AVCJ at 25: Joe Bae of KKR

Joe Bae's fact-finding missions began in late 2004. Over the course of several months in Asia he met with scores of private equity investors and service providers, head hunters, bankers, regulators and government officials. The objective was to return to New York and present KKR's co-founders, Henry Kravis and George Roberts, with an entry strategy for the region.

There was only one cast-iron requirement: the private equity firm's approach had to be differentiated from the competition.

"People had been looking at Asia since the late 1990s but we wanted to do it properly, rather than send three people to Hong Kong and tell them to generate deal flow," says Bae, who has been head of KKR Asia since 2005. "The growth dynamics were clear. Across our global portfolio companies, there were already about 40 manufacturing facilities on the ground here. The question was how do you take advantage of that opportunity as a PE investor and build a sustainable franchise?"

KKR's global expansion has been characterized by conservatism and considered movement. For the first 20 years of its existence, the firm focused solely on North America. A debut European investment came in 1996 with the acquisition of a UK newspaper company and a full regional operation came online in 1999. Around this time a foray into Asia was debated - the Asian financial crisis was offering rich pickings to a handful of global firms - but dismissed in favor Europe's bigger buyout potential.

On-the-ground assessment

When the issue came up again a few years later, Bae was sent to investigate. And what he found were perceived gaps in the market that could be exploited.

"We started our business in Asia with a clear recognition that this part of the world was very different from North America and Europe and that to succeed we would have to localize dramatically in terms of people," Bae says. "You couldn't be an American buyout shop and set up a presence in Asia and think you could succeed just because you had been successful in the US."

He concluded that few of the private equity firms operating in Asia at the time had credible region-wide franchises, rather different participants boasted pockets of expertise, such as strong teams in China or Korea. And none of these franchises were fully plugged into their parent firms' global operations; an observation that might be contested by some but in the case of others was broadly accurate. KKR wanted an integrated approach, with the Asian operations able to draw on expertise from private equity, operations and capital markets teams in the US and Europe.

The region was still divided up into six key markets - an acknowledgement of how different languages, cultures, regulatory systems and growth trajectories influence individual investment environments - but this was so KKR could address them one by one. China was the top priority, followed by Southeast Asia, India, Australia and New Zealand, Japan and Korea in no particular order.

"We had to be disciplined and sequentially build the platform market by market around the best people we could find, and when we found those people accelerate the entry strategy," says Bae. "A lot of the Western firms started out with a very Western approach, putting a lot of expatriates and US-trained investment bankers and consultants on the ground. We wanted a highly localized team in each market."

This approach is reflected in the makeup of KKR Asia today. With the addition of a Singapore office in October, Asia now accounts for seven of the private equity firm's offices globally with approximately 100 executives working out of them. Half are private equity professionals and only two - Bae is one of them - are expatriates. Private equity operations in Beijing are run by mainland Chinese natives, Indians in Mumbai, Australians in Sydney, Koreans in Seoul and Japanese in Tokyo. Singapore-based team members come from Southeast Asian countries.

Hiring policies

It has taken seven years to achieve this balance. KKR moved first in China, hiring current Head of China David Liu and three other senior executives from Morgan Stanley Private Equity Asia in 2006. This group had been investing in China for 12 years, building up a strong track record of domestic consumption-oriented deals that KKR saw as the basis for its own strategy in the country.

Growth capital investments have followed in the likes of clothing companies China Outfitters and Novo Retail, niche healthcare player China Cord Blood Corp, water treatment specialist China Envirotech and milk supplier China Modern Dairy. In 2010, four years after KKR launched its $4 billion debut Asia fund, a $ 1 billion China growth fund was created to accommodate investments of below $75 million that are seen as strong proxies for the domestic consumption story but are too small for the buyout-focused Asia vehicle.

"We want to hire world-class local people but they don't have to be private equity executives," says Bae. "The fifth senior person we hired in China, Xiang Li, came from Goldman Sachs but he spent most of his career at the National Development and Reform Commission (NDRC) so is close to policy executives. In India, we took Sanjay Nayar, formerly CEO of Citigroup South Asia, and paired him with HerambHajarnavis, who used to be country head at Goldman Sachs."

As head of KKR India, Nayar has been given license to pursue a local strategy in much the same way as the China team with their dedicated growth fund. Notably, the private equity firm set up a non-banking financial company (NBFC), a balance sheet vehicle that allows it to provide local currency debt products to entrepreneurs who don't want standard equity financing. The onus is on building ties with good companies that may ultimately require a variety of funding options as they expand.

KKR had been tracking Nayar for several years but it was only after the global financial crisis in 2008 that he was persuaded to leave Citigroup. Bae notes that the relationships his country head established with key local families, regulators and government officials during his time as a banker, plus an instinct for what will work in the local market, is more relevant in India than 10 years as a global PE investor.

The other major gap in the market Bae identified when conducting his initial reconnaissance is perhaps best described as anti-opportunism. Private equity made its mark in the region through restructuring deals in the wake of the Asian financial crisis, which opened up a channel for larger-scale buyouts. By the time KKR arrived on the scene this window had closed, although arguably some of the spirit remained. The private equity firm felt the time was right for a longer-term, active involvement approach that it had already introduced in the US and Europe.

"In Capstone we have a large operations team on the ground," Bae says. "When you look at China and Southeast Asia, where you are participating predominantly as a minority investor, entrepreneurs want more than just capital. They are picking a partner and your ability to deliver dedicated high-impact operational executives to help drive growth is critical."

This input might concern sales and marketing, opening new stores, introducing manufacturing efficiencies or rolling out improved IT systems. Yet arguably the most vivid example of KKR value-add was China Modern Dairy, which saw the implementation of a whole new business model. The private equity firm teamed up with CDH Investments Management, a leading domestic GP, to acquire a 45% stake in Modern Dairy for $181 million in 2008.

The announcement came a matter of weeks after the melamine scandal when tainted milk products cost the lives of six infants and hospitalized hundreds more. One dairy company went out of business and it took the industry as a whole months to recover due to the massive drop in consumer confidence. The contamination arose from poor oversight of the fragmented supply chains through which Chinese dairy products manufacturers sourced their milk and KKR focused on this problem.

"A lot of people rushed in and invested in the milk processing companies because the stocks were down 30%," recalls Bae. "We stepped back and said the issue is there are no large-scale dairy farmers supplying milk in a safe way, there is an opportunity to create value for the industry by developing some. We brought in a lot of experts from the US and Australia to help set up this operation and ran it as a joint venture with Mengniu, China's leading dairy processer."

Where to deploy?

KKR has committed $5 billion across 28 deals in Asia over the last seven years. At least one major investment has been completed in each of the six key markets, with China accounting for more than one quarter of capital deployed, followed by Southeast Asia on 23%, India and Korea both on 17%, Australia on 10% and Japan trailing on 6%.

A pan-Asian fund has the luxury of investing in different markets as and when opportunities arise: KKR completed two large buyouts in Australia in 2006 and then sat on the sidelines until this year as valuations moderated; China is on schedule with more upside anticipated; India and Southeast Asia have seen more activity than expected.

However, preconceived notions on North Asia, and Japan in particular, appear to have been misplaced. Even though existing investments are performing well, the portfolio hasn't grown due to a lack of quality assets coming to market. For Bae, the situation is an example of how KKR must play the long game and wait for cycles to turn. A second Asia fund, with a reported target of $5-6 billion, is in the pipeline and he expects to deploy a larger portion of the corpus in these countries.

It is also reminder that, even though the private equity firm has been in Asia for seven years and the region is responsible for some of its best returns globally, local markets remain difficult to fathom.

"What's always challenging about Asia, especially in my regional management seat, is the complexity," he says. "What we thought would be hard, such as dealing with local entrepreneurs, has turned out to be hard. A lot of issues that you take for granted in the US - like return on capital - aren't looked at in Asia. The day-to-day execution is complicated and you need a lot of patience."

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