2010: A roaring Year of the Tiger?

Private equity wags have long remarked that activity in the sector tends to lag the public markets by about a year. By this rubric, the industry is nowhere near off the danger list from the crisis of 2008-09.  More than just the prevailing gravitational pull of a downturn, Asia Pacific private equity is still exhibiting the specific fractures and fault lines opened up by the crisis, and these show no signs of healing soon. Persistent portfolio company issues and still-slack fundraising are holding back the industry from a full recovery of confidence and momentum. Everyone expects that 2010 will be an easier year than 2009, with the world banking on Asia’s tiger economies to deliver growth; but there is no consensus on how high the Year of the Tiger will spring, compared to the plodding Year of the Ox. 

Recovery recognized

At least the resurgence in Asia Pacific seems already under way. AVCJ’s sources concur broadly that overall private equity deal activity should pick up in 2010, across Asia’s diverse markets. 

“I absolutely expect 2010 to be a much busier year from a new investment and realization perspective,” remarks George Raffini, Managing Director at HSBC Private
Equity Asia. “With all of the stimulation packages around the world, we’re seeing improved momentum in most of our portfolio companies. With better performance visibility, and hopefully less volatility, it should become easier to close deals in 2010 as due diligence exercises become more straightforward.”

“We do expect activity (i.e. new investments) to increase dramatically, given the level of dialogue we're having today, particularly on the growth side,” observes Chin Chou, MD in Hong Kong with Morgan Stanley Private Equity Asia. “I would also expect M&A to increase in the region, which is positive for buyouts.”

Evidence is also accumulating to fortify hopes that the third leg of the private equity tripod – fundraising – may also be less shaky in 2010. “There has been a recent pick-up in interest in the past few months, particularly for certain strategies – secondaries, distressed – as well as a renewed interest in China,” remarks Doug Coulter, VP and head of private equity for Asia Pacific at LGT Capital Partners.

Onwards ever upwards?

The ostensible recovery is already starting to influence investor behavior in more or less expected ways. Pak-Seng Lai, Managing Director and Head of Asia at Auda International, contends that “improvement in fundraising activities will drive GPs to speed up their investment pace. They are more willing to draw down existing funds when they believe they can raise more funds in the near future.”

According to AVCJ’s other sources, if the Asian IPO markets remain open in 1H10, more funds will be ready to move on public market exits – welcome news for LPs hungry for cash returns. However, there is a downside: the spectacle of publicly-documented windfall returns in listings may increase the regulatory oversight, especially from a tax perspective, on Asia Pacific private equity fund managers – a phenomenon already observable at the end of last year in the Australian Taxation Office’s aggressive moves on TPG Capital’s profits from the listing of Myer on the ASX.

Private equity funds may also face a difficult picture if competitive challenges from strategic acquirers increase. Chou notes, “the key will be whether or not strategics become aggressive (and win most of the deals), as they have been in the US.”

Frank Tang, Managing Partner and CEO at FountainVest Advisors, sees a valuable niche – though increasingly mainstream – opportunity in environmentally-focused investment.
“The increasing awareness and global effort to cope with climate change will affect many sectors, and benefit many others. How will private equity seize opportunities or factor the impact into investment decisions?” he asks.

Vincent Chan, CEO and co-founder of Spring Capital Asia, believes that some of the new breed of RMB vehicles raised in mainland China may bear with them potential for much greater disruption in the industry. “For those pure RMB funds raised from private HNW individuals and corporates, we expect to hear of more disputes and disagreements with GPs.”

Performance and persistence

As the effects of the downturn linger on, competitive and comparative stresses within the industry are likely to increase. In Asia Pacific, these competitive pressures should rarely manifest in head-to-head battles over deals: outside the big buyout space, investment opportunities are just too fragmented and the region’s entire corporate base too under-penetrated by direct investment. Rather, GPs are going to distinguish themselves on how they perform as investors, and LPs will punish the underperformers.

“I think GPs will really begin to differentiate themselves through their performance in the years post-crisis, as certain GPs will continue to be hampered by their portfolios, while others will generate large gains,” Chou believes. “There won’t be one winning formula – in other, words, country funds, pan-Asia funds, etc., will all have successes and failures.”

Tang believes that private equity in 2010 may face a dilemma: “to invest or not invest? Are we facing another bubble?”

Coulter, meanwhile, feels that conditions are still harsh enough to force significant creative disruption, even in the region’s most fashionable markets. “In China and India, the private equity business could undergo real change during the next cycle. These changes are likely to include the need for more operational expertise to manage existing portfolios and drive new exits; the emergence of a real buyout market over time to compete with the crowded growth capital space; a more developed secondary market for private equity interests; much more scrutiny of cash returns as the industry matures – the ‘China story’ alone will not longer be enough to raise serious institutional capital – and a very marked difference between top-decile private equity funds and everybody else.” Lai also cautions that the timing of the fund raisings and investments over the past few years may deliver some shocks to GPs, with “LPs demanding more concrete results for funds raised during the boom in 2006-07, with these funds reaching end of their investment periods.”

Chan is concerned that the new breed of relatively inexperienced Asian LP, unused to the long-term and hands-off nature of the asset class, may be a more activist, even interfering, investor. “More and more LPs may step in and ask for involvement in decision-making, particularly when the market turns south.”

Funds and raisings

Fundraising may resume its proper place in the private equity life cycle in 2010, but Asia Pacific GPs hoping for 2010’s fundraising recovery to be a panacea for 2009’s ills appear destined to be disappointed. Lai warns that the hoped-for rebound in fundraising and LP sentiment in 2010 could have a significant negative component. “A 1.5-year backlog of funds will rush to the market,” he warns. “GPs who were planning to raise funds in 2H08 and 2009 will all come to the market in 2010. Competition for LPs’ capital will be keen, with more than 100 funds expected to be in the market.” Some sources indicate an even higher figure for funds in the market in 2010.

Other senior sources agree that 2010 is likely to see, if anything, a disproportionately positive rebound in fundraising for Asia, with global LPs increasing their allocations, given the relatively good performance of major regional economies, and the relative under-allocation to Asian private equity in most institutional portfolios. Indeed, fundraising in Asia Pacific, at around $12.5 billion in 3Q08, outdistanced European fund formation – at $11.9 billion over the same period – for the first time during the nadir of the crisis. The downside of this is that the greater supply of capital will feed through into dealmaking and is likely to help cause valuations to continue to rise, especially in China and India.

However, one major regional GP raises one important caveat: “the key question: will the mega-funds ($4 billion and above) be able to get invested and perform to expectations?” Coulter likewise reports that, “in Asia, the firms that are perceived to be best-in-class in China and India are again getting traction on the fundraising trail. That said, $300 million is the new $1 billion for an Asian fund, and most LPs hope that the era of multi-billion-dollar funds for Asia is over.” Lai does feel, though, that “high-profile leading GPs will meet their billion-dollar fundraising targets.”

A new, expanded fundraising base for Asia Pacific is also one of the most keenly-awaited developments for 2010. Coulter, indeed, anticipates a lasting move away from the traditional capital base of the industry. “Newer sources of capital, such as funds of funds and sovereign wealth funds, will be more important contributors of capital to Asian GPs in the next cycle than endowments and pension funds.” Chan also expects an evolution the family office space. “Long-term, we expect the local LP market will develop; but we are not sure how [it will develop] as compared to the family offices in Europe, US and other developed countries,” he adds.

AVCJ sources also expect that global LPs will have to learn to accommodate themselves to the new situation for China-focused investing. “The fuss over RMB funds will die down over time, as it becomes clear that good returns (and bad) will be seen with both USD and RMB strategies,” Coulter says. “What will count is which firms develop their private equity businesses to compete in an increasingly crowded and competitive landscape.”

A new contingent of LPs, as well as more active established IIs, chasing a universe of smaller – and consequently more fragmented – funds presents an interesting scenario for advisors and intermediaries of all kinds. Industry figures have long predicted that Asia Pacific will be disproportionately rewarding versus Western markets, for all types of fund of funds, packagers and parsers of investment opportunities. Exactly how the industry reconciles LP demand for Asian private equity with the realities of the regional alternatives spectrum may be one of the more interesting stories for the year – and years – ahead.

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• Topics
• Funds
• Performance
• Fundraising
• Investments
• LGT Capital Partners
• TPG Capital
• HSBC Private Equity
• Vincent Chan
• H. Chin Chou
• Doug Coulter
• George A. Raffini
• Frank Tang
• FountainVest Advisors
• Morgan Stanley Private Equity Asia
• Spring Capital Asia