
Deal drivers across Asia Pacific
As three-figure deals on both the entry and exit side – and in the case of some secondary transactions, both – start to rack up across the region, 2010 is already looking like a bustling year for Asia Pacific.
Doubts may remain about the level of LP support for new fundraisings, or even backing for well-established players, but the numbers are starting to argue for themselves when it comes to actual investments and liquidity events. So what are the drivers behind the building momentum, and what do these indicate about the trends supporting deal flow for the rest of the year – as well as some of the opportunities and the problems for private equity? AVCJ investigates.
Favored markets
There is no doubt that the deal tempo is indeed picking up. As Jie Gong, Vice President at Morgan Stanley Alternative Investment Partners, notes, “Pace is gathering on announcements both on the investment and the exit side.” Anand Narayan, Head of the Financial Sponsor Group at JPMorgan, finds that, on the corporate and financial investor side alike, “people are thinking about what they might do. There’s confidence in boardrooms.”
“The cycle has started again, which is positive,” affirms Stephen Seelbach, Executive Director for Investment Banking at Morgan Stanley. “Clearly last year was very challenging, both on the buy side and the sell side.” Of deals currently underway, confidence and continuity have returned, but with some significant changes since the GFC.
“Korea and Southeast Asia are where people are putting the big checks to work,” says Narayan. However, he emphasizes the new significance of Southeast Asia, including Indonesia and even the Philippines. “The biggest checks I see are for Southeast Asia.”
Seelbach sees much of the interest targeting Asia’s more developed buyout markets. “There’s a lot more pressure to invest into Korea, Taiwan, Singapore, etc,” he notes. However, he also cites one important drop-out since 2008. “Australia as a market has been very quiet, and has not come back,” he points out. “Usually about 50% of the region’s deal volume has been in Australia.”
John Eydenberg, Global Head of Financial Sponsors at Deutsche Bank Securities, sees the new appeal of Southeast Asia as driven by similar macro characteristics as China. “Indonesia has very much the same advantages as China does,” he notes, while confirming that “Singapore, Korea, Taiwan” are also preferred destinations for money. But one formerly popular developed market is unlikely to return to favor any time soon. “Private equity’s been disappointing in Japan,” he cautions.
Morgan Stanley’s Seelbach also believes that Indonesia is “a market that will get a lot of attention this year.” Despite the country’s historical legacy of problem outccomes, he concedes “it’s a pretty good environment for private equity, at least right now.”
Finally, China is almost unavoidable in everyone’s deal diary. “China’s always going to be an area of focus,” says Seelbach. “The problem has always been how to invest with scale.” However, China is proving a healthy driver on the exit side, whatever its problems as an investment opportunity. “The exits are mainly in China,” Eydenberg avers.
Preferred sectors and strategies
Certain sectors are benefiting most from the resurgent impetus in dealmaking, driven by local and global macro dynamics, but also by micro considerations dictated by the private equity firms themselves, and their supporting banks and corporate counterparties.
“The good thing about Asian-based strategics is that they have come through the challenges of this global financial crisis relatively strong,” Seelbach points out. “And importantly, their balance sheets aren’t so levered.”
One strong emerging trend is private equity acting in support of outbound acquisitions by Asia Pacific companies – whether within the region, or further afield into the US or Europe. Jie Gong sees “the corporates in Asia becoming the purchasers of overseas assets. Historically, a lot of entry strategies were US and European firms entering Asian markets. Their [Asian] counterparts have taken on the tag of asset gatherers, and are looking to expand their footprint overseas by acquiring brands, distribution or technologies.”
Examples would include Indian healthcare chain Fortis’s recent investment into Singapore’s Parkway Holdings, which netted $685.3 million for TPG Capital’s almost 24% stake. Eydenberg confirms that, “a big theme for all banks is outbound acquisitions … There are a lot of logical targets.”
“That will drive the thinking of private equity firms investing in certain assets, particularly in control-type assets that will be more suited to trade sales down the road,” Jie Gong continues. “The private equity firm can see itself playing an active role professionalizing the company and making it attractive to buyers.””
As for the preferred sectors, Narayan notes that: “always consumer and retail is pretty hot. Healthcare is coming up.” He also sees natural resources as one preferred play. Jie Gong likewise feels that, “natural resources is one sector that has been a sweet spot and target area.”
AVCJ sources though, maintain that private equity opportunities in the resources sector are fairly limited in size, not least given the cash flow characteristics needed to drive leveraged deals, and will continue to trend towards the specialized services companies hitherto invested in Southeast Asia and Australia.
“Private equity funds rarely take on direct commodity exposure,” notes Seelbach. “Funds don’t feel they are experts in predicting the commodity price moves. They like to invest in opportunities one step away, such as services companies.””
And Eydenberg sees consistent residual risk aversion still influencing GPs’ investment approach. “On the entries, defensive industries, are getting the most attention” he remarks. Private equity firms are looking for companies that can continue to perform if prevailing economic conditions worsen again.
Structural fundamentals for deals
Several structural factors needed to facilitate deals in Asia Pacific also seem to be particularly favorable now. The relative health of banks in Asia Pacific is one strength of the regional industry, but post 2009, this advantage is waning as institutions in general recover their risk appetite, particularly in the US. “Risk capital largely went out of the markets,” Eydenberg remarks, looking back, but now he sees institutional demand for private equity leverage “really came back in with a vengeance. In the US, “there’s depth of demand,” and as a result, “we will see a deal of $5-10 billion of debt.”
As Mike Hermsen, MD at Babson Capital, recently pointed out to AVCJ, “Banks seem pretty comfortable with 2.75-3x senior debt, at least for a quality company. Overall leverage seems to be around 4x.”
Narayan feels that bank leverage in Asia, to some extent, never went away. “There’s always been abundant bank liquidity,” he notes. However, he cautions, “You will see bank debt getting maxed out.” Asia has capacity limits, it seems, that have not seen significant change.
Corporate attitudes towards private equity also seem to have changed positively since the GFC. “There’s a generally more entrepreneurial acceptance of sponsors as funding sources in Asia,” Eydenberg believes.
Access, however, does remain a problem. As JPMorgan’s a Narayan puts it, “you’re still getting reluctance to let private equity into the family dining room.” But on the exit side, he adds, “Businesses are back. Corporate guys are looking at private equity portfolio companies.”
Fundamentals in the industry
Finally, the characteristics of the private equity sector itself, and its accelerated evolution prior to and through the global financial crisis, are dictating much of what is happening now in Asia Pacific.
For one thing, there is the straightforward issue of fund life cycle for many of the multi-billion dollar buyout funds raised for Asia Pacific around 2005-07. “If you aggregate the Asia-focused capital of the larger global players, and assume that most of them have invested half of their funds, you’re looking at $10-12 billion they have to invest,” notes Seelbach. ”
This creates part of the pressure to take assets to market. “You are going to see a string of 2000-04 assets come to market,” confirms Anand Narayan. However, there is a new intensity in this pressure, owing to LPs’ experience during the GFC and their expectations of investee funds.
One very clear message from AVCJ’s sources is that LPs are not content to see pure paper value increases on their GPs’ assets. They want to see actual realizations and substantive exits that return dollars to them. This is partly a simple matter of cash on hand; many LPs still struggling with the deflation of their portfolios and a diminution of cash resources after the GFC need to see money come back from private equity before putting more money in.
But it is also a simple question of trust and alignment of interest. LPs, not least when their allocations are in the hands of alternatives specialists who need to make an investment case before their own boards, want to see GPs show that they can create value and bring it back. Post GFC, they are not ready to allow themselves the luxury of taking things on trust.
In formerly hot sectors across the region, Seelbach notes, “you need to see the sponsors selling out of those assets,” both to restore momentum and to validate the thesis. And here an anticipated trend towards secondary deals in Asia Pacific may really take hold. As Eydenberg remarks, there is “so much dry powder” Asiawide, and some will almost certainly come into play buying into the early assets already mentioned by Narayan. The auction of Daiwa SMBC Capital’s Japanese drinks investee Q’sai, invested in 2006 for $644 million, already appears to be one case, with the Carlyle Group, CVC and Unison Capital among reported bidders.
“In other markets, there’s a robust market for secondary sales,” Seelbach adds. “In Asia, you haven’t seen that, because the track record is generally selling to strategics. However, you are going to see some sales to sponsors.”
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