ASEAN: The integration effect

The trouble-hit euro zone is hardly a poster child for regional economic integration, but it has yet to dent similar single-market efforts underway in Southeast Asia.

Although the Association of Southeast Asian Nations (ASEAN) has been around for 45 years, it is only in the last half decade that policies have been put in place to bring the 10 member economies closer together. Tariff barriers have been torn down, investment channels opened up and promises made to create a level commercial playing field for companies throughout the region.

The idea of an integrated Southeast Asian market is compelling. Taken as a single entity, Indonesia, Malaysia, the Philippines, Singapore, Thailand, Brunei, Myanmar, Cambodia, Laos and Vietnam are the world's ninth-largest economy, with a GDP of around $2 trillion. Annual economic growth is expected to be at least 5% through 2015. Their collective population is 600 million, larger than that of the EU.

If they buy into the ASEAN story, private equity firms looking for scale opportunities in Asia suddenly have an alternative to China and India. But do they buy into it? It comes down to assessing where the marketing campaign stops and reality begins. And establishing whether, even with the support of greater economic integration, private equity firms are able to build cross-border businesses within the region.

"Many PE firms look at the region from a country level but we look at how we can leverage this single market," says Karam Butalia, executive chairman of Southeast Asia-focused GP KV Asia. "When we invest in a company in Thailand, for example, we might want to use it as a platform to enter Laos, Cambodia and perhaps now Myanmar."

At the same time, though, there is recognition that one size doesn't fit all. While the ASEAN members are inextricably moving closer together, cultural and political differences - if not real rivalries - are profound. Any manner of local incongruities or obstacles might prevent the seamless transition of a company from one location to another, although such challenges are by no means unique to Southeast Asia.

"ASEAN member countries are at peace with each other, trade freely, and allow visa-free travel for short stays - other than that, I cannot think of many issues that they are fully aligned on" says Nicholas Ashby, CEO of Malaysia-based advisory firm Celadon Capital. "ASEAN is a convenient geo-political grouping, but it is an acronym for a collection of extremely contrasting economies, spanning from one of the world's richest (Singapore) to one of the poorest (Myanmar)."

Building blocks

The ASEAN Vision 2020, signed in 1997, laid the groundwork - and set a target date - for broad-based integration covering political-security, economic and socio-cultural issues. A decade on, the member countries agreed to speed up the process, targeting the creation of an ASEAN Community by 2015.

By the time a blueprint for an economic community was adopted, also in 2007, a free trade area (FTA) was already in the process of being established, and tariffs on a majority of selected products were reduced to 0-5%. Efforts on trade have been bolstered by a comprehensive investment agreement (ACIA) intended to facilitate capital flows. Regular exchanges and policy frameworks also exist for energy and natural resources, food and agriculture, finance, telecom and tourism.
Last year, in collaboration with the Asian Development Bank (ADB), ASEAN launched an infrastructure fund, with initial capital of $485.2 million, to address the logistical challenges to regional trade.

"Is ASEAN more integrated today than ever before? The answer is clearly yes," says Jin Cyhn, who works out of the ADB's Office of Regional Integration and is responsible for the infrastructure fund. "There is no turning back. It's not just policymakers agreeing on pie-in-the-sky issues; there is a real demand in the business community to get it right."

Since the region's ninth summit in 2003, when the concept of an ASEAN Community was first endorsed, GDP has risen from $722 billion to $1.8 trillion in 2010, while GDP per capita more than doubled to $3,100. Trade also rose twofold to $2.1 trillion, one quarter of which is intra-ASEAN trade. Over the same period, China leapfrogged the US and Japan to become ASEAN's largest trading partner, accounting for $232 billion in imports and exports in 2010, or 11.3% of the region's total.

Foreign direct investment (FDI) inflows rose from $24.5 billion in 2003 to $76.2 billion in 2010. Intra-ASEAN capital flows have increased more than fourfold, accounting for 16.1% of the regional total in 2010 compared to 11.1% seven years ago. Only the EU contributes more.

It is a matter of debate as to who has benefited most from these developments. "We have seen multinationals take advantage of the FTA, but the problem is small- and medium-sized enterprises (SMEs) don't have the manpower and resources to do the same," says Sanchita Basu Das, lead researcher for economic affairs at the Institute of Southeast Asian Studies' (ISEAS) ASEAN Studies Center in Singapore. "Around 90% of firms in the region still fall into this category."

Although ADB's Cyhn cites increased engagement from Exim Bank of Malaysia as evidence that smaller companies are looking for cross-border opportunities, the reduction in tariff barriers has clearly made life easier for multinationals.

As longstanding investors in the region, Japanese corporates - whose government introduced regional trade agreements well before ASEAN got in on the act - are well positioned to benefit. For example, it is suggested that the auto component supply chains that Japanese care companies have cultivated in Thailand could spread across Southeast Asia. ISEAS' Basu Das says large Chinese companies, supported by government policy and financing, will be the next to benefit.

The private equity angle

This trend doesn't preclude Southeast Asia-focused private equity firms from guiding portfolio companies into new markets.

According to Rodney Muse, co-managing partner of Navis Capital Partners, a wariness of overseas expansion, or an inability to execute, represents an opportunity. As many of 20 of Navis' past and current portfolio companies have in some respect expanded regionally. Muse singles out Alliance Cosmetics, a Malaysian beauty products player whose Silky Girl brand is currently being rolled out in Indonesia, and diaper manufacturer Drypers Asia, which used its Malaysia and Singapore platform to enter Thailand and the Philippines, eventually becoming the leading player in Southeast Asia.

"It's all about the addressable market," Muse says. "Malaysia has a population of25-30 million and so the market for Alliance Cosmetics is 4-5 million women. Indonesia's population is 240 million, so the potential market is 20 million people. That's a 4-5x increase."

Navis' experiences of Alliance Cosmetics and Drypers reflect both the advantages and limitations of the ASEAN initiative in private equity terms.

When Navis bought Drypers in 2001, diaper manufacturers in the region were obliged to set up operations in individual markets so that tariffs didn't eat into profit margins. Trade liberalization has transformed the industry, allowing the creation of super-scale factories with 20 production lines rather than two. Consolidation ensued. Navis exited the company in 2004 to Sweden's SCA, a global player in the diaper and hygiene products space that recognized the potential of Southeast Asian exposure.

Alliance Cosmetics is a different creature. If a private equity firm wants to take a highly discretionary consumer brand into a new market, it must first establish that there is sufficient reason - economics, cultural affinity, unmet demand, and so on - for locals to buy it. In the case of Alliance, Navis pinpointed the similarities in skin tone and dress sense between its target demographics in Malaysia and Indonesia, as well as the likely appeal of Silky Girl's halal ingredients to Indonesia's Muslim population. When marketing the products, it recruited brand ambassadors - mostly pop culture figures - with clear cross-border appeal.

Even with localized marketing, distribution and business plans, success is not guaranteed. Navis resisted entreaties to take Malaysia-based outdoor advertising business Big Tree into Indonesia on the grounds that difficulties securing concessions on highways, the headaches of dealing with various government bodies and competition from strong local incumbents posed significant obstacles. In this context, the commercial benefits of a dominant position in Malaysia were enough.

"The industrial space is lower risk but the big challenge is: can you take consumer brands that are indigenous to one country and roll them out successfully elsewhere?" Muse adds. "Thinking you can take a Singapore business model, product range, pricing and marketing and just mimic it in Malaysia is a very risky strategy."

The ASEAN initiative has its detractors. ISEAS' Basu Das argues that constructive policymaking has not been matched by implementation. Although tariffs have been reduced or removed, she says, customs procedures aren't yet harmonized. This can cause delays, particularly when routing goods through a third location within ASEAN that isn't covered by a separate trade pact that exists between the other two.

"The policymakers have come up with measures to address concerns such as a "single national window" in each country for anybody who wants information on ASEAN," Basu Das says. "Of the 10 countries, only 4-5 have them."

She is not optimistic about the region meeting its 2015 deadline for the creation of the ASEAN Community, suggesting it might not happen until after 2025. The ADB's Cyhn, meanwhile, is not so downcast, noting that the ASEAN initiative has sufficient momentum and political support to address implementation issues. "By 2020, I think it would be a single market," he says.

Invisible barriers

For PE investors, the principal challenges, as Muse notes in his assessment of Big Tree's prospects in Indonesia, exist in gray areas - invisible barriers that vary from market to market.

KV Asia's Butalia contrasts the ease with which he once relocated a contract manufacturer from Singapore to Vietnam for cost reasons with the brick wall private equity firms face when government-mandated price controls for certain goods and services make it economically unfeasible to roll out a business into a country. Other industry participants cite endless streams of manufacturing permits, restrictions on retail operations and challenges registering products for distribution as perennial local headaches.

There is a general desire for ASEAN to focus more on non-tariff barriers, particularly in the services sector, but in Southeast Asia as elsewhere, political will remains an issue. It could be argued that the region is more likely to see a single ASEAN currency than a single ASEAN airline, for example.

This doesn't make Southeast Asia a less popular investment destination - on the contrary, the degree of integration that has been achieved combined with the strong economic fundamentals of the region are attractive. Private equity firms simply have to respond to conditions on the ground, and identify whether businesses have the capacity to go cross-border and how it can be achieved. In this context, expertise and networks in individual markets, as opposed to the fly-in, fly-out approach, are invaluable.

"If you look at it in the grand scheme of things, ASEAN is doing quite well," says Chihtsung Lam, managing partner at Axiom Asia. "When you consider what is happening in the EU and the challenges of integrating entities that have separate political and cultural identities, it's not easy to go beyond what ASEAN already has. It's just not going to be as scalable a market as China or India and that's not ASEAN's fault."

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• Topics
• Southeast Asia
• Asian Development Bank
• Axiom Asia Private Capital
• Southeast Asia