Southeast Asia exits: Greener pastures

Trends are hard to find in the early days of a market, but even in a relative lack of activity, there are insights to be gleaned. In Southeast Asia, private equity exits have long warbled at a low level that befits the region's patchwork of developing and frontier markets. Now, the silence appears to be sending more interesting signals.

The total value of PE-backed exits in the region amounted to only $6.1 billion last year according to AVCJ Research, a figure that represented a return to the norm after an anomalous 2017. At the mid-year point in 2019, the total stood at $4.2 billion, on track to match the $5-8 billion range of the past decade. But in at least one way, this sometimes frustratingly incremental progress is considered a positive sign.

That's because slowness in exits has coincided with growing pressure among investors to deploy and a rise in valuations across the bulk of the region's opportunity set in traditional mid-cap businesses and growth-stage tech. All expectations are for these signs of market maturation to translate into widespread secondaries activity, which hasn't happened yet. The takeaway is that GPs remain confident enough in their portfolios that there's no rush to sell down positions, even though buyers appear to be circling.

Ground-level industry participants do, however, offer reminders that there are many more nuances to be understood. Wayne Lee, chairman and CEO at W Capital Markets, says that most of the PE-backed M&A activity that his firm advises on falls into the categories of PE-to-PE secondaries and corporate sales to PE rather than strategic acquisitions. The dry powder driving this phenomenon has been both the cause and the result of some historically high valuations in Southeast Asia, but in the context of an uncertain macro environment, it nevertheless implies the region may be poised for a surge in exits.

"Vendors are ready to ride on this high valuation wave and take the opportunity, because it's a no-brainer that a global recession will come," says Lee, noting rising pressure to deploy, especially among midcap buyout funds. "Whether its 2021 or 2022, we don't know, but smart vendors and smart founders know it's near. They know they're not going to have a second or third generation taking over their business and that now is the best time to leverage these valuations."

Turning point

Much of the thinking here is statistically pinned on 2017 as a breakthrough year for Southeast Asia. Private equity deal value in the region grew 75% during that year to $15 billion and is set to double this amount within five years, according to Bain & Company. On the venture end, some 1,300 Southeast Asian companies have received a first round of funding since 2011, including 261 in 2017 alone – five times the level of 2011. The region now claims at least 10 unicorns worth a combined $34 million.

Valuations are consequently said to be at an all-time high in some areas, although the overall picture remains more representative of a higher-risk geography. Price-to-earnings multiples for middle market assets in the consumer and education sectors, for instance, have been clocked at 25-30x and 17-18x EBITDA, respectively. This compares to 9-10x for companies in financial services. Market leaders in new-economy industries, meanwhile, command price-to-revenue multiples of 3-6x, versus 8-10x in developed regions.

Although higher competition among fund managers is seen as the main agent behind these numbers, strategic investors are expected to be the primary drivers of M&A and therefore exits. In the technology space, the early evidence for this viewpoint such as China's Alibaba Group acquiring e-commerce player Lazada in 2016 have morphed into a more regionally confined story. For example, Indonesian ride-hailing player Go-Jek began investing heavily in Southeast Asian fintech start-ups in late 2017 and acquired Philippines-based Coins earlier this year, reportedly for about $70 million. 

Strategic interest appears to be following a reverse narrative in the middle market, with Southeast Asia-based buyers increasingly giving way to their international peers. The key geographies here have been China and North Asia. Recent activity in this vein includes Japanese beauty products maker Mandom acquiring Malaysia's Alliance Cosmetic Group from Navis Capital Partners, and Sumitomo Corporation purchasing healthcare companies MediExpress and PMCare from Ekuinas.

"Valuations will always be a hot negotiation point, particularly for good assets. Strategic buyers looking to build market share quickly in Southeast Asia might, however, see more value in growing via acquisitions in the mid-market space instead of organically," says Gabriel Ho, a managing director at Dymon Asia Private Equity. "M&A allows them to mitigate the early ramp-up costs and gestation period, and foreign strategic buyers may find it more compelling to underwrite the takeover of a good and professionally-run company in the mid-market segment."

Dymon, which launched in late 2012, has realized at least four exits to date, all of which have been to strategics. These include industrial operator Wah Loon Engineering, healthcare player UEMS, preschool-focused Nurture Education, and wallpaper distributor Goodrich Global, all based in Singapore. Interestingly, this cohort helps illustrate a lesser but broadening interest from buyers in Western markets, with both Wah Loon and Nurture exited to their respective French counterparts. UEMS eventually sold to Malaysia's Edgenta but was also initially courted by a European buyer.

With Wah Loon and Goodrich sold as minority stakes, the Dymon exits also reflect a growing willingness among strategics to settle for non-control deals in Southeast Asia for reasons ranging from caps on foreign ownership to the indispensability of local market knowledge. Still, Ho advises that in addition to leveraging the increasing appeal of the region as an expansion market, GPs with minority holdings might smooth the path to exit by persuading founders to sell some or all of their equity at the same time.

On the same page

Alignment of interests is the key starting point. If the GP makes a purposeful contribution early and follows through, founders may then be more willing to consider losing control to a strategic partner that takes the company to greater heights. Other approaches popular among minority investors include negotiating deal terms such as exit rights and arrangement for redemption or share buyback options.

Meanwhile, it is becoming increasingly important to recognize that Southeast Asia's improving profile as a zone for footprint and production capacity expansion is no longer the sole rationale for corporate entry. In many cases, strategics will find it cheaper to pursue greenfield expansion than buy existing assets, especially in the quickly modernizing industrial sectors that are expected to see traction as a result of shifting global supply chains. A deeper value proposition will therefore be necessary.

"If you want to see acquisitions from strategics, you have to offer something different either in technology or an extensive AVL [approved vendor list]," says Wai San Loke, founder and managing partner at Novo Tellus Capital Partners. "These are valuable to North Asian strategics, including the Chinese. They don't always have the ability to get on AVLs, so they need to buy into them. That mindset for process technology and high-specification products is a Southeast Asian strength that's becoming very attractive given the trade war."

The idea that trade tensions are having a direct impact on exit markets in Southeast Asia is growing. This is expected to continue regardless of diplomatic progress because the friction has already highlighted the collateral damage that can be suffered as a result of a geopolitical force majeure. Siew Kam Boon, a partner at Dechert, notes that investments are being made into Southeast Asian companies as part of platform and market consolidation strategies. Businesses within the region are following suit, but the economic and political vagaries of it all make the exact impact on deal flow difficult to predict.

"Whether this trend continues or not remains to be seen because it will largely depend on whether these companies amass sufficient financial resources to continue these proxy wars and whether the target companies in Southeast Asia are willing to continue being part of this proxy war," says Boon.  

The role of market consolidation in driving private equity exits may be most immediately apparent in venture capital, particularly within consumer-related verticals. In e-commerce, Indonesia is expected to see amalgamation first, largely due to the relative maturity of the companies. In fintech, Singapore could witness an M&A boom in the payments segment, where a field of poorly differentiated start-ups are facing growing competition from corporate subsidiaries with greater access to resources.

"Singapore has 40 wallet licenses issued for a country of five million people, but how many wallets is each person really going to download his phone," says a Singapore-based vice president for a multinational investment bank. "Capital is not going to be chasing these companies unless they're very niche. These guys are going to either run out of money completely or be part of the consolidation trends that are coming around now."

The largest arenas for roll-ups are expected to be Indonesia and Singapore. This process will echo the B2C nature of the existing unicorns but increasingly require back-end support and complementary B2B development. Vietnam, perceived as an emerging hub for IT professionals, is often mooted as a likely hotbed for companies and talent in these areas. The resulting scenario here would dovetail naturally with the business sector development story to date, which has seen a conspicuous evolution in digitization paralleled by more nuanced momentum in scaling.  

"If there's one massively interesting but under-sung story in Asia in the past 5-6 years, it's the advent of true pan-Southeast Asian businesses," says Nick Nash, a managing partner at Asia Partners. "The attractiveness of those companies means that they are bought, not sold, and when that happens, exits are lovely. When companies are sold rather than bought, exits are a different set of affairs. Now, we think the next few years will be quite special for Southeast Asian exits."

Nash made a name for himself in Southeast Asian exits by helping usher mobile internet and gaming platform Sea to the region's largest-ever IPO in 2017 with a $884 million float. His decision to leave the company to launch Asia Partners was partially motivated by a conviction that other start-up would have difficulty following Sea's example without later-stage funding in the $20-100 million range – a missing ingredient in Southeast Asia.  

"That's the check that takes you from one or two countries to all six," Nash adds. "If the company uses the capital wisely, it's the check that puts the company in a position to go public within three years at a valuation of $2-3 billion. That's the minimum efficient scale to have research coverage, liquidity and buy-side interest to list on the US exchanges."

IPO awakening?

Asia Partners is one of a clutch of regional VCs looking to tap later-stage opportunities, including EV Growth, Golden Gate Ventures, and Jungle Ventures. If a new crop of pan-regional businesses can indeed be developed from this effort, a simmering IPO market could finally get the fuel it needs to take off. 

IPOs on regional exchanges have enjoyed modest but noteworthy growth in recent years, rising from about $19 billion in total value in 2016 to $46 billion in 2018, according to Deloitte. Vietnam was a standout performer last year with big local listings for property developer Vinhomes and Warburg Pincus-backed Techcombank, which raised $1.3 billion.

However, most of the PE and VC-backed companies expected to foster a pan-regional ecosystem are not expected to find homes in these markets. Even in the more tech-savvy US exchanges, IPOs may continue to be rare exceptions. Luke Pais, a partner at EY, estimates there are some 500 PE and VC-backed companies in Southeast Asia and that up to 50 of them may realize exits in the near term. But this activity will remain overwhelmingly in strategic trade sales and secondary acquisitions.

"Most of the companies out there still have a fairly good runway with value to be created, and frankly, it's easier to do that in the private market than in the public market," Pais says, noting that the average ASEAN portfolio company is in its fourth year of investment or later. "Some entrepreneurs have personal ambitions to be listed, and sometimes that drives it, but it's an unproven story. There will be healthy pipeline of exits in the next few years, but by and large, the mechanism will be trade sales."

The asset lifecycle planning importance of having vision around the most plausible exit channels is coming into focus in Southeast Asia as end-game optionality improves. But with an influx of risk capital into the region and growing opportunity to notch returns before a value-add plan has been fully realized, investors will have to be careful to avoid selling out too soon lest they miss out on a significant portion of their anticipated upside.

"Exits are a function of value creation. If you create value, the options for exits will come. Entrepreneurs and investors, both LPs and GPs, shouldn't be too wrapped up in exits," explains Peng Ong, a managing partner at Monk's Hill Ventures. "You should be mindful and understand what your options are – but go create value. Once you do that, everything else takes care of itself." 

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• Topics
• Southeast Asia
• Exits
• IPO
• Trade sale
• Open market
• GPs
• Singapore
• Indonesia
• Vietnam
• Dymon Asia
• Ernst & Young
• Monk's Hill Ventures
• M&A
• Technology