Southeast Asia GPs: Judgment day

The founders of two of Southeast Asia’s younger pan-regional private equity firms, Novo Tellus Capital Partners and Archipelago Capital Partners, both draw on European comparisons in describing their investment theses. The parallels are in some respects apt. Both geographies are amalgamations of economies, united by trade policies but divided by stark differences in language, culture, and development. Investment success in multiple markets means being local in each one.

Unlike Europe, however, Southeast Asia is still finding its feet as a private equity destination – even though Navis Capital Partners, the oldest manager in the region and the only one to achieve meaningful scale, has been in operation for 20 years. LPs generally cite uninspiring performance and a shallow pool of investable managers as reasons for their wariness. The reality is that no GP has found the optimal combination across fund size, strategy, and geographic coverage.

“The top-down perspective is positive in that there is economic growth and the environment is supportive of private markets activity,” says Wen Tan, co-head of Asian PE at Aberdeen Standard Investments. “But the asset class is bottom-up as well, and relative to other parts of the world, there is a lack of established, institutional quality GPs that have strong track records and distributions over multiple cycles. That’s where the disconnect comes from: the potential versus the facts so far.”

These are timely observations because nearly every sub-regional manager of note is, has or will spend some part of 2018 trying to convince investors that their potential is real. Dymon Asia Private Equity closed its second fund earlier in the year at $450 million, but there are at least six other GPs in the market looking for around $3.5 billion between them. Annual commitments to Southeast Asian managers – including single country GPs – have topped $3 billion only twice in the past eight years.

Southern Capital has already raised $220 million towards a total of up to $500 million for its fifth fund. Creador recently completed a first close of $430 million on its fourth fund and has set the hard cap at $550 million. The others range considerably in size and scope. Navis is targeting $1.75 billion for its eighth fund, while Novo Tellus is seeking $150 million for its second vehicle and Archipelago wants the same amount for its debut fund.

Changing sentiment

The environment is markedly different from six years ago when, with India out of favor, Southeast Asia was being primed as the regional counterpoint to China as a market defined both by scale and growth. Investor sentiment on Indonesia was sky-high and several sub-regional managers were among the beneficiaries. It was during this period that Creador and KV Asia launched their debut funds, while Southern Capital closed its third vehicle at $408 million after increasing the hard cap.

Novo Tellus was established around the same time, but the reception wasn’t so warm. “I had meetings with LPs who weren’t interested because we weren’t doing Indonesia consumer,” recalls Wai San Loke, founder and managing partner at Novo Tellus. The GP eschews the consumer sector entirely in favor of technology and industrial plays around what Loke calls the “Southeast Asian mittelstand” – an equivalent of the precision manufacturing businesses of German-speaking Europe.

Even though the emerging middle-class thesis remained relevant, Indonesia has struggled in the past few years with a natural resources downturn, a currency crisis, and tumultuous public markets. It coincided LPs questioning the performance of certain managers in their portfolios, notably their ability to deploy capital efficiently across different markets.

“We really like Southeast Asia. It’s a place where you can still get relative value – you have fast-growing companies but generally single-digit EBITDA entry valuations. But it’s hard to get very strong deal flow,” says Pamela Fung, an executive director with Morgan Stanley Alternative Investment Partners.

If anything, the macroeconomic difficulties that have beset individual markets should make a pan-Southeast Asian remit more compelling. In markets that are cyclical and exit windows open and close rapidly, being able to pick and choose where to operate is a distinct advantage. It is also easier to take companies into new geographies, something Nick Bloy, a managing partner at Navis, describes as one of the most attractive value creation levers in the region.

Unigestion debated the country versus sub-regional issue when considering the best way to get exposure to Southeast Asia. A client wanted to commit $20 million to the region and it was a straight choice between backing a single sub-regional fund or supporting a combination of local players. They went for the former option, but Eric Marchand, an investment director with Unigestion, admits it was a difficult decision.

“If you are not going to do a patchwork of firms focusing on individual countries, then you must go for the pan-regional players. That’s the road we went down,” he says. “With pan-regional managers you have to understand that you won’t be hitting all the countries. For example, it’s unlikely you will find a manager that is as good at getting deals in Thailand as it is in Vietnam. Southeast Asia is much like Europe in that it’s hard to find someone that is strong in every geography.”

How many markets?

While Novo Tellus’ affinity to Europe sits in the mittelstand, Archipelago has found that European investors are familiar with its small to mid-cap buyout strategy. The firm was formed in 2017 by three partners who worked together at McKinsey & Company before going their separate ways to Temasek Holdings, Khazanah Nasional, and Singapore Post. They want to build a concentrated portfolio and take a highly operational approach, running investee companies directly if necessary.

Jovasky Pang, Archipelago’s CEO, believes performance in Southeast Asia has been volatile because most incumbent GPs are skewed towards certain geographies and not arbitraging the market. “They concentrate on one country and so the fund follows the economic cycle of that country,” he says. “We want to start a real Southeast Asian fund focusing on four markets that have counter cycles.”

Those markets are Indonesia, Malaysia, Thailand, and the Philippines. By comparison, Southern Capital targets Singapore, Malaysia and Indonesia, and is most active in the first two, while KV Asia has a pan-Southeast Asia remit but the bulk of its investments have been in Singapore and Malaysia. Novo Tellus primarily targets Singapore, Malaysia and Thailand.

Others have sought to broaden their coverage. Dymon was initially Singapore-only but now has offices in Malaysia and Thailand as well, and Creador is adding Vietnam to its core geographies of Malaysia, Indonesia, Singapore, and India. However, only Navis is truly pan-Southeast Asian with four offices across the region and a track record of investments in every major market. The GP also selectively covers Australia and Greater China.

It is the view of one veteran Southeast Asia-based private equity manager – not currently with a major firm – that limited geographic coverage can be linked to concerns about performance. “There is a dearth of deal flow because most managers are only doing one-and-a-half or two locations. That makes it difficult to deploy in a risk efficient manner,” he says. “The question for smaller GPs is: Do they have enough in fees to cover the fixed costs required to operate in these markets effectively?”

Only three funds of more than $1 billion have been raised for Southeast Asia, all of them by Navis. Bloy believes it would be difficult to maintain local teams in five or six countries with a smaller fund than that. “It’s a complex region with different languages and cultures and economies at different stages of development. You need people in a lot of different places to manage that complexity,” he says, admitting that Navis was fortunate to scale up when few competitors were around.

Creador found that two funds and $500 million in assets under management (AUM) was enough to support offices in Malaysia, Indonesia and India. Now the firm’s AUM is approaching $1.5 billion, it is ready to support a presence in Vietnam. Brahmal Vasudevan, Creador’s CEO, identifies two major challenges that go beyond whether there are enough fees to cover costs. First, is a GP able to recruit and empower local teams or is it too personality-driven? Second, can the firm deliver returns?

Simply adding a geography to a fund remit is just the start of the battle. Creador branched out into the Philippines on launching its third fund in 2015, sending one team member to Manila to meet companies and having a managing director fly in every few weeks to assess the opportunities. The arrangement was shelved after one year due to difficulties finding high-quality assets. Now the GP is looking to help portfolio companies from elsewhere in the region expand into the Philippines.

Size matters

The tension between fund size and opportunity set is arguably greater in Southeast Asia than anywhere else in Asia. Private equity firms want to accumulate assets and invest in their operations, citing the region’s growth prospects and the generally acknowledged fact that they cannot be fully realized on a fly-in, fly-out basis with Singapore as the hub. LPs look at the track records and are yet to be convinced that many managers can deliver on this potential.

Come Fund III, Novo Tellus may face this line of questioning, given its specialized remit. The private equity firm raised $25 million for its debut fund and completed five deals, although the capital deployed reached $200 million including contributions from other GPs. One of them was MFS Technology, a flexible printed circuit board manufacturer that serves industrial clients. Novo Tellus and Navis bought the business in 2015 and sold it earlier this year, generating a 3x return.

The Novo Tellus portfolio is said to include several other winners. Asked whether the Southeast Asian market is deep enough to sustain this performance across a larger fund, Loke replies emphatically in the affirmative, noting that there are dozens of companies that could be carved out from conglomerates – as was the case with MFS – or have founders who are approaching retirement and have no obvious successors. These businesses are simply overlooked.

“Everyone says it’s a narrow market, but it’s large: 65% of major multinationals have regional headquarters here. There is 30 years of cumulative experience in Southeast Asia, not only in manufacturing but also in industrial engineering,” he says. “They speak English and they speak engineering. When someone says they want to design something for six sigma, Singaporean and Malaysian engineers know that means sourcing components with sub-level tolerance.”

Manufacturers in Southeast Asia may also benefit from a reluctance among Western companies to do bleeding edge technology development in China because of concerns about intellectual property security, further enhancing the lower middle market investment opportunity. This is likely sufficient to make investors comfortable about the prospect of a $150 million fund, but there is a residual discomfort with private equity firms in Southeast Asia becoming too big, too fast.

“Some managers have put together decent portfolios with smaller funds and then tried to scale up, but the relative lack of opportunity in those markets means it is difficult to replicate with a larger fund,” says Aberdeen Standard’s Tan. “You are almost left with a situation where GPs scale up but at the expense of returns or they stay small and remain off the radar of many institutional investors.”

Southern Capital has to a certain extent been a victim of these issues about fund size. The GP deployed its third vehicle in the space of two years, having agreed to limit the corpus to $408 million despite demand reaching $600 million. The GP set a target of $650 million for Fund IV last year, reasoning that its investment pace would be the same but spread out over a longer period.

Investor feedback was that a 60% increase was excessive, and the process stalled, leaving the GP with no money to invest over the past two years, according to a source familiar with the situation. The LP take is somewhat different, with several investors saying there were concerns about delayed exits from earlier funds.

All to prove

These reservations should not be interpreted as a lack of interest in Southeast Asia, more an uncertainty about how to access it. In its annual LP survey, EMPEA asks investors to rank emerging markets by attractiveness. Southeast Asia ranked number one in the 2018 iteration, reclaiming the position from India, and didn’t feature outside the top two in the four years before that.

For many LPs, exposure to the region will come through pan-Asian buyout funds that operate in a tier above the sub-regional managers. Some industry participants make the case that the market simply isn’t deep enough to sustain funds outside that top tier. The gradual proliferation of fund-less sponsors in Singapore in recent years – some working deal-by-deal basis through choice and some through necessity – suggests there are alternative ways to address Southeast Asia’s middle market.

Others are not so quick to write-off small to mid-cap funds. “There is a limited number of players because there is a limited appetite,” says Unigestion’s Marchand. “People want exposure to Southeast Asia, they are excited about it. But the fact that people were burned in countries like India before makes them a bit reluctant to go full on into Southeast Asia.”

Overcoming this reluctance involves cleaning up existing portfolios and demonstrating through the new vintage of funds that Southeast Asia has a future that isn’t sub-scale. It would likely only take a couple of breakout stories to challenge prevailing opinions. However, this does not mean there will be a spike in new sub-regional managers, even if improved performance from the incumbents coincides with greater integration of the ASEAN members.

“There will be two or three guys that capture the attention and the rest will struggle,” says Vincent Ng, a partner at placement agent Atlantic Pacific Capital. Indeed, those that retain investor support could benefit from a less competitive environment.

At the same time, these managers may win new support not so much for anything they have done, but because perceptions of them change relative to other parts of Asia. “In the next cycle, the survivors in Southeast Asia are going to get overfunded,” another placement agent predicts. “People will realize they didn’t put enough into the region. It’s like what happened in Japan. Four years ago, the market was cold and then in the next cycle everyone got funded.”  

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• Topics
• Southeast Asia
• GPs
• Fundraising
• Morgan Stanley
• Unigestion
• Navis Management
• Indonesia
• Malaysia
• Vietnam
• Thailand
• Singapore
• Philippines