Korea: A good time to be different?

Several private equity firms have expanded into Korea’s credit space in the past 18 months, taking advantage of regulatory reforms permitting managers to operate multiple business lines.

These moves – by the likes of IMM Private Equity, VIG Partners, Affirma Capital, and Glenwood Private Equity – were driven by a desire to capitalise on openings not necessarily suited to equity. However, this logical diversification play has evolved into something more like a strategic imperative as difficult macro conditions present complex situations and call for more creativity in structuring.

“We are seeing more special situation-related credit opportunities,” Chulmin Lee, a managing partner at VIG, told the AVCJ Korea Forum. “There are companies we previously didn’t consider mid-cap, and they’ve grown, they need more funding, and they can’t do an IPO. They may team up with private equity and hand over majority control.”

Lee pointed to the KRW 300bn (USD 255m) acquisition of sporting equipment brand Majesty Golf by golf services business Smart Score, Striker Capital Management, and SG Private Equity as an example of as an unexpected transaction. But the pipeline is broad, encompassing buyout and growth capital deals. Even fast-growing e-commerce platforms are calling on VIG as other funding sources dry up.

Lee added that the firm’s credit unit, which is led by the ex-head of Goldman Sachs’ special situations business in Korea, is pursuing opportunities in areas ranging from real estate to venture capital.

This breadth of exposure, plus the downside protection that comes with credit strategies, resonates with investors looking for deals well beyond Seoul. Bain Capital closed its second Asia special situations fund on USD 2bn in June, with debt, structured solutions, distressed assets, hard assets, and growth equity all on the agenda.

“Distress used to be the core of special situations strategies, but now it’s a small piece. You can diversify across a range of asset classes – we see a lot of opportunities to support entrepreneurs and invest in assets that banks are selling,” Jim Hildebrandt, a managing director at Bain, told the forum.

“A lot of it is backed by real estate, so you have downside protection as well as equity upside. Especially in the current environment, equity upside can be substantial.”

Under pressure

Recalibration of the opportunity set is unfolding against heightened global uncertainty, characterised by interest rate hikes in key markets, mounting inflation, and assorted geopolitical, regulatory, and trade risks. Korea is not immune to these effects, and its position is exacerbated by a 15% depreciation in the won against the US dollar over the past six months.

Liquidity is another risk factor, as managers consider not only whether business models will remain viable through an extended period of volatility, but also the prospects for exiting in a timely fashion and at an acceptable multiple. Underwriting a traditional buyout can be treacherous in these conditions – if, indeed, the numbers add up at all given rising financing costs.

“Investment environment is not easy. Financing is almost shut down because credit providers have become very cautious,” Michael Chung, co-founder and CIO of Glenwood, told AVCJ. “It’s not just interest rates. Even at 7-8%, it’s tough to raise capital, and this makes deals very hard to accomplish.”

This view was endorsed by industry participants speaking at the forum. Jay Kim, a partner at Korea-based Orchestra Private Equity – a cross-border investor that operates on a project fund basis – noted that the cost of financing his firm’s recent acquisition of a Japanese scaffolding business was half the level it would have been in Korea. The gap used not to be so wide.

These difficulties are echoed in the data, which show Korea tracking a broader Asian trend. Investment hit a record USD 35.2bn in 2021 – twice the 2020 total – before retreating to USD 15.2bn as of early September, according to AVCJ Research. Over USD 13bn was deployed across 72 buyouts in 2021, up from USD 8.2bn from 59 in 2020. The running total for 2022 is just USD 5.3bn from 31.

GPs are seeking comfort in resilience. For Affirma, this can come from diversity – backing companies with exposure to multiple Asian markets reduces single-country risk and widens the pool of potential funding sources. As for sectors, Taeyub Kim, Affirma’s head of Korea, favours areas like energy and consumer staples, where there is enough pricing power to pass on inflation to the end user.

Themes emerging from buyout deal flow for 2022 to date included a robust interest in industrial manufacturing and healthcare, a drop-off in technology and logistics, and an ongoing surge – yet from a relatively low base – in areas like consumer products and utilities.

Digging deeper, within manufacturing and utilities, there sits an intriguing sub-theme around environment services and energy transition. E&F Private Equity, for example, has about half of its KRW 2trn in assets under management (AUM) in industrial waste management. Taeho Lim, CEO of E&F, estimates that ownership of the industry is split equally between private equity and strategics.

“The first area of consolidation was incineration, construction waste, and landfill. The next phase will be wastewater, waste resources, and recycling in those areas,” he explained, adding that E&F is especially interested in wastewater treatment services for the semiconductor industry.

Waste not, want not

The E&F portfolio includes Kolon Environment & Energy, a waste treatment plant operator carved out from local conglomerate Kolon Group in 2020. Affirma has already demonstrated the potential wastewater segment with another Kolon subsidiary, Kolon Water & Energy, which it first backed in 2009, assumed control of in 2016, and exited four years later for KRW 1trn and a 14.2x return.

Affirma took full ownership of Kolon Water & Energy – renamed EMC Holdings – after several IPO attempts failed. As controlling shareholder, the PE firm oversaw the development of an integrated environmental services platform through M&A-driven expansion into waste incineration and landfill.

VIG made its first foray into waste treatment last year with the USD 100m acquisition of a controlling stake in Bio Energy Farm Asan, a waste-to-energy (WTE) facility operator that turns livestock manure and food wastewater into renewable energy and eco-friendly fertiliser. This came on the heels of Equis Development selling a portfolio of WTE projects to Hana Financial for USD 85m.

“We are at an early stage – revenue and profit are small,” VIG’s Lee said of Bio Energy Farm Asan. “This industry has no sizable companies, but when consolidation happens, private equity and conglomerates with interests in this area will enter. It will be the same as in other waste segments.”

Hahn & Company is on a similar journey, but from a different starting point. It built Ssangyong C&E into Korea’s largest cement producer with a market capitalisation of KRW 3.2trn, while retrofitting the kilns to run on synthetic resin or plastic waste instead of coal. Near-term goals include supporting recycling efforts by feeding unwanted plastics into kilns and acquiring waste management assets.

“[These plastics] can’t be recycled, exporting is no longer an option, and space available for landfill is limited. We can incinerate these mountains of trash and use the energy to heat our kilns. The government is supportive because we are addressing the plastic problem and using less coal,” Scott Hahn, CEO of Hahn & Co, told AVCJ in July.

The private equity firm began accumulating cement assets in 2012, but the key transaction came for years later when a controlling interest in Ssangyong Cement was acquired for USD 1.2bn. Other industry participants were also in consolidation mode, and around the same time, Glenwood and Baring Private Equity Asia (BPEA) bought LafargeHolcim’s Korean cement business for KRW 560m.

There was an energy transition angle here as well, with heat from the kilns used to generate other forms of electricity. “You need to invest in equipment to recycle the heat, but the net present value (NPV) is high, and a return is guaranteed within three years,” said Glenwood’s Chung. “The idea was just sitting there because all Lafarge wanted was cash from the business.”

Ticket to realisations

For Glenwood, the cement deal helped set in stone what has become a dedicated carve-out strategy: mid-market assets with strong management teams and, because they were previously overlooked by corporate parents, plenty of capacity for business development and operational improvement.

The rich vein of private equity activity in environmental services and energy transition points to both the size of the opportunity set and the willingness of managers to back their domain expertise and engage in heavy lifting. Carve-outs have been central to IMM Private Equity’s strategy for 16 years and with that comes a concerted approach to operational improvement that applies to all deals.

Typically, the team responsible for executing an investment will stay with the company for six months post-closing, tracking day-to-day operations and supporting management. IMM is also collaborating more frequently with other corporates to maximise operational impact – such as with GS Retail on pet products retailer Pet Friends and with Lotte Shopping on furniture retailer Hanssem.

“You can achieve value creation through management improvement and sales growth, you can focus on leverage, or you can buy at a good multiple and get a good valuation on exit,” said Joseph Lee, a partner and CIO at IMM. “With interest rates rising and financing more difficult, you cannot expect to get lucky on multiple expansion every time. Portfolio management is more important than ever.”

Diversification and differentiation have become priorities in how private equity firms think about exits as well as investments. Rather than sell Ssangyong C&E, Hahn & Co bought five more years to work on its transformation thesis by bringing in Coller Capital and Goldman Sachs to anchor a USD 1.5bn single asset continuation fund. Sales to other financial sponsors are another growth area.

Proceeds from PE-to-PE transactions from 2018 to date amount to approximately USD 22bn, a near threefold increase on the prior five years. The increase in overall exits over the same two periods is 1.6x. Activity dropped off as market conditions deteriorated, but GPs are still buying assets from one another, with USD 1.4bn transacted so far this year compared to USD 3.7bn for trade sales.

“It’s usually an IPO or a trade sale, but managers are thinking more about alternatives, including deals with other private equity firms and single- or multi-asset continuations,” said Affirma’s Kim. “They aren’t the mainstream, but the current situation is making us consider multiple options.”

Lee of VIG notes that won depreciation makes Korean assets even more attractive to overseas investors with US dollar-denominated funds. Nevertheless, VIG is wary about exits, mindful that miscalculations on timing or depth of demand could lead to failed processes. Affirma, meanwhile, has started running limited auctions to exclude buyers that lack the funding to consummate deals.

The ability to be nimble and adaptive to circumstance is highly valued during times of dislocation – and Bain’s Hildebrandt takes it one step further, emphasising that GPs must demonstrate how they are different from the mainstream if they are to gain traction with LPs. Ultimately, though, they will be judged on how much capital they give back.

“A lot of managers have performed well during upcycles, but how have they done during downcycles?” said Kim. “LPs are looking for managers with experience across cycles. Loss ratios are also a key factor, on top of basic track records. LPs want GPs that are more resilient than before.”

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• Topics
• North Asia
• Buyouts
• GPs
• Industrials
• Trade sale
• South Korea
• VIG Partners
• Bain Capital Asia
• Glenwood Private Equity
• IMM Private Equity
• Affirma Capital
• Hahn & Co
• AVCJ Events