AVCJ Awards 2020: Firm of the Year - Large Cap: Warburg Pincus

“Picking the wrong thing in China is the classic category error; there just aren’t enough sleeves to roll up to fix problems quickly. On the other hand, the notion of putting your money on a winner and staying for the ride without doing much is a rarity these days. Why would the entrepreneur want your investment in that context?” says Julian Cheng, co-head of China at Warburg Pincus.

“You have to add value: Be there at a critical moment in a company’s development process, validate the model, and enable the financing to get done; or go into a larger, more complicated situation, streamline it, spin things off, do all kinds of M&A.”

This thinking gives some context to the 12 months ended September 2020 at Warburg Pincus, a period during which $2.5 billion was realized from investments in Asia and another $2.5 billion was put to work in new deals. ESR took center stage. Having seeded the business a decade ago and helped it become the region’s largest logistics real estate platform, Warburg Pincus was rewarded for its efforts with distributions of $1.65 billion following an IPO and subsequent share sales. Another partial exit last November saw the private equity firm’s stake fall into the single digits.

If ESR’s public offering marks the beginning of the end of a journey, several other situations represent new beginnings: the resumption of an earlier relationship with a Chinese company – online classifieds player 58.com – through one of Asia’s biggest take-privates; expansion rounds for a couple of other local start-ups that are replicating 58.com’s earlier growth trajectory; and a debut investment in the Philippines, with broadband provider Converge ICT going on to complete the country’s largest-ever IPO.

What these deals have in common – indeed, what to some extent distinguishes Warburg Pincus from most other global private equity firms given its ability to operate across the entire spectrum, from early-stage to buyout – is that they are underpinned by local partnerships. The entrepreneur is the starting point, and alignment is the watchword.

“Our mindset has always been to partner with best-in-class entrepreneurs and management teams. We believe in the combination of what they bring to the business through vision and execution and our strategic input and ability to assist and contribute resources,” says Jeffrey Perlman, the firm’s head of Southeast Asia and Asia Pacific real estate. “And what we’ve done as well as anyone is think about how to position for the capital markets, not just an IPO but a successful life thereafter as a public company.”

Friends reunited

58.com might be a buyout, but Cheng describes it as “a growth buyout, because there is still a founder with special class shares who behaves like an entrepreneur.” He first met the individual in question, Jinbo Yao, 10 years ago.

Since then, Warburg Pincus has played both roles outlined by Cheng: the business model validator that supported a $40 million Series B round in 2010 and the solution provider to a mature company through its participation in an $8.7 billion privatization in 2020. The latter deal, which also featured General Atlantic, Ocean Link and Yao, is the firm’s largest equity check in China.

“It was a terrific ride, and we made a lot of money [58.com listed in 2013, the year its revenue hit $145 million]. Now it’s a $2 billion business by revenue and it is in five different industries. Do they all fit in the same structure or will new companies emerge as vertical properties? That takes internal corporate reengineering under a new governance structure, and potentially M&A to consolidate these verticals,” says Cheng. “It’s a very different investment effort from putting some money in and watching it grow.”

The growth thesis for 58.com in 2010 was straightforward: online classifieds were dominant in mature markets globally, so the same would inevitably happen in China, albeit in a slightly different way. The company entered its five verticals – real estate, jobs, automotive, second-hand goods, and local services – in part via M&A. Acquisitions included Ganji, 58.com’s closest competitor in 2015. It was an early example of rivals coming together rather than burning through cash in a battle for market share.

Cheng draws parallels between 58.com then and online education platform Yuanfudao now. Warburg Pincus led a $120 million round for the company in 2017, making it the first unicorn in China’s K-12 online tuition space.

However, when the private equity firm first looked at Yuanfudao, its K-12 credentials were unproven. There was a civil service aptitude test business that did turn a profit and two other services that did not – a mobile app that allowed users to search for online tests by taking snapshots of their textbooks and an online database of practice exam papers.

“It was not apparent Yuanfudao would become a winner. We took on some real risk in terms of validation, but we liked the team and the financial profile – there was a profitable business that could support the part that required a lot of investment. The fact you could do K-12 online was only really proven a year after we made our first investment. We did a second round after that happened. We have been paid for those efforts because a lot more people have shown up behind us.”

Valued at $3 billion following its Series E in 2019, the company closed two more rounds in 2020 at valuations of $7.8 billion and $15.5 billion. Yuanfudao has benefited from an acceleration in digital adoption in response to COVID-19, smashing all its targets for online education penetration. The rates charged for live online classes are close to those for offline courses, which means investing more in the back end so that service standards are also comparable.

The company remains a high-cash-burn business, competing for students against a handful of other well-funded platforms, but Warburg Pincus is happy to play the consolidation game. Cheng observes that the firm has never shied away from high burners; rather it’s a case of making sense of the burn rate and justifying it in the longer term. However, management team quality is a key issue.

“Everyone wants to go online, but how do you go from 2,000 to 10,000 teachers and maintain a high level of service? When there is one teacher to 1,000 students and teaching assistants for smaller groups of students, how do you make it work seamlessly? When opportunities arise, great management teams figure out what to do quickly. Yuanfudao’s ability to mobilize has made it a success,” Cheng says.

He adds that Warburg Pincus was impressed by the team from an early stage, based on its willingness to grow away from the civil service aptitude test comfort zone and target K-12.

Platform play

The GP had much the same conviction regarding the management of ESR, which helped when making its first platform-style investment in Asia. Pursuing scalable business opportunities through lines of equity or staged investment structures is commonplace in the US and well-suited to capital intensive sectors like energy. Warburg Pincus essentially married that approach with its early-stage technology investment experience in China – and meaningful alignment with the founders made the concept easier for the global investment committee to swallow.

“Equity lines are good for both IRR and risk management. If the thesis isn’t playing out the way you expected, you can shut off the line of equity and monetize what you have. If it works, you continue to phase in more capital over time. We’ve also found in the past that if you give companies too much money too early, they feel compelled to put it to work too quickly, which can cause its own set of issues,” says Perlman. “The big difference between ESR and what you normally see in the US is management put in substantial capital alongside us. For a while, they owned a majority of the company.”

Confidence in the execution capabilities at management level – in part because they were incentivized to deliver – helped Warburg Pincus rationalize taking what had become a successful China business and making it pan-regional. This was not in the original blueprint. An equally challenging decision had to be taken at the same time simply because of the substantial expansion-related capital requirements: switching the business model from asset-heavy to an asset-light model by moving assets off the balance sheet into third-party funds.

In 2014, ESR – then known as e-Shang – launched its first US dollar-denominated logistics development fund in China, with APG Asset Management coming in as the anchor LP. Later that year, Warburg Pincus backed a Korean spin-out from Prologis, which ultimately became a subsidiary of e-Shang.

A key M&A event came in 2016 when the company merged with Redwood Group, significantly enlarging its portfolio and gaining a foothold in Japan. ESR is now present in Singapore, India and Australia as well, with 18.7 million square kilometers in gross floor area in operation and under development as of June.

Meanwhile, total assets under management have grown to $26.5 billion. Regional expansion has fueled the fund management business as institutional investors seek exposure to similar assets across Asia and appreciate the convenience of underwriting a single platform. The same applies on the tenant side. Multinationals like Amazon would prefer to work with a few logistics providers across multiple geographies who understand their needs than hunt for reliable partners market by market.

Perlman describes the expansion decision through a blackjack analogy – “If you’ve got a winning hand, don’t split a pair of kings” – and it has been vindicated. ESR’s stock has gained 60% since the IPO, giving the company a market capitalization of $10.7 billion. “I always joke that if you look at Prologis in the US, it was a $1 billion company when it went public 25 years ago and today it’s a $65 billion company,” he adds. “Building the equivalent in Asia is a long journey.”

The founders of e-Shang and Redwood retain substantial stakes in the business even as Warburg Pincus has sold down. Moreover, Dongping Sun, one of two entrepreneurs who established e-Shang, is still in business with the private equity firm on two other platforms. Warburg Pincus backed business park developer D&J China and logistics services player NewEase China. “They could be ESR 2.0,” says Cheng.

Strategic evolution

The ESR thesis evolved from the firm’s early investments in Chinese real estate and technology, media and telecom (TMT) in the mid-2000s. These continue to be two of the six core sectors – alongside business services, healthcare, financial services, and consumer – across China, Southeast Asia, and India, with more domain expertise added to the mix. The China and Southeast Asia team comprises 12 deal partners, including Cheng, Perlman, and Frank Wei, the other China co-head. They are supported by more than 30 operational and back-office professionals. Four more partners are based in India.

But the pace and direction of development varies between markets. “With China crossing the $10,000 GDP per capita mark, the growth from that point onwards is of a different class to when we were going from $2,000 to $10,000. We used to invest in milk powder and apple juice; now it’s cosmetics and biotech. We call it a consumption upgrade, but it’s a completely different set of opportunities when you have solved your basic household needs,” Cheng explains.

In 2020, Warburg Pincus backed Perfect Diary, a leading domestic cosmetics brand that went public towards the end of the year, and made its first foray into biotech with Haihe Pharmaceutical. Another China investment theme involves building the supply chains that support this domestic consumption economy. Verticals previously defined by B2C interaction are increasingly B2B or B2B2C.

For Warburg Pincus in North America, technology has always been dominated by B2B and enterprise services, but entering China two decades ago, the firm was forced into a speedy B2C pivot. It has been looking for a way back in ever since, recognizing that opportunities in areas like software only exist where there is high-value data to be managed. The tide appears to be turning. Last year, the GP took part in a funding round for Sensors Data, a big data company that serves internet industry clients.

Southeast Asia is a more nascent proposition. Real estate – a consumer proxy that comes with some fixed-asset downside protection – was again the starting point, in Vietnam and then Indonesia. Financial services and TMT came next, and the geographic scope widened as well to include Singapore and the Philippines. Converge ICT is a classic developmental play: an entrepreneur-led business intended to challenge the incumbent duopoly by enabling broadband connectivity in a country that spends more time online than any other in Asia but has the slowest internet speeds.

The success of Warburg Pincus in China derives from a growth agenda, targeting industries and companies that enjoy structural tailwinds. A similar course is being plotted in Southeast Asia, but it is a considered progression, characterized by familiar business models and entrepreneur alliances.

“One of the big mistakes we wanted to avoid is being labeled an investor tourist – someone who goes into a market, gets everyone excited, and then comes out without getting anything done,” says Perlman. “We wanted to take the things we know well and have done well in, especially in China and India, and apply that to Southeast Asia. You have to crawl before you can walk.”

Pictured: Julian Cheng of Warburg Pincus receives the Firm of the Year - Large Cap award from Baker McKenzie's Dorothea Koo

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• Topics
• Greater China
• Southeast Asia
• Expansion
• IPO
• GPs
• Technology
• Real estate
• Asia
• Warburg Pincus Asia
• AVCJ Awards