The Philippines: SE Asia's next big thing?

SPI Global, a Philippines-based business process outsourcing (BPO) firm, is no stranger to PE investment. MBO Partners and Electra Partners Asia are the first backers listed in AVCJ Research's records, committing $17.5 million via a management buy-in in 1998. Over the next two years, a few minority investors came on board before T.H. Lee Putnam Ventures led an $87 million buyout in 2004.

Two years on, with SPi an established global player and the Philippines en route to becoming the call center capital of the world, Philippines Long Distance Telephone Company (PLDT) acquired the company for $135 million. It retained full ownership until last year, when CVC Capital Partners completed a carve-out that valued SPi at more than $300 million. PLDT still holds a 20% stake.

This may have been the fourth change in control in 15 years, but it still represented a breakthrough. The Philippines had never seen a larger private equity buyout; it hadn't seen many buyouts at all. And thanks to SPi's strong international customer base, obtaining debt to underpin the transaction was a fairly painless process. Cash was borrowed in US dollars, opening the process up to more banks, with a portion of the fundraising taking place in the US itself.

Unsurprisingly, 2013 was a record year for PE investment in the Philippines - if Ashmore's 2008 acquisition of oil refiner Petron from Saudi Arabia's Aramco is excluded. Yet the momentum remains, with $474 million deployed so far this year, the second-highest total on record. The SPi acquisition is by no means the only factor, but perhaps it did make the PE community pay more attention to the strong macro fundamentals and rapid industrial growth behind the latest Southeast Asian consumer story.

"From the Asian financial crisis until about 2-3 years ago, the Philippines had been shunned. Private equity firms with regional strategies just avoided the country," says Jesse Ang, Philippines resident representative at the International Finance Corporation (IFC). "Now they are saying, ‘we've ignored the Philippines for a while, why don't we go back and take a look?'"

Robust fundamentals

Strong macro growth has played a role in changing sentiment. The Philippines' economy has expanded by more than 6% in three out of the last four years and the Asian Development Bank projects growth of 6.2% and 6.4% in 2014 and 2015, respectively. Furthermore, despite a sell-off in October, the country's public equities market is among Asia's best-performing, with the PSEi Index gaining more than 60% over the last two years.

Foreign direct investment (FDI) has been low by regional standards, averaging about $2 billion between 2008 and 2012. However, the decision by Standard & Poor's and Fitch Ratings last year to raise their long-term credit ratings for the Philippines to investment grade, has turned the situation on its head. FDI reached $3.8 billion in 2013 and then $3.6 billion for the first six months of 2014 alone.

Inbound remittances from the Filipinos overseas, a key contributor to consumer spending, also increased sharply to $12.7 billion in the first half, but PE investors are arguably more interested in what is happening within the country's borders. Consumer spending already accounts for two thirds of GDP, yet the Philippines has ASEAN's second-largest population and the demographics are favorable.

Mary Jade T. Roxas-Divinagracia, deals and corporate finance managing partner at PwC Philippines, identifies the hot sectors as retail, financial services, healthcare, technology, logistics and distribution - all of which can be seen as natural beneficiaries of the broader consumer trend.

The three private equity transactions that account for the bulk of capital deployed so far this year follow similar lines: GIC Private has backed Metro Pacific Investments' hospital business and made a pre-IPO commitment to canned tuna business Century Canning Corporation, while TPG Capital and Khazanah Nasional invested in affordable housing developer 8990 Holdings.

However, Dennis Montecillo, president of BPI Investment Banking Group, argues that investment targets are just one half of the issue. "Exits are the Holy Grail of private equity and history is starting to show that, however modest, the amounts might be, private equity can come in and then get out of the Philippines," he says. "Two exits do not a market make; but they are good for visibility and profile."

The first of the two recent exits he highlights involves CVC, which has agreed to sell the bulk of its stake in Rizal Commercial Banking Corporation (RCBC), the country's fifth-largest lender by assets. The PE firm paid $115 million for a 15% interest in 2011 and completed a partial exit last year, raising around $45 million. As of December 2013, CVC held 139.2 million shares - or a 10.91% stake - and 118.9 million shares will be sold to Cathay Life as part of the Taiwan-based insurer's acquisition of a 20% interest in RCBC. CVC is expected to take away around $170 million, with IFC also making a partial exit.

The second exit came earlier in the year as Aureos Southeast Asia Fund - now managed by The Abraaj Group - sold its minority stake in restaurant operator Pancake House for around $18 million, allowing Max's Group, a larger local dining player, to privatize the business. The Aureos fund invested around $6 million. It helped treble the number of outlets and also took Pancake House into other Southeast Asian markets.

To a certain extent, these investments also represent points on the deal spectrum at which industry participants expect to see considerable activity - or at least considerable interest.

Big deal, small choice

AVCJ Research has records of fewer than 25 PE deals of $50 million or more in the Philippines. While Brian Hong, senior managing director at CVC, notes that the number of opportunities is greater as companies from fast-growing sectors cross the minimum investment threshold, there are also more people looking for deals.

"The challenge nowadays is there is increasing competition, not just from other PE firms but from the capital markets," he says. "Investor interest in the Philippines has awakened or grown and many of these companies have multiple suitors and multiple options."

Montecillo claims that in the last 13 months at least 20 private equity firms have come to see him, either looking to enter the Philippines or build on their current market coverage. Nine in 10 firms quote equity check sizes that Montecillo believes are too big for the market to handle on a per deal basis at present. He tries to manage their expectations downwards, noting that any investor with a $50 million cut-off would struggle to complete one transaction a year.

An added complication is that most pan-regional funds still cover the Philippines on a fly in-fly out basis, which means it is potentially harder to source deals outside of sales processes run by investment banks. These processes may also pitch PE investors against strategic players that are often capable of paying higher prices. Rising valuations are cited as a concern by several industry participants.

"Strategics have the advantage of bringing with them synergistic value and the promise of growing the business or keeping the legacy of the family," says PwC's Roxas-Divinagracia. "Further, domestic strategic investors have the advantage of being more familiar with the local environment. The business environment is still dominated by local conglomerates and this can be difficult for foreign investors."

According to Thomson Reuters, M&A reached a four-year high of $9.6 billion in 2013 and stands at $5.7 billion for 2014 to date. While more foreign investors are showing interest, domestic players account for 22 of the 30 largest deals announced since 2013. The buyers include local Forbes rich list members such as the Sy family (SM Prime Holdings), Andrew Tan (Alliance Global Group), John Gokongwei (JG Summit Holdings), the Aboitiz family (Aboitiz Equity Ventures) and the Ty family (Metrobank).

CVC has found a way to work with local partners, taking a minority stake in RCBC, which is owned by the Yuchengco family, and keeping PLDT involved with SPi. Hong stresses the importance of being differentiated and making a proposal that adds value. "We look for situations where someone wants a partner who can help achieve some strategic goals and the capital is one piece of that puzzle," he says.

Taking this approach, the identification of openings in selected businesses owned by conglomerates is just one angle. Another is targeting family-run firms that sit several rungs further down the corporate ladder. For example, an entrepreneur might require capital and expertise but wants to avoid the conglomerates, fearing that taking their money might result in him losing control of business.

BPI's Montecillo is currently working on a sell-side mandate for a private equity investor that wants to make a partial exit from a renewable energy enterprise. It is drawing interest in part because of the nature of the investor. "When the original owner took PE funding 2-3 years ago he needed bridge equity but didn't want to tie up with a conglomerate," says Montecillo. "The PE investor is willing to stay in and take more upside risk, but prospective buyers know it has to exit within seven years."

Companies of this size could also be going through transition periods and value the guidance provided by an independent foreign investor. Industry participants present two hypothetical scenarios. In the first, the founder-entrepreneur is approaching retirement age and his children are preparing to take over the business but they want help professionalizing the management. In the second, a company wants to expand overseas and the PE partner can advise on market entry and potential acquisitions.

Pancake House would fall into this category, but offering guidance to family-run businesses - regarding onshore or offshore strategies - resonates across the spectrum.

Diamonds in the rough

In another sign of the increasingly positive sentiment on the Philippines, IFC has made its first LP commitment to a country-focused manager since the 1990s. The recipient was Navegar I, a $120 million vehicle run as a partnership between Swedish alternative asset manager Brummer & Partners and two local investors. Angeon Advisors, which was looking to raise $100 million for a Philippines vehicle, has put its plans on hold until next year, but this isn't for lack of deal flow.

Gerald Baldivia, managing director at Angeon, says he has plenty to work on - split roughly 50-50 between growth and buyout opportunities - and rarely encounters competition from other managers. Educating entrepreneurs on how private equity works and the value it can bring is a challenge, but the situation is improving.

"Some people need hand-holding, but a lot of family businesses here have some experience working with external and semi-professional investors such as local family offices," Baldivia says. "However, we do generally find that families we approached some time back, and who were not quite right in terms of their mindset, are now starting to revisit discussions."

Like other nascent groups in the market, Angeon is working on a deal-by-deal basis, usually sourcing and managing assets on behalf of financial investors. There is at present no great pressure to go out and raise a fund because there is ample demand from domestic investors - typically semi-formal family office structures - for exposure to the asset class.

Based on his exchanges with IFC, Baldivia suggests that the development finance institution may wait a couple of years, and assess the performance of Navegar I, before committing to another country-focused manager. To make the leap from semi-formal arrangements to managing money on behalf of multiple institutional investors, the likes of Angeon must make the same kind of value proposition to small companies as pan-regional PE players put before larger ones.

Private capital providers have made headway in the Philippines by being opportunistic. As early as 2005, hedge funds were coming into the market and getting deals by moving fast, investing small chunks of capital and taking a passive approach post-investment. There is still a sub-set of opportunities that hinge on picking the right moment. Local public markets are comparatively illiquid, with many smaller companies seeing little trading volume. Private equity could step in when they need capital at short notice but the public markets are unresponsive.

"Consumer is on the radar screen of everyone from the man in the street to the partner at the PE firm," says BPI's Montecillo. "Prices are getting bid up but sometimes the timing of a fundraise and market receptivity will not be aligned and there's the opportunity. This is not a value market - you are not going to come in and buy a consumer company at 10x price-to-earnings - but can you take advantage of market dislocation?"

It remains to be seen if this is a temporary or permanent phenomenon, or indeed whether it becomes the prevalent mode of investment. H&Q Asia Pacific established operations in the Philippines in 1986 and the country and its early investments included fast food business Jollibee, now worth about $4.5 billion. Yet in its latest incarnation, the Philippines private equity is still finding the way: capital committed since 2011 is 25% short of Vietnam's total and less than half that of Indonesia.

It is unclear how - and how quickly - the deal environment will fill out.

SIDEBAR: Strategic honeypot

Two private equity firms currently hold stakes in Philippines banks, and one of these players is exiting a large portion of its holding. It is a sign of the potentially frantic M&A market that has been created by the decision to scrap the 60% cap on foreign ownership of domestic lenders, as well as the limit on the number of wholly-owned overseas banks allowed to operate in the country.

"It a big development," says Neeraj Budhwani, a partner at Clifford Chance. "A lot of people are interested and doing work behind the scenes in terms of which targets they want to pursue. We do see that as an area where there will be more M&A, for sure."

Both Northstar Group and CVC Capital Partners have invested in Philippines lenders in the last three years. While there appears to be no movement on the former's stake in Philippine Bank of Communications, the latter has agreed to sell the bulk of its 10.91% interest in Rizal Commercial Banking Corporation (RCBC) as Taiwan-based Cathay Life acquires a 20% interest in the country's fifth-largest lender by assets. International Finance Corporation (IFC) is also making a partial exit from RCBC.

"It is one of the few markets in Southeast Asia with fairly limited international bank presence and you have loan growth in the mid-teens with average net interest margins of 4%, which are some of the largest in the region," says Brian Hong, senior managing director at CVC. "With the removal of the cap there is the potential for regional and international players to come into the market."

The removal of the cap should bring much-needed consolidation to the banking sector. The Philippines has around 700 banks and the seven largest commercial players account for two thirds of total industry assets.

There is also a substantial gap between the top three players and fourth place. The chief consolidators are tipped to be financial institutions from within Asia that are seeking to create regional franchises, although they will likely have to make do with minority stakes initially.

Groups from Japan, Malaysia and Taiwan are said to be leading the charge. Although private equity firms are believed to be looking for deals, strategic players are expected to dominate. "If you were placing bets on whether the next bank acquisition will be by a strategic or private equity, the momentum has shifted towards strategic," says Dennis Montecillo, president at BPI Investment Banking Group.

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• Topics
• Southeast Asia
• Consumer
• Philippines
• IFC
• GIC Private
• TPG Capital
• Khazanah Nasional
• Financial Services
• Exit
• Aureos Advisers (Aureos Capital)
• Consumer
• CVC Capital Partners