Taiwan PE: Local problem, local solution

Cathay Securities Investment Trust (Cathay SITC) started lobbying the Taiwan government to allow mutual fund managers to enter the private equity space late last year. Its efforts didn’t take long to bear fruit. In August, the Financial Supervisory Commission (FSC) accepted the proposal, keen to see more private capital put to work in the local economy.

Cathay SITC – which is Taiwan’s largest asset management company – was the first to win approval for a private equity unit. The firm subsequently launched a NT$10 billion ($329 million) fund that will target infrastructure investments in alternative energy and water resources, both areas that are favored by the government. The fund is expected to generate a stable annualized return of 6-7%.

“The government is eager to push its ‘5+2 Industrial Transformation Plan’ which aims to support strategic industries such as green energy, recycling and agriculture. During the communication process, they knew that we intended to invest in these areas. They are willing to support us because we’re backing these government initiatives. They feel we are on the same page,” says Steven Peng, a fund manager at Cathay SITC. He previously led Cathay Life Insurance’s alternative investment department.

A new structure

Cathay SITC has been politically astute in its lobbying efforts, but it was already performing to a sympathetic audience. Infamously hawkish on foreign buyout firms pursuing large-cap deals in Taiwan, the government nevertheless sees the value in nurturing a domestic private equity industry. Onshore asset management firms are expected to benefit, but it will take time for them to build professional teams and develop sustainable investment strategies.

“It’s a positive move that local securities investment trust companies can raise capital to make PE investments. It could help Taiwan cultivate a new talent pool by investing in the asset class,” says Andy Tsai, a partner at StepStone Group. “While the government is heading in the right direction and this will help stimulate the entire PE industry, Taiwan is still a long way from becoming an attractive market to invest in Asia.”

Reinvigorating Taiwan’s slowing economy was always a priority for President Tsai Ing-wen, the Democratic Progressive Party leader who came to power last year. The “5+2 Industrial Transformation Plan” is integral to this effort. The five in its name refers to the pillar industries – the Internet-of-things, biomedicine, green energy, smart machinery and defense – on which the new government wants to focus. Agriculture and the circular economy subsequently became the “+2.”

The National Development Council, a policy planning agency, responded last July by establishing an NT$100 billion private equity fund – the so-called Industrial Innovation & Transformation Fund – to focus on restructuring traditional industries and promoting the new economy. This may seem ironic to foreign private equity firms that have struggled to win regulatory approval to buy Taiwan-based assets or exit the ones they already own, but it’s a homegrown solution to a homegrown problem.

“The government has concerns when global private equity firms try to privatize Taiwanese companies, especially large businesses. But based on our conversations, they also think it’s important to have a channel for Taiwanese capital to support the local industries. Private equity is a type of financial instrument to achieve that purpose,” adds Cathay SITC’s Peng.

Taiwanese financial institutions have been able to set up captive venture capital investment units to invest in local emerging industries for several years. However, they have made investments directly from their balance sheets, without raising capital from third parties. Most securities investment trust companies (SITCs) have only participated in pre-IPO rounds through private placements, with a view to enhancing their role as an underwriter and obtaining shares in unlisted companies below the IPO price.

Now, though, private equity funds launched by SITCs must be structured as limited partnerships comprising a GP and a LP – the first time for Taiwanese financial institutions have been required to adhere to what is commonly seen as an international practice. To prevent conflicts of interest, SITCs should set up dedicated private equity departments staffed by independent teams, with revenues booked separately from the main mutual fund business.

“Taiwan is deregulating its private equity industry, which traditionally has been highly-regulated. Financial institutions, in particular insurance companies, have been paying attention to the asset class and have started to deploy meaningful amounts of capital,” says Lionel de Saint-Exupéry, chairman and CEO of CDIB Capital. “This trend is overall very positive for the industry as it will unleash capital within the system and will benefit the Taiwanese economy.”

As part of these deregulation efforts, commercial banks have also received approval to enter the local PE industry. A few weeks ago, the FSC lifted the restriction on the establishment of VC investment units by banks, allowing them to own 100% of their VC investment arms, up from 5%. It is estimated the change could channel about NT$100 billion into the real economy.

There has been further liberalization on the investment side. The 15% unlisted company ownership cap that applies to banks and their subsidiaries has been removed for VC units, which are able to invest up to NT$150 million in a business operating a 5+2 or creative industry and up to NT$50 million for other industries.

The LP angle

Domestic banks and insurers are estimated to have NT$2 trillion and NT$300 billion, respectively, in investable capital – making them a logical target for new local managers in search of LP commitments. J.P. Morgan Asset Management in Taiwan is said to be considering the establishment of local currency infrastructure fund aimed at institutional investors. Meanwhile, Cathay SITC is in the process of raising its own infrastructure vehicle, with domestic pension funds and insurance companies among the LPs being approached.

Taiwan’s insurers have been able to invest in PE since 2008, but most of the $30-50 billion they have deployed in the asset class has gone overseas. This is because the domestic market is deemed to have insufficient targets for institutional investors. Should more GPs launch funds in Taiwan, these investors could introduce some geographical diversity to their portfolios. Infrastructure is favored because it offers stable returns in a low-interest-rate environment.

In addition, private equity funds launched by SITCs are expected to provide new opportunities for high net worth individuals (HNWIs) to participate in the asset class. SITCs can tap into wide retail networks from their securities and mutual fund businesses, although educating HNWIs is a time-consuming process.

“Retail investors don’t have the same level of ability as institutional investors in constructing investment portfolios by allocating capital to different asset classes. They need more education to build up their knowledge of illiquid investment products. The challenge might be that retail investors have little interest in this asset class because they can’t sell at any time as they can with mutual funds,” says StepStone’s Tsai.

It is also difficult for asset managers to build internal expertise across deal sourcing and structuring, not to mention marketing PE funds to institutional and retail investors. Much like their clients, SITC employees are used to following public equity and fixed income strategies. Cathay SITC’s Peng is an exception in that he is familiar with global PE firms and direct investments in local infrastructure from his time at Cathay Life.

“Several SITCs in Taiwan are interested in launching their own PE funds, but finding the right people to manage those funds is the biggest challenge because their existing teams are only focused on investing in public equity. Investing in private equity is a different game. Of course, some professionals have invested in VC before but the know-how is different from PE,” says C.Y. Huang, president at of FCC Partners.

Indeed, a fund manager from a large Taiwanese financial institution notes that his parent company wants to set up a PE unit under its SITC subsidiary but recruitment difficulties are delaying the process. “We will see the type of professional we can hire and then to decide what kind of investment strategy we can deploy,” the manager says.

There are no restrictions as to the sectors in which SITC-sponsored funds can invest, but managers targeting areas the government wants to promote, such as infrastructure, may find regulatory approval is expedited. However, some industry participants question whether renewables or transportation can deliver stable long-term investment returns.

“I have not yet observed a sustainable market demand to support the infrastructure investments in Taiwan, especially in the transportation area. For all infrastructure investments, it requires other supporting ecosystem and policies from the government in order to generate sustainable returns to investors,” says Vincent Chang, a partner with KPMG’s deal advisory team.

He notes that it is uncertain whether solar farms and wind farms targeted by private equity investors would be approved by the authorities under current land use and environmental policies, while existing projects have suffered from delays due to public opposition. Even if these renewables facilities do get up and running, electricity prices increases might not be large or consistent enough to justify the returns investors are targeting.

Beyond stable-yield assets, Cathay SITC ultimately plans to pursue other strategies including growth capital. For now, the priority is execution of a single strategy in over to build up government’s confidence on the asset class, but many industry participants see it as natural that other PE products will emerge to target opportunities presented by the local economy.

“Taiwan has never developed a late-stage PE industry. A lot of VC funds have been launched by local corporates that only focus on biotechnology, early-stage TMT [technology, media, and telecom], or even angel investment. As the economy has grown, I would say a late-stage investment strategy has become more suitable for Taiwanese industries in general because a lot of companies are reaching a stage where their business scale has peaked or even started declining,” says FCC’s Huang.

Long-term game

The government is seeking to reverse this decline, and improve the global competitiveness of local enterprises, by pursuing an industry consolidation agenda. In August, the Industrial Innovation & Transformation Fund backed Taiwan-listed textile company Roo Hsing’s acquisition of mainland China-based apparel supplier JD United Manufacturing, facilitating an exit for Hong Kong’s boutique PE firm EmergeVest. The fund is also said to be supporting consolidation efforts by solar cell and module manufacturer Neo Solar Power Energy. 

Industry consolidation and operational upgrades are also an objective of CDIB Capital’s latest growth capital fund, which closed at NT$3.5 billion. The PE firm has invested in approximately 250 small and medium-sized enterprises in Taiwan over the years across a variety of sub-segments under advanced manufacturing, technology and healthcare. It hopes to facilitate communication between entrepreneurs with a view to combining these smaller businesses to form larger corporations. 

“Unlike South Korea – where chaebols control different kinds of businesses – Taiwan is highly fragmented across different industries. Everyone wants to be their own boss and families typically keep tight control of their businesses. Therefore local businesses tend to be smaller in scale,” explains de Saint-Exupéry. “Private equity can be a domestic catalyst for industry consolidation.” 

The Industrial Innovation & Transformation Fund, which at present is targeting direct investments, is expected to co-invest in consolidation deals led by local managers, domestically and overseas. This would offer yet more opportunities for the initial cluster of new local managers. Assuming the government remains a cheerleader for domestic private equity, GPs are therefore optimistic about the industry’s prospects.

“Taiwan will enter a golden era of private equity,” says FCC’s Huang. “I don’t think it will be driven by the global PE firms, probably by domestic firms, and gradually. We need two or three examples to demonstrate that local GPs can make successful investments in Taiwan. And then other local financial institutions will enter the industry.”

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• Topics
• Greater China
• Buyouts
• Infrastructure
• Infrastructure
• Expansion
• Regulation
• Taiwan (China)
• CDIB Capital
• Stepstone
• Cathay Securities Investment Trust (Cathay SITC)