Fragmentation factor: Deal-by-deal draws interest in Southeast Asia

From his base in Singapore, Lachmi-Niwas Sadani claims to be embracing the future of private equity: deal-by-deal investing. Lensbridge Capital, the firm he established last year, has completed six transactions in India, using capital from different sets of family offices for each one. Southeast Asia is next on the agenda: exclusive negotiations are currently underway over a small buyout in Vietnam.

"A number of family offices have been set up in Singapore in recent years and still more have been active in the region for some time - and most of the ones I've interacted with are averse to investing in blind pool funds," Sadani says. "Either they have an in-house team doing direct deals or they work on a deal-by-deal arrangement with GPs like us, paying fees on deployed capital. They understand Southeast Asia, they are close to the ground, and they bring a lot of value to us beyond just the capital."

Family offices are just one LP type on Lensbridge's call sheet. The firm is working with a group of development finance institutions (DFIs) on a transaction and it also sees large institutions like sovereign wealth funds as potential partners. Some DFIs like deal-by-deal because it means they can work with first-time managers that might otherwise fall outside of their remit, but on a general level, LP interest has several drivers: a desire to pick and choose deals rather than take blind pool risk; discomfort with the level of fees paid on capital that has been committed but not yet deployed; and an interest in structures that allow more flexibility than the typical 10-year private equity fund.

"Some GPs have been doing deal-by-deal well for years, but since 2008 I've seen LPs start to get more interested," says Sadani, who has previously worked for Nomura, Terra Firma and Ardian. "I've been close to a number of investors over the years, as an LP myself and having led investor relations functions at different organizations, and I have come to realize it's a model LPs have a strong appetite for."

Deal-by-deal is not for everyone. To LPs that lack on-the-ground resources, it can be a risk too far, and they prefer to invest in funds run by managers with whom they are well-acquainted. On the GP side, blind pools are eminently preferable because they offer certainty of funding. However, the deal-by-deal model is becoming more prevalent in Asia, with an admittedly small but growing number of managers pursuing the strategy out of Singapore. The obvious, pan-regional explanation is the challenging fundraising environment, but why Southeast Asia in particular?

A thin market

First of all, for all the interest in the region, relatively few new GPs with multi-market strategies have emerged recently. AVCJ Research has records of around 40 final closes by mostly Southeast Asia-focused private equity funds since 2010. Of these, five were first-time funds launched by independent players, among them Quadria Capital, KV Asia Capital, Dymon Asia Private Equity, Armstrong Asset Management, and Creador. Several others have tried and failed.

All five were around $300 million or below, although Creador has since accelerated through the gears and is chasing $450 million for its third fund. Above them sit a handful of incumbents. Southern Capital Group, Credence Partners, SEAVI Advent PE, Lombard Asia, and TAEL Partners currently manage funds of sub-$450 million. Only Navis Capital Partners and Northstar Group have broken through to higher ground; the former raised $1.5 billion for its seventh fund, for which the core markets are Southeast Asia and Australia, while the latter is investing an $810 million vehicle that primarily focuses on Indonesia.

The Southeast Asia GP landscape remains shallow largely because LPs have yet to buy into the notion of a sub-regional manager. "It's still a nascent industry and people may not necessarily think they should allocate capital there" says Eric Marchand, a Singapore-based investment manager with Unigestion. "There is growth but Southeast Asia is a hugely complex landscape. You have Singapore with one of the highest per capita GDPs in the world and then Myanmar with one of the lowest."

Marchand recalls a client visit to the region last year, which included meetings with local GPs from Indonesia and Vietnam as well as a number of pan-Southeast Asia players. This precipitated a discussion as to how best to cover the region: opt for a pan-Southeast Asia GP and exposure could be lumpy, driven by the fact that most managers are proficient in two or three markets as opposed to them all; go with a local GP and performance is wedded to the fortunes of a single, potential volatile, economy.

An alternative solution was for example to carve up the client's usual single commitment size, and allocate it to three different managers - essentially creating a hybrid Southeast Asian fund that offered strength in multiple markets. In the end he chose to back a pan-regional GP instead, uncomfortable with the practical and logistical challenges of splitting an already somewhat small commitment.

It is not unusual for LPs to play safe with a pan-regional. For many institutional investors, Southeast Asia remains a niche market: too small or too risky for a dedicated allocation. Indeed, deal flow - in US dollar terms - is driven by large, usually intermediate transactions that are contested between the flagship Asia funds. PE investment in the region came to $5.1 billion in 2015, down from $8.3 billion in 2014, and each year the five largest transactions accounted for about half of total capital. There has been a steady increase in number of deals, but this was largely due to increased VC activity.

The headline numbers do not accurately reflect activity in the middle and lower middle markets, but it is still peripatetic. "India sees around 400 deals a year and there are maybe 50-70 active private equity firms. In Malaysia there might be 10-12 deals a year but only three or so firms chasing them. In Indonesia the market is being whittled down to three or four firms and there are 6-8 deals per year," notes Brahmal Vasudevan, CEO of Creador, referring to the sub-$50 million space his firm targets.

Theory and practice

The theory is there is a mismatch between the middle market investment opportunity and the number of funds pursuing it - "There simply aren't as many groups doing private equity in Southeast Asia as in other parts of Asia," Brian Lim, a partner at Pantheon, notes - and deal-by-deal practitioners are trying to fill the gap. Lensbridge claims to take this approach through choice, one of a few. Most of these managers seek to build a track record and raise a fund on the back of it.

"There are lots of people running around doing ad hoc deals. I recently met with a group that wants to raise a hotel fund; they aren't sure whether they can do it, but the first deal is lined up and they are pretty confident about closing that," says Dean Collins, partner and head of the Singapore office at Dechert. "Also, partly because of the size of deals people are doing, they usually know a few rich guys who can put up $50 million. But they can't necessarily find institutions willing to do a $300 million fund."

Not everyone subscribes to the idea of a lack of competition for deals. Andrew Thompson, head of Asia Pacific private equity at KPMG, claims there is no shortage of private equity funds chasing the sell-side deals KPMG originates; rather, a series of cultural and regulatory issues and seller information challenges result in a higher proportion of transactions being unsuitable for the wide auctions seen in developed markets. As a result, GPs must "get a little bit deeper inside a business, and really understand the principal and management team," which means some deals are better suited to bilateral transactions.

However, this complexity within Southeast Asia - the collection of markets with different regulatory and cultural barriers, populated by company founders who are not wholly familiar with private equity - presents a challenge to all GPs in terms of how to assign limited resources to the region. Most firms admit there is an element of advocacy to their deal-sourcing, and an emphasis on establishing touch points with a wide range of counterparties.

For example, Creador claims to meet with 300 companies a year in Malaysia alone, and much of this time is spent educating owners and management on what PE has to offer. Navis writes bigger checks, but the environment is much the same in the less developed markets it covers. "There is a fair amount of educating, a fair amount of getting to know small investment advisors and explaining your track record of closing deals," adds David Ireland, a Thailand-based partner with the firm. "We meet with a lot of companies, just chatting to them and sowing the seeds - sometimes over a period of years."

This approach is unworkable without adequate resources on the ground. Navis had a head start in this respect, opening its first office in Kuala Lumpur in 1998 and then its fifth Southeast Asian base - out of eight offices overall - in Ho Chi Minh City two years ago. Others have been more concentrated in their approach. Southern Capital's core markets are Singapore, Malaysia and Indonesia (it used to consider China opportunistically but has not made an investment there since 2008) and it has an office in each one, with 16 investment professionals in total who are native to these markets.

According to Eugene Lai, the firm's co-managing partner, Singapore, Malaysia and Indonesia account for 90% of private equity activity by value in Southeast Asia and are well-suited to a control strategy targeting deals of $100-150 million. Southern Capital has resisted the temptation to enter additional markets because it would involve creating new teams.

"There are 10 countries in Southeast Asia and they are all quite different. As such, a team that is good in Malaysia or Indonesia isn't necessarily also good in Vietnam," he explains. "There is a sweet spot in terms of size that enables you to focus on a few countries without feeling the need to expand into new markets. If you are too big you feel the need to do different things and you might lose discipline; if you are too small, it is hard to cover these markets effectively."

Creador is trying to maintain this balancing act as it adds coverage of the Philippines. The firm chose Malaysia, Indonesia and India as its core markets on starting out in 2011 - dismissing Thailand due to the lack of synergies - and established a local presence. Now there is one person in Manila whose job it is to meet companies, and a managing director flies in from Malaysia every few weeks to assess the opportunities. While Vasudevan accepts the market is nascent, he feels that if steps aren't taken to build relationships, Creador will be poorly positioned when the Philippines takes off.

Chicken and egg

As long as this chicken-and-egg dynamic remains, and GPs have to invest in a market in the anticipation of seeing deal flow, expansion is likely to remain challenging even for the more established managers. It is therefore difficult to see, in the near-term at least, a substantial bridging of the gap between single country funds and the large pan-Asian players. Factor in the deep dive, relationship-heavy sourcing, and deal-by-deal practitioners may find plenty of opportunities to feed on in the middle market.

Lensbridge's Sadani expects to see more managers pursue this strategy and he has been in touch with several groups that are semi-dormant, no longer having funds to invest from or much prospect of raising new ones, and see deal-by-deal as a way to become active again. But he cautions that the approach is time-consuming, is uncertain in the absence of strong relations with a core group of LPs, and requires capital, not least to cover operating expenses while looking for investments.

This raises the question of how many GPs would opt for such an existence other than through necessity. Capital Square Partners, for example, closed a couple of investments on a deal-by-deal basis, but the ultimate objective was a blind pool; the GP is now in the process of raising a Southeast Asia and India-focused fund. Whether others can follow depends not only on the market deepening, but also on whether investment teams show they have the quality to justify LPs' support - and this will take time.

"It is still very difficult for LPs. With the exception of a few core groups, track records are not as long as in China or India, and so it is more difficult to say there is enough evidence that the model really works. As a result, they don't want to take that leap," Pantheon's Lim observes. "Part of unlocking that lack of capital provision is encouraging participation by local institutions. Either the framework isn't there or there aren't enough government incentives or DFIs active in these markets. But we have seen this approach work elsewhere."

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• Topics
• Southeast Asia
• Fundraising
• GPs
• LPs
• Singapore
• Creador
• Pantheon
• KPMG
• Navis Management