anytime soon, said a source familiar with the matter, who was not authorized to speak publicly on the issue.       

Who You Know

The big gap between market leader Credit Suisse and the chasing pack is unusual in investment banking. The Swiss Bank, whose current global investment banking head, Eric Varvel, helped build the Indonesia business in the wake of the 1997 Asia crisis, has cultivated ties with the family-run conglomerates who dispense most of the fees on offer.

It topped the rankings of investment bank fee income in Indonesia in four of the last five years, pulling in an estimated $35.4 million last year, Thomson Reuters data shows.

In 2010, the bank — which is private banker to the politically connected Bakrie family — arranged a $3 billion deal between Rothschild and the Bakries to build Bumi into an international coal mining giant. 

Behind the Swiss bank last year were Citigroup, with fees of $31.2 million, local rival Bank Mandiri, and Deutsche Bank and HSBC.

“I don’t think big names will win mandates. It’s more to do with client relationships who you know,” said Kunardy Lie, Citigroup Indonesia’s head of global banking.

Citi last year topped the underwriting rankings for the country’s international bond sales, using a dedicated team to win the bulk of government and state-owned enterprise deals, such as the sale of $1 billion of Islamic bonds, and state utility Perusahaan Listrik Negara’s $1 billion bond issue.

Those deals came despite an embarrassing setback for the US bank in May, when it was banned from adding new credit card clients for two years and new customers for its premium wealth services for a year, in the wake of alleged embezzlement by a relationship manager and the death of a client following questioning by external debt collectors working on Citi’s behalf. 

For Morgan Stanley, getting closer to Indonesia’s business power families is the logical next step. These families own interests and companies that often seek loans and fund raising deals that keep fees flowing to their preferred bank adviser.

For example, Bank of America Merrill Lynch has become a go-to banker for Indonesia’s Lippo Group, controlled by the Riady family, raising money from the market and providing advisory services, such as in the sale last year of a stake in its cable TV unit to private equity worth $269 million.

The Jakarta Globe is affiliated with Lippo Group.

The ratings upgrades will increase the funds available to Indonesian companies, says Credit Suisse’s Gunaman. He doesn’t predict much change in the cost of funding as investors already priced in the sovereign upgrade, but the boost will see Indonesia loom larger on the radar at the big funds that can only buy investment grade debt.

Deeper knowledge of the local market will be key in avoiding some of Indonesia’s pitfalls.

“Investors have become much more knowledgeable about Indonesia,” said Gozali, Gunaman’s co-head at Credit Suisse. “Fifteen years ago when you talked to foreigners, many knew very little about the place, but now they know much more about the market and what it takes to do business here.”

Reuters