In response to two recent Abu Dhabi mergers – National Bank of Abu Dhabi with FGB (a combined market value of US$30 billion) and the International Petroleum Investment Company with Mubadala Development Company (with combined assets of $127bn) – one may wonder: why, and why now?
While the prevailing state of oil prices has been correctly characterised as a driving factor, a deeper look exposes subtle yet important differences between the two mergers, with implications for what lies in the future.
Economics has a lot to say about mergers. The Abu Dhabi mergers are examples of horizontal mergers, as they involve combining organisations that occupy the same position in the production chain. The alternative is vertical integration, which occurs when, for example, a supermarket buys a farm. There are three broad motivations for horizontal mergers.
First are efficiency considerations – companies may seek to save on replicated costs, such as IT departments. Alternatively, when some units operate at a larger scale, there are economies of scale. For example, a larger organisation can more cheaply provide day-care facilities for its staff’s children than would multiple, smaller units. The 1998 merger between the oil supermajors Exxon and Mobil was motivated by such factors.
Second is strategic market positioning – companies may look to eliminate a competitor by buying it or to gain access to an important client base – both played a role in Facebook’s acquisition of WhatsApp. Because of the potentially adverse consequences for consumers, some governments counter this by operating antitrust agencies that oversee merger activity.
Finally, horizontal mergers can be effective ways of combining organisationally useful knowledge, such as proprietary technology. This, together with the first motivation, is sometimes described as synergy benefits to mergers, with an example being Microsoft’s purchase of Skype.
When studying the history of mergers, a key finding is that they tend to come in spurts and that they are underlain by some kind of external regulatory or structural shock. In the case of Abu Dhabi, the impetus has been the significant decline in oil prices since the middle of 2014. But there are some notable differences in the role of oil prices in the two mergers.
The banking merger is a very traditional horizontal one: all three classic motivations contribute to the decision. Global capital markets are becoming increasingly competitive and dealing with the Byzantine regulations haphazardly erected after the global financial crisis of 2008 is expensive. The merger brings efficiency benefits and gives Abu Dhabi a much stronger foundation for its goal of becoming a global financial capital. Moreover, Brexit presents the entire GCC banking system with an opportunity to seize a larger slice of the global financial pie as Frankfurt, London, and Paris all suffer from the existential threat faced by the European Union.
The wealth fund merger is underlain by more subtle strategic thinking. At first glance, there is surely a role for the traditional goal of cost saving. Beyond this, there is an additional benefit relating to the UAE’s economic diversification goals.
Traditionally, the primary function of a sovereign wealth fund is to transfer wealth from current to future generations in a low-risk manner by buying assets from across the entire globe. This is especially important for an economy such as the UAE, which is highly exposed to the volatility of oil prices.
The goal of diversifying the economy presents a new role for wealth funds. In the GCC, the uncertain future of oil prices is forcing governments to accelerate their economic diversification efforts. The goal of transiting to a knowledge economy requires rapid absorption of world-class technology and the development of the capability to produce it. GCC governments have correctly inferred that the board seats acquired in top global companies through wealth fund investments can be used as vehicles for knowledge transfer.
In this sense, merging the two investment funds helps in two ways. First, the larger the fund, the greater the likelihood that board seats can be purchased, as opposed to passive shareholdings that yield no proprietary knowledge. Second, there are synergies and economies of scale in processing and collating the knowledge that is to be imported through the investments. For example, Ipic’s energy investments are focused on downstream assets, while Mubadala’s energy holdings are primarily upstream. The combined knowledge from upstream and downstream assets is worth more than the sum of the parts.
Abu Dhabi is not alone in seeking to deploy its investments and partnerships as a means of importing technology and developing the local economy. Saudi Arabia recently invested heavily in Uber as a precursor to Uberising the Saudi economy, while the UAE recently announced a partnership with Nasa for space exploration that is clearly designed to develop the capabilities of UAE citizens.
What does the future hold? Predicting merger activity is very difficult, especially when the organisations are partly controlled by governments that have multiple goals beyond profit-maximisation. Consolidation is most likely in the industries where the UAE wishes to compete globally.
While the above advantages to merger activity may seem enticing, one must not fall into the trap of assuming that bigger is always better. The greatest benefit of operating organisations independently is that it allows for market competition, and as humans have painfully discovered in their past dalliances with socialism, monolithic conglomerates become unwieldy and sclerotic. For example, Google recently divided itself into two separate organisations with the goal of improving efficiency and transparency. Much of the UAE’s economic success can be attributed to its commitment to free markets and competition and maintaining that philosophy will surely contribute to the goal of a prosperous and diversified economy.