Buyouts in 2021: Winners and losers

SMS doesn’t necessarily mean text message during internal discussions at The Blackstone Group. It is also shorthand for the three key characteristics of any deal: sector, management, and set-up.

The GP won’t look at assets outside of five sectors: technology, consumer, healthcare, financial services, and value-added industrials. The prospective investee requires strong management, either by retaining incumbents or recruiting new talent. And then close attention is paid to the set-up of the operational intervention plan, given the days of buying low and selling high in Asia are deemed past.

“It used to work in India in 2010, but India has gone from a 5-6x P/E [price-to-earnings ratio] to 18x. Take any part of Asia, it is well-discovered,” Amit Dixit, head of India private equity at Blackstone told the AVCJ Forum in November. “It’s not about what you buy, it’s about what you build. You need to have a plan. You can’t build everything – you must pick the right spots, where you have certain angles or operating or interventional capability. If we get the SMS right, it is very profitable.”

Dixit expects this blueprint to help Blackstone thrive in a bifurcated post-COVID-19 period. The pandemic is seen has having widened the gulf between winners and losers in the corporate sphere, with size and sector the key differentiators. Those with ready access to capital and a convincing growth narrative will prevail. The rest will find it increasingly difficult, creating opportunities for private equity from carve-outs to succession situations.

Having control of assets and the ability to effect operational change is vital. But the environment remains challenging. Structural changes arising from the pandemic, notably in terms of technology and consumption patterns, are still in their early stages. Growth trajectories are therefore difficult to plot. A fast-rising industry vertical, business model or company might attract a flood of capital only to become less relevant as conditions normalize, while those written off as dislocated no-hopers find a way back.

Regional champion

Pan-regional investors observe that COVID-19 impact on the investment landscape varies more by sector than by geography. Healthcare and technology are thriving across all markets. However, the geographic effect does come into play when comparing Asia to other regions. With most economies bouncing back faster than their peers in North America and Europe, two of Asia’s key selling points – high growth, low leverage – might become more accentuated.

“Investors in the US and Europe, which make up about 90% of LPs in Asian funds, are really looking to Asia for growth. That has been the case historically and it continues to the case,” said Doug Coulter, a partner at LGT Capital Partners, which has half of its Asia-focused capital in China, speaking at the same forum. “Some of these markets have emerging market risk, one of the things we don’t have in Asia are high levels of debt. Across our Asian portfolios, the average debt to EBITDA ratio is around 1.5x.”

The regional economic opportunity is well documented. Asia will account for 50% of global GDP by 2050, according to the Asian Development Bank. In 2010, its share was roughly 25%. Over the same period, the region’s urban population will nearly double and per capita GDP will become similar to that of Europe today.

Private equity investors have piggybacked on this progress. One-quarter of capital raised globally now gets deployed in Asia, up from around 5% 15 years ago. The pandemic could accelerate its rise. Asia already accounts for two-thirds of global GDP growth, but Dixit argued that in the current environment it could be 100%.

“Asia as a region from a macro perspective and then private equity as an industry has matured quite significantly,” he added. “In developing Asia, what we are seeing is a massive increase in control-oriented transactions. We are a control-only firm in Asia. When we started on this strategy a decade back it was slim pickings, but now we are seeing a significant acceleration. Japan and Australia were always control markets. In India and China as well as now, we see an increasing amount of control.”

For some LPs, this transition can’t happen soon enough – and COVID-19 has entrenched their views. While Asia is seen as a growth play, driven by a rising middle class, increasing discretionary spending, and ever deeper penetration of digitalization, growth managers are not necessarily best positioned to act in times of crisis. A minority investor is subordinate to the founder-entrepreneur in terms of decision making, which could impact the speed and nature of operational fixes or the path to exit.

MetLife is underweight China for this reason, preferring control-oriented GPs with stronger track records in terms of distributions. Andress Goh, Asia Pacific CIO at Allianz Capital Partners, takes it one step further, questioning whether growth capital has a long-term future in Asia.

“I’ve always thought that in the long-term Asian managers would need to develop specializations, sector expertise and value-adding capability like in the West,” she said. “Especially with the crisis, managers who actually know what to do, who know how to help their companies navigate issues, are the ones who can sustain themselves and their returns. We have been quite cautious in some growth markets because we couldn’t see value there.”

Control counts

This is already playing out on an operational level, globally and within Asia. More than 80% of Clayton, Dubilier & Rice’s (CD&R) investments are control deals. In each case, an operating partner or advisor – who previously worked alongside the deal partner in sourcing and underwriting the transaction – becomes chairman of the portfolio company. For corporate divestments, that individual might serve as interim CEO.

“Our operating partner usually has unique insight and visibility into how the business is operating, what the challenges are, and what the growth opportunities are. In the case of COVID-19 or any crisis, having that day-to-day interaction with the CEO, understanding the minutiae of what is happening any given day, is crucial,” said James Ahn, an Asia-based managing director at CD&R. “That trust, mentorship and alignment allowed us to build a plan within a few days on what the priorities were and how to move forward.”

Permira, like CD&R, has a sizeable in-house operations team. Four years ago, the GP acquired Asia-headquartered corporate and investor services provider Tricor Global as part of a buy-and-build strategy. Recognizing that technology could be transformative in terms of efficiency and customer service, it launched several value creation initiatives in this area. They included the construction of a shared service center in Malaysia and the development of a service that helps listed companies to hold shareholder votes remotely.

In March 2020, the Malaysian government announced at short notice that large parts of the country would be subject to a work-from-home requirement. Relying on the remote capabilities of the shared service center, Tricor’s operations continued seamlessly even as some competitors struggled, said Shane Lauf, a principal at Permira. Meanwhile, demand for virtual meeting platforms soared as distancing restrictions were introduced around the world.

“We thought there would be a good tailwind for that kind of need, but it has turned from a tailwind into a couple of jet engines on the back of that,” Lauf added, regarding the remote meeting service. “We are glad to have leaned in on the technology opportunity. We always saw it as relevant to the business as it was, but it’s much more relevant now.”

Being bold

CD&R enjoyed one its busiest years in terms of new deal flow in 2020, having drawn on a lesson learned during the global financial crisis: be aggressive. Ahn observed that, once steps had been taken to stabilize the portfolio, the firm looked to invest heavily. “You almost never want to let a good crisis go to waste,” he said, pointing to the consolidation opportunities that emerge when weaker competitors come under pressure.

BGH Capital entered the pandemic with two global financial crisis takeaways of its own. First, private equity firms are often reluctant to make new investments when existing portfolio companies require remedial attention. Second, it pays to focus on situations where there must be an outcome of some description, for example, companies with debt or liquidity issues they must address, whether that is through selling to private equity or negotiating with creditors.

The Australian manager only had two companies in its portfolio, so the entire investment team was soon hunting for new deals. Four buyouts were agreed between June and October. Two are healthcare service providers; they took an initial hit during COVID-19 but have since rebounded. The others are a theme park and cinema chain operator and an online travel agent; their road to recovery will be longer.

“We always want multiple ways to create value. In all four investments, there is underlying organic revenue growth, the potential for performance improvement, and the ability for buy-and-build strategies to be executed,” said Ben Gray, founder of BGH. “With the exception of one, you can use leverage to drive up your returns. In every deal, we have the potential for multiple expansion.”

Targeting assets in areas where there is less certainty also translates into reduced competition, which means there is a better chance of securing exclusivity and negotiating attractive entry valuations. The theme park business was bought for 6.5x EBITDA; Gray claimed such companies normally trade at 10x globally. The two healthcare companies cost 6.5x and 8.2x, versus global norms of 12-15x. the travel agency was 6.5x EBIT, compared to pre-COVID-19 levels of 17-20x.

For the companies that will take longer to bounce back, BGH had to factor periods of negative free cash flow into its valuations. Financing was another challenge, with banks reluctant to back new deals in travel and leisure, for example, so in one instance existing lenders were asked to roll over their exposure.

Dixit of Blackstone takes much the same view on competition. His firm has completed 15 buyouts in India; each one was exclusive at the time of signing, and but three or four were completely proprietary. The average EBITDA entry multiple is in the single digits.

“For the deals that have hair on them, you see limited competition. Owning a business with some issues is not desirable in developing Asia,” he said, noting that Blackstone’s extensive operating resources mean it can take companies with problems and try to price those into its valuations. “When the complexity is higher, competition is very low or non-existent. When complexity is low and you have a broad auction format, there is a lot of competition.”

Predicting the future

The consensus view among Asia buyout managers appears to be that deal flow is at 70-80% of pre-COVID-19 levels. However, their willingness to engage hinges on the pricing-in process. David Gross-Loh, Asia managing partner at Bain Capital, noted that the window of opportunity for buying assets at deep discounts in dislocated sectors was shorter than anticipated. At the same time, technology and healthcare have accelerated, and valuations often reflect that.

Specialization is highlighted as the key differentiator – it gives investors the expertise to get the best out existing assets and the conviction to pursue new ones. EBITDA growth in Blackstone’s Asia portfolio was the highest in a decade in the second and third quarters of 2020; it is no coincidence that 85% of the assets are in technology, consumer, and healthcare.

But sector concentration doesn’t come without risk, especially if investors are accumulating or shaping assets with a mindset guided by the current market dynamics rather than what might follow.

Longreach Group has exposure to a variety of industrial and consumer-related companies across North Asia. The firm owns food and beverage businesses that have been impacted by COVID-19 and service offerings have been tweaked accordingly. Mark Chiba, group chairman and partner at Longreach, said this was being done with care because “it’s not a new normal, it’s a temporary normal.”

There is an expectation that, assuming vaccines prove effective and the pandemic dissipates, many people will return to their former habits. Chiba believes there are great opportunities for investors who target dislocated assets, devise robust operating plans, and implement them during what might be a protracted renormalization process. At the same time, people must “be careful not to overpay for assets that are booming right now” but may lose their edge as the market recovers.

Some changes will be permanent. The acceleration of digitalization has implications for demand and supply chains in almost every industry. In many areas, virtual will become the new normal. These are long-term structural trends, but investors must consider them alongside cyclical issues, not least what happens when fiscal stimulus programs are phased out.

“Those of us who lived through the Asian financial crisis and global financial crisis know that what has been good in the last 12 months may not necessarily be the best in the next 36 months,” said Ganen Sarvananthan, Asia co-managing partner at TPG Capital.

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• Topics
• Greater China
• Australasia
• Southeast Asia
• North Asia
• South Asia
• Buyouts
• Asia
• covid-19
• coronavirus
• Operating partners
• The Blackstone Group
• TPG Capital
• Bain Capital Asia
• The Longreach Group Limited
• Permira Advisers
• LGT Capital Partners
• Allianz