3Q analysis: Guarded reengagement

1) Fundraising: China VC to the fore

The steady but thoroughly imbalanced revival in Asia PE fundraising continues. The second quarter total was revised upwards from $24 billion to $39 billion, largely reflecting a first close of around $10 billion on KKR's fourth pan-Asian fund, which was confirmed after the fact. Previous calculations had two-thirds of every dollar raised going into three funds. Including KKR's effort doesn't change this ratio, but it underlines how the already evident flight to quality has intensified.

In the third quarter of 2020, we saw more of the same. Approximately $27.2 billion was committed to Asia-based managers – a substantial improvement on the first quarter, but the 70 incremental and final closes represent a 17-year low. This provisional total is likely to rise as AVCJ Research uncovers further fundraising activity, but not enough to topple the trend of LPs favoring the few.

While KKR turned out to be the big beast of the second quarter, China's National Green Development Fund takes that honor in the third. The central government guidance fund, which will back national strategy programs such as the green development of the Yangtze Delta region, cruised to a first close of RMB88 billion ($12.6 billion) with support from the country's three largest state-owned banks, the Ministry of Finance, and a string of provincial and municipal governments.

Renminbi fundraising tracks the general upturn for Asia as a whole, but it is skewed towards large government guidance funds designed to spur China's slowing economic growth. Strip out the renminbi share and capital committed to Asia-based managers during the third quarter slips to $12.5 billion. There were no large pan-regional vehicles to prop up the total, though they will do so again in subsequent quarters: KKR Asian Fund IV has surpassed its target of $12.5 billion and is eyeing a year-end final close, while Hillhouse Capital is in the market for $12 billion across two funds.

In their absence, China venture capital stepped up – or to be more specific, Sequoia Capital stepped up. The VC firm's China affiliate raised $3.68 billion for its latest set of funds: $180 million for seed investments, $700 million for venture, and $2.8 billion for growth. With Sequoia Capital raising $1.35 billion for deployment in India and Southeast Asia, three of the seven largest closes during the quarter had Sequoia in the title.

The $4.4 billion committed to US dollar-denominated China funds is the largest quarterly total on record. While it was very much the Sequoia show, nine managers achieved partial or final closes – compared to three (with $757 million) in the first quarter and six ($2.8 billion) in the second – including M31 Capital, Sherpa Healthcare Partners, Vitalbridge Capital, and BA Capital. All four are spinouts from established managers or Chinese tech giants raising their debut US dollar funds.

This activity confirms China's appeal as an investment destination while other countries in the region are still grappling with COVID-19, and it comes despite continued uncertainty regarding US-China tensions. There are concerns that LPs, especially those from the US, might be less willing to back China managers at this time. However, demand appears to be relatively strong, for first-timers in the US dollar space as well as for established names like Sequoia.

2) Exits: Signs of a revival

Three months ago, private equity exits in Asia were still in a trough and there were no megadeals to offer respite. In the third quarter, two were announced: Kuwait Investment Authority sold a 20% stake in Australian electricity grid operator TransGrid to Ontario Municipal Employees Retirement System (OMERS) for $1.4 billion and Softex Indonesia was acquired by Kimberly-Clark for $1.2 billion, facilitating an exit for minority investor CVC Capital Partners.

These were followed by Affirma Capital exiting Korean wastewater management business EMC Holdings to SK Group for KRW1 trillion ($855 million). CVC and Affirma have profited from their investments – 3.3x and 14.2x, respectively – but they are part of an encouraging trend for private equity generally. While the absolute number of exits was unchanged between the second and third quarters on about 60, proceeds rose from $4.9 billion to $7.3 billion.

Trade sales and sales to other financial sponsors both increased by value, giving some credence to claims from transaction advisors that sellers and buyers are reengaging after months of uncertainty. They claim to be busy pitching for mandates and preparing to launch new deals or transactions that were pulled earlier in the year and are now being reactivated. No prizes for where they are most active: countries that have coped with COVID-19 most effectively, like China, Japan and South Korea.

Buyers are increasingly willing to compromise on certain aspects of due diligence. In the absence of in-person interaction, videoconferencing, virtual site tours, and relying on trusted third-party advisors for verification are becoming more prominent aspects of processes. That said, domestic buyers have advantages in terms of proximity and familiarity. Of the 15 largest exits to strategic or financial players in the third quarter, 12 went to buyers that are local or have a local presence.

Softex was exceptional in terms of its size – $1 billion trade sales are a rarity in Southeast Asia even in normal circumstances – and the lengths Kimberly-Clark went to secure the asset. The US-based multinational utilized in-house and third-party resources within the region as well as dispatching people from headquarters who were quarantined at either end of their trips.

Meanwhile, private equity-backed IPOs continued their resurgence, with 60 offerings generating proceeds of $12.4 billion compared to $8.9 billion from 70 in the second quarter. Shanghai's Science & Technology Innovation Board – also known as the Star Market – remained the most active market, with $5.9 billion raised from 22 IPOs in which financial sponsors held an interest.

The Star Market accounted for 11 of the top 20 offerings in Asia, up from five in the previous three-month period. If was also responsible for one-third of all PE-backed IPOs in the region and nearly half the proceeds. Including the other Shanghai boards, Shenzhen, Hong Kong and New York, Chinese companies attracted more than 90% of all the capital raised region wide – a typical share in recent years. Only one offering from outside the country surpassed $300 million as Bain Capital exited Japanese mushroom business Yukiguni Maitake.

The two largest public market liquidity events both came in the US, with online real estate platform Ke Holdings and electric vehicle manufacturer Xpeng raising $2.1 billion and $1.5 billion, respectively. It is unclear what geopolitical tensions mean for where Chinese companies list. More will likely choose to stay closer to home – spurred in part by reforms in the domestic market – but the US will remain an attractive destination for those with the right business model.

3) Investment: Hot healthcare

The Blackstone Group established a Japan team in 2017 with a view to participating in an expected rise in large-cap deal flow coming out of the country. In August, the firm secured its second buyout – and first corporate carve-out – with an agreement to buy a portfolio of medicines and health products from Takeda Pharmaceutical for JPY242 billion ($2.3 billion).

It was by some distance the largest private equity transaction of the July-September period and it helped propel healthcare to its largest-ever quarterly total. Technology has enjoyed and almost uninterrupted monopoly on top spot for the past five years, only challenged by intermittent mega deals in infrastructure, utilities, and financial services. It retained this status in the third quarter, but the gap to healthcare in second place has never been narrower – $11.9 billion to $10 billion.

Healthcare was popular before COVID-19, given attractive demographic trends and clear unmet medical needs in certain markets, but the pandemic has increased its appeal relative to other sectors. Investment rose from $3.5 billion across 146 deals in the first quarter to $7.8 across 158 in the second and then $10 billion across 192 in the third. It is as much a growth as a buyout play, with Hillhouse Capital's $838 million commitment to the healthcare unit of China-based JD.com coming in as the second-largest healthcare deal in the most recent three months.

Overall private equity investment reached $47.8 billion, down from $52.3 billion in the previous quarter but continuing the general rebound from the initial months of COVID-19. Again, activity is concentrated in markets that appear to be least affected by the pandemic.

Investment in China fell from $27.1 billion to $22.4 billion, largely due to the absence of a large take-private such as 58.com. Elsewhere, Australia and New Zealand, Japan and South Korea all saw more capital committed than in the previous quarter. Some deals – Metlifecare in New Zealand, Village Roadshow in Australia – are reconstituted agreements that ran into coronavirus headwinds, with valuations revised downwards. Others are renewals of processes that previously stumbled.

A few more are taking advantage of current economic conditions. In Korea, Affinity Equity Partners and Baring Private Equity Asia might not have injected $980 million into Shinhan Financial Group – a healthy business – if the stock prices in general were not depressed and Korean Airlines wouldn't have sold its in-flight catering and duty-free businesses to Hahn & Company for $831 million if it wasn't obliged to shore up its balance sheet.

And then there is India. Still among the Asian countries worst affected by the pandemic, it attracted $7.9 billion in PE capital between July and September. The average for the previous eight quarters is $8.3 billion, a figure inflated by private equity firms plowing $9.5 billion into Jio Platforms, a Reliance Industries-owned holding company for an assortment of digital assets, earlier in the year.

Reliance is now repeating the trick with its retail unit, which has a digitization strategy targeting India's 20 million small-scale merchants. Silver Lake, KKR and General Atlantic committed $2.5 billion between them in final weeks of September and several of their peers joined the investor roster in early October. Expect Reliance's expansion ambitions obscuring a general weakness in private equity sentiment in India to be a talking point in the fourth quarter as well as the third.

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• Topics
• Fundraising
• Exits
• Buyouts
• Expansion
• Asia
• IPO
• Growth capital