2023 preview: Buyouts

Leveraged finance markets in Asia have often been compared unfavourably to those in the US and Europe. They remain dominated by banks instead of institutional funds, which usually means a more conservative view on the amount of leverage required for buyouts and less flexibility on the terms of repayment and how private equity owners operate target companies.

Heading into 2023, however, Asia is the world’s most liquid and deal-friendly market. “Financing is harder to pull together [in Asia] and we must do more leg work, but we can get it,” said David Gross-Loh, a managing director and a founding member of the Asia business at Bain Capital, noting that not much can be financed in Europe right now and the US is challenging.

The disparity is a consequence of market structure. Banks in the US and Europe underwrite transactions with a view to distributing all the debt to collateralised loan obligation (CLO) funds and other institutions. However, they have struggled to syndicate positions underwritten prior to the Ukraine war amid weakening investor demand, and so capacity to support new deals is limited.

In Asia, there are three standard routes: domestic banks – typically Chinese lenders for China-related assets – finance deals and hold the entire debt package on their balance sheets; international banks underwrite transactions, hold a small piece, and distribute the rest to banks in Korea and Taiwan; or private credit funds hold the debt and generate returns from interest payments.

“The Korean and Taiwan secondary bank markets have largely closed early for 2022, but for Taiwan in particular, it doesn’t feel like there’s any reason for this apart from it is year-end and banks are cautious about the market generally. Next year, the secondary market will still be viable,” said Daniel Abercromby, a partner at White & Case. “However, I think direct lending funds will play an increasing role next year and it will be interesting to see how banks respond to that.”

Tighter terms

Even with debt providers operating at closer to full capacity, a 300-400 basis point increase in base rates over the past six months has made debt more expensive: five-year senior debt facilities have risen from 4.5% to 8.5%. Manas Chandrashekar, a partner at Kirkland & Ellis, adds that pricing for subordinated debt is now in the low to mid-teens, which means sponsors who find their senior debt won’t stretch far enough may have to consider bridging the gap with equity rather than mezzanine financing.

Moreover, he notes that assembling groups of debt providers for mega-deals is difficult. "If there were three underwriters before, now you are looking for four or five and so on,” Chandrashekar said. “Banks are not keen to be a big underwriter selling into this market, so you must do extra work upfront to have the right underwriting syndicate with the right levels of allocations.”

The net effect is GPs are more cautious. "Over the past year, The amount of leverage available in Asian LBO transactions has reduced, the cost of leverage has gone up, and the rules around flexibility have tightened. For five or six years, the market was moving towards increasingly borrower-friendly terms. Now that trend has reversed and terms are more lender-friendly,” said Cyrus Driver, a managing director in the Asia private equity team at Partners Group.”

This has contributed to a slowdown in deal flow. Approximately USD 74.7bn has been deployed in Asia buyouts so far this year – less than half the 12-month 2021 level though still comfortably ahead of 2020. Transactions worth USD 22.9bn were announced in a relatively buoyant first quarter, but activity slowed thereafter as the macro picture worsened.

Partners Group completed its largest-ever China investment at the start of the year, paying more than USD 400m for a 24.9% stake in Apex Logistics. This came a few months after supply chain giant Kuehne+Nagel acquired the business from MBK Partners. It is unclear whether the transaction would have proceeded under the current, more challenging market conditions

Driver notes that Apex is performing strongly – it has exposure to markets beyond China – and that investor appetite for hard assets like logistics and infrastructure hasn’t dropped off as much as in other sectors. Still, Partners Group isn’t rushing into opportunities, and the firm is comfortable waiting for quality assets that it has been tracking to become available.

“Some of the high-quality businesses we proactively source and chase will not transact for a while because shareholders are waiting for better macroeconomic conditions. We believe 2023 will prove to be a very good vintage eventually, but it’s unclear at what pace we can put money to work,” Driver said. “In the past, There have been situations where we have gone a long way and then, following due diligence, chosen not to finish. We will remain disciplined.”

The China factor

The pace of deployment is inextricably linked to how quickly China normalises, which would give impetus to the broader regional economy and drive investor confidence. Opinion on the matter is divided: some industry participants expect to see more China deals and more liquidity in 2023; others suggest that the hesitancy of the fourth quarter will persist long into the new year.

Alex Emery, Asia chairman at Permira, notes that China is caught between two poles. On one hand, US-China relations could further deteriorate and recent moves to ease pandemic-related restrictions come to nothing, resulting in uncertainty in North Asia. On the other, geopolitical tensions could abate while China moves beyond zero-COVID-19 and sentiment would be revived.

“The two ends of those scenarios are radically different outcomes from a private equity perspective,” Emery said. “It’s going to be an interesting year.”

Bain’s Gross-Loh sees opportunities emerging elsewhere in Asia because of the pressure on China, in part because the region still possesses strong fundamentals. For example, manufacturers in Japan, Korea, and India that previously might not have seemed that attractive are winning new business from customers looking to diversify their supply chains.

“You do have to be very nimble and sensitive to these changes. If you watch them carefully, and the second-order effects of those changes, there are opportunities,” said Gross-Loh. “The market might slow for a bit – it’s hard to say that anyone would be immune to a global economic downturn – but there are more bright spots in Asia than maybe anywhere else in the world right now.”

Others are more guarded in their optimism. Permira’s Emery observes that the risks are so high in China, investors need to be compensated with higher returns, which means entry multiples that facilitate such outcomes. He isn’t seeing big enough discounts for the types of assets Permira would be interested in. Moreover, the valuation problem extends across Asia.

“The analogy is prime real estate. Just because the overall real estate market is down, that doesn’t mean you can buy the nicest house for a huge discount. Anyone who can afford to will hold out,” Emery said. “It’s the same in private markets. Even willing sellers want last year’s price.”

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• Topics
• Buyouts
• Financing
• GPs
• Asia
• Leveraged finance
• Permira Advisers
• Partners Group
• Bain Capital Asia