South by Southeast: Asia’s next growth engine?

The BRIC concept was devised as an investor-friendly lens on emerging markets growth. Goldman Sachs is credited as the originator, claiming in a 2001 research paper that Brazil, Russia, India, and China would achieve sufficient economic heft over the coming 10 years to warrant their inclusion in the G7. Two years later, it projected that the BRIC group’s GDP would overtake that of Western economies by 2039.

Dozens of research projects and financial products were launched on the back of the concept – and the BRIC members held their first summit in 2009. BRIC subsequently became BRICS with the addition of South Africa. According to the UN, the BRICS accounted for 26% of global GDP and 42% of the world’s population in 2021. Foreign investment inflows and per capita GDP had risen 400% and 60% since 2001.

However, globalisation doesn’t distil neatly into five-letter acronyms. The BRICS economies were united by size and rapid growth; otherwise, the differences were stark. More recently, the concept has become increasingly frayed by geopolitics, most visibly an economic war between the US and China and Russia’s actual war in Ukraine. The case is now being made for alternative emerging economic power bases.

“The BRICS report talked about where growth was going to be over the next few decades, but when you look at the countries listed, Brazil has some political instability, Russia is currently un-investable, and we can safely replace South Africa with Southeast Asia,” Sandeep Naik, a managing director and head of India and Southeast Asia at General Atlantic, told the AVCJ Southeast Asia Forum.

From a foreign investment perspective, China’s appeal has also dwindled as GPs and corporates either wait for greater political and regulatory clarity or actively diversify away from the market. South and Southeast Asia are expected to benefit from this trend. “Investors are trying to find the next billion-plus people come and deploy their capital. South and Southeast Asia provides that opportunity,” Naik added.

Aggregating the two markets is problematic for the same reasons as the BRICS: they encompass such diversity across economics, culture, language, and business norms as to defy broad characterisation. But investors do trace common threads in business model application, penetration of technology, cross-border scaling, and evolving consumer demand. Panning out, they also see interesting historical context.

“There might be more commonalities between metropolitan cities like Jakarta and Mumbai than with the countries these cities reside in, but it goes without saying that doing business in any of these markets requires a deep amount of localisation and understanding of domestic nuances,” said Sachin Bhanot, head of Southeast Asia investments at Prosus Ventures.

Yet he added that the notion of a South-Southeast Asia growth engine is hardly new: 2,000 years ago, Greater India – which included Southeast Asia – contributed more than 30% of global GDP and the interconnection continued for centuries through the flow of goods, people, and ideas. South-Southeast Asia’s GDP share was just 3% in 2000 “due to a few historical blips,” but it is tipped to reach 20% by 2050.

In China’s shadow

The rise of South and Southeast Asia, which to private equity investors means India and Southeast Asia, is often captured as a counterpoint to recent declining interest in China.

For much of the previous decade, annual PE and VC deployment in China was more than India and Southeast Asia combined. In 2021, China received a record USD 129.9bn, but India and Southeast Asia climbed by more than two-thirds year-on-year to USD 91.2bn, according to AVCJ Research. In 2022, the gap narrowed even further: China secured USD 64.4bn; India and Southeast Asia got USD 57.8bn.

The 2023 showing to date is more modest, but investors in India and Southeast Asia are undeterred. They point to a long-term growth story underpinned by a young working-age population, an expanding middle class, and digitalisation turbo-charging economic activity.

The China versus South-Southeast Asia dynamic plays out on several levels. LPs speaking at the Mergermarket Private Equity Forum in New York were united in their wariness of China, noting that the risk-return trade-off doesn’t work in the medium term, and some are reconsidering other markets.

“We have some allocation to China that we are not actively re-upping with, and we are looking elsewhere in Asia at places where we don’t have as much exposure,” said Richard Chau, CIO of the Tulane University endowment, highlighting India, Southeast Asia, Japan, and Korea. “In the past, China has sucked up all our Asia allocation. Now we can look around and see where else we can spread that.”

On a GP level, pan-regional managers are looking to diversify their exposure, strengthening their teams in markets outside of China and in certain cases deliberately targeting businesses that span multiple Asian geographies rather than relying heavily on just one. To some extent, this mirrors corporate activity as companies recalibrate supply chains, so they are no longer beholden to China.

“Almost daily, customers of our portfolio companies are expressing their desire to reduce manufacturing in China and reduce their exposure to China,” Kyle Shaw, founder and managing partner at industrial ShawKwei & Partners, which invests in industrial manufacturing assets, said in a recent interview.

“No procurement officer sitting in the US or Europe wants to be in a position where they can’t put anything in the warehouse, so they just aren’t taking risks. They are going to Southeast Asia and asking suppliers to provide the same components.”

The situation is not binary. As much as India and Southeast Asia are benefiting from so-called China-plus-one strategies, they are – to varying degrees – also increasingly bound to China.

One of the challenges of the BRICS concept was China’s dominant position. The bloc’s share of global GDP reached 26% in 2021, but China was responsible for 70% of that. A significant slowdown in foreign investment into the BRICS in 2011-2021 from the prior decade was counterbalanced by a six-fold increase in intra-BRICS investment; China’s contribution rose from 53% in 2010 to 91% in 2020.

While the mega infrastructure projects that accounted for many of those dollars are not being replicated in South-Southeast Asia, China is making its mark in other ways. For example, Chinese companies are partly responsible for Southeast Asia’s manufacturing surge as they respond to customers’ diversification imperatives by recasting themselves as global players.

“One of our CDMO [contract development and manufacturing organisation] companies is a supplier to the global pharma industry. Its manufacturing was 100% China, but when the macro environment changed, the founder began to think about having a second manufacturing base to serve global markets,” said Steven Wang, a founder and CEO of healthcare-focused HighLight Capital.

“The company is sizeable – it has 2,000 engineers already – so it can send 20 to Indonesia to train local workers and then shift some of the key components manufacturing from China.”

Migration of talent

HighLight opened an office in Jakarta, making it one of numerous China GPs to establish a presence in Southeast Asia. Adrian Li, a founder and managing partner at Indonesia-based AC Ventures, questioned how they can “build a portfolio construction that works from a numbers standpoint” when deploying multi-billion-dollar funds in a market ill-equipped to accommodate hundred-million-dollar cheques.

The more prevalent trend he sees is China-born or China-connected entrepreneurs coming to Southeast Asia and eking out cost and scale advantages by connecting more efficiently to China supply chains. The appeal of following entrepreneurs as they move across borders was referenced by other GPs, including Jessica Huang Pouleur, a partner at Southeast Asia-focused Openspace Ventures.

The VC firm has noted an uptick in entrepreneur quality in the region as founders embark on their sophomore start-ups or spin out from increasingly mature technology platforms. “There is an added boost of capital and talent inflows from places like China that bring different skillsets and backgrounds and experiences,” Pouleur said. “It amplifies the talent base and the kinds of companies we can produce.”

Southeast Asia could use a talent infusion, with investors identifying this as a key area of weakness compared to India. Bhanot of Prosus observed that India produces 1m-1.5m new engineering graduates every year; Southeast Asia produces less than one-third of that number. Moreover, India’s technology ecosystem is older and deeper, so the repeat founder-spinout founder phenomenon is stronger.

“India has 1bn people, 1bn ideas, and 1bn entrepreneurs. The depth of entrepreneurialism is exceptionally high, which is backed by decades of India investing in its education system. We don’t see that same depth of tech talent in Southeast Asia, and so it will take longer for technology companies to scale up in a non-linear fashion,” said General Atlantic’s Naik.

The flip side of this dynamic is that India is ultra-competitive, with dozens of start-ups proliferating around a single idea, which drives down unit economics and triggers a race for scale rather than commercial sustainability. Naik doesn’t see the same effect in Southeast Asia, noting that companies are able to grow without causing near-irreparable damage to their unit economics.

Amit Varma, a co-founder and managing partner at Quadria Capital, a healthcare investor active in Southeast Asia and India, put it slightly differently. Each market requires an element of domain expertise and concerted operational effort: in India, it’s to stay ahead of the chasing pack; in Southeast Asia, it’s because of the work involved in getting companies to scale.

Scaling to exit

Quadria deploys its capital equally between India and Southeast Asia, resolutely sticking to micro and country themes. “There’s no business where I am trying to build an inter-country platform. These are massive populations, massive countries. If I need to do Indonesia, there is so much to do that I don’t have to worry about going elsewhere,” Varma said.

A lot of investment in South-Southeast Asia has been predicated on the realisation of scale, but companies have made countless missteps on the journey – and relatively few in Southeast Asia can point to a successful track record in multiple markets.

“Scalability has been somewhat of a challenge for the first phase of growth,” said Rajeev Natarajan, a managing director and head of Asia Pacific at Iconiq Capital. “The statistics – USD 4trn cumulative economies [in ASEAN], 700m people, 10% of the world’s population – are fantastic. It’s just a case of channelling founders’ TAMs [total addressable markets] and business building more effectively.”

This is in part a function of prevailing business models. Most technology investments continue to be consumer-facing, which means the challenges of cross-border expansion in markets with distinct local characteristics must be addressed head-on. Both Prosus and Iconiq have extended their Asia Pacific coverage to include Australia because start-ups tend to be B2B-focused and globally-minded.

India already has a bedrock of IT services companies with North America-centric client bases and a legion of B2B software-as-a-service (SaaS) start-ups looking to straddle the same markets with front-end sales and marketing teams in California and back-end delivery teams in Bangalore. Some have expanded into Southeast Asia, but there seem to be more logical sources of demand.

Gaurav Ahuja, a partner at India-focused ChrysCapital Partners, noted that portfolio companies across all sectors tend to favour the Middle East over Southeast Asia, citing the level of like-for-like competition in the latter market. “Our companies have found it easier to be in other regions,” he said. “And then we have IT services companies serving the US – it’s a big market and they’ve been doing it for years.”

Exits are an enduring concern across South-Southeast Asia, but India can claim to have done more to assuage it. Indian GPs gained traction as their peers in China were losing it. They generated proceeds of USD 28.9bn and USD 22.2bn in 2021 and 2022, as China posted USD 20.9bn and USD 5.2bn. For the prior five years, China bettered India by 1.75:1. Southeast Asia hasn’t seen a similar spike.

Iconiq’s Natarajan highlighted the progress India has made on domestic IPOs in the past 18 months, arguing that post-offering price declines reflect broader market conditions and the fact that companies need time to grow into their valuations, not a fundamental lack of support. That said, public markets trailed sponsor-to-sponsor transactions and trade sales by exit dollar value in 2021 and 2022.

General Atlantic’s Naik noted that the upturn in India’s fortunes in the past 3-5 years during which “a tonne of capital got returned to LPs” is a consequence of having all three major exit routes open. Southeast Asia, by contrast, has neither capital markets with sufficient depth to accommodate billion-dollar IPOs – companies that do list struggle with illiquidity – nor the confidence of strategic investors.

“They have all identified it as a region they want to enter, but they are hesitant because it’s not one market. They must get comfortable across many different countries, regulations, and policies,” said Naik. “There is no single buyer for a combined asset, so the only option is a venture capital firm selling to a growth equity firm selling to a private equity firm, and that’s a very shallow market.”

Growth paradigm

These incongruities appear to undermine the relevance of South-Southeast Asia as one bloc. Indeed, Goldman has long since moved beyond BRIC to study the convergence of developed and emerging economies more broadly. It divides the two decades since the acronym was created into one of outperformance and one of underperformance, with Russia and Brazil among the key underperformers.

This has inevitably positioned Asia as the main driver of emerging markets convergence. Goldman projects that China, the US, India, and Indonesia will be the world’s four largest economies by 2050, although China’s deteriorating demographics will lead to a marked slowdown from 2030 onwards while growth in the likes of India, Indonesia, and the Philippines remains relatively robust.

Sustained growth in the face of declining global growth, at least over the next decade, is what investors in South-Southeast Asia are buying into. It gives context to the build-up of uninvested capital targeting both markets and the sense that valuations remain obstinately elevated.

Ahuja of ChrysCapital spoke of the need to delve deeper into target sectors, identify underappreciated sub-segments, and get comfortable with situations “that might be a little hairier” than normal – in the expectation of a lower entry valuation but harder slog in pursuit of returns.

Thomas Lanyi, head of Southeast Asia at CDH Investments, expressed similar sentiments. He described an increasingly bifurcated universe populated by a relatively small number of top-performing companies that continue to command high investment multiples and an expanding rump of mediocre, less desirable assets. The latter group may offer the best opportunities provided a GP provides the right solution.

“This is a tricky environment and I prefer to not gamble on whether great assets will continue to transact at these great multiples for the next 5-10 years,” he said. “I would rather focus on getting something done in category B, but with a plan.”

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• Topics
• South Asia
• Southeast Asia
• Greater China
• GPs
• Consumer
• Industrials
• Technology
• Healthcare
• India
• Indonesia
• China
• General Atlantic
• Prosus Ventures
• Tulane University
• ShawKwei & Partners
• HighLight Capital
• Openspace Ventures
• Quadria Capital
• ChrysCapital Management
• CDH Investments Management
• manufacturing
• Logistics
• Economy