Fourth quarter analysis: The end of multiples arbitrage?

1) Farewell, pre-IPO deals

The average price-to-earnings (P/E) ratio for a Chinext-listed company at the end of December was 37.62, less than half the level a year earlier. The peak of 127 in late 2009 seems a very long time ago. The Shenzhen main and SME boards have followed a similar, though slightly less dramatic, path while IPO markets elsewhere in the region are stuttering.

For months, industry participants have been saying the era of multiple arbitrage is over. The rationale for much of China fundraising in the last two years - that GPs could double their money within 12 months by taking firms public at sky-high P/E multiples - no longer exists. Finally, this appears to be clearly reflected in the investment numbers.

According to AVCJ Research's preliminary fourth quarter data, the total value of growth capital deals in Asia was down 50% on the previous three months, at $2.2 billion. With second-quarter activity reaching a more than 12-month high, the third-quarter decline to a level comparable with much of the previous year was no great surprise. But growth capital investment for October to December was the lowest seen in two years. Moreover, aggregate buyout deal value saw only a minor decline on the previous quarter, while venture activity nearly doubled.

In the first three months of 2011, growth capital accounted for 47.3% of total investment compared to 32.8% for buyouts. Come the final quarter, the growth capital share was just 15.7%, while buyouts were on 45.6%.

This should not be seen as a resurgence in the buyout space, but as a byproduct of a retreat elsewhere. Buyout deals reached $6.3 billion for the quarter, still well down on the comparative period in 2010. And then a big transaction weighs heavily on the overall total: Bain Capital's acquisition of Japanese restaurant chain Skylark from Nomura Principal Finance came to $2 billion; CVC Capital Partners and Malaysian state investment arm Johor Corp's takeover of QSR Brands and KFC Holdings was worth $1.65 billion.

Investment for the region as a whole came to $13.9 billion, lower than the previous two quarters but still ahead of the $12.4 billion recorded for January to March. Although China continues to be the dominant player, the quarter-on-quarter increase in deal value came against a fall in the total number of transactions. It is notable that Temasek Holdings and China Investment Corp's participation in the group purchase of the China Construction Bank shares offloaded by Bank of America in November accounted for two thirds of aggregate deal value.

This adds credence to the argument that pre-IPO deals are on the wane.

2) Strong GPs prevail in difficult times

Asia's fundraising endured a miserable fourth quarter, with 45 vehicles reaching a close and attracting aggregate commitments of $7.3 billion, the lowest level in more than two years.

Studying the third-quarter figures back in early October, AVCJ questioned the sustainability of China fundraising. The country accounted for three-quarters of the $19.3 billion raised across Asia between July and September, but half of the national total came from two state-linked funds. With such large vehicles unlikely to emerge in the fourth quarter, surely dollar numbers would plunge? They did. A similar number of funds - 25 versus 32 in the third quarter - raised less than half the amount of capital.

While the five largest funds from the third quarter were China-related, the country occupied only two of the top five spots for the October to December period. The other three were made up of representatives from Australia and India. Those two countries were the only ones to post a year-on-year increase in fundraising for the quarter. Of the major markets, only Australia saw a capital commitments rise on a quarter-on-quarter basis.

We heard plenty about LPs' ambivalence toward Indian fund managers - wanting exposure to the country on the one hand and experiencing disappointment in past performance on the other - at the AVCJ India forum in December. As a result, the consensus among GPs is that 2012 will be difficult for fundraising. A total of 29 funds were raised in each of 2009 and 2010, attracting commitments of $4 billion and $2 billion, respectively. Sources told AVCJ that nearly twice as many vehicles are expected to chase less than $3 billion this year.

Australia's prospects appear to be much the same. With superannuation funds scaling back their commitments to private equity as an asset class, GPs are increasingly turning to overseas investors and reportedly making concessions on management fees.

So why did India and Australia buck the fourth-quarter trend? It comes down to the individual fund managers. Archer Capital led the way with $1.5 billion for its fifth fund, closing the vehicle in less than four months. The firm's position was strengthened by a strong track record for investments and exits in 2011, with approximately A$600 million ($614 million) spent across four transactions and divestitures worth A$2.5 billion.

Tata Capital Private Equity was India's number one performer, reaching a second close on the $1 billion Tata Opportunities Fund at $550 million. Not only does the Tata conglomerate contribute a portion of the vehicle's capital, but its brand name and presumed access to proprietary deal flow is a draw for third-party investors. The other leading Indian vehicle was the $450 million Multiples Private Equity Fund. It is run by Renuka Ramnath, former CEO of ICICI Ventures and a familiar figure to domestic and international LPs.

These three cases are in some respects a microcosm of the fundraising environment in Asia as a whole. Private equity firms unable to offer a strong track record of a differentiated approach are likely to struggle to win mandates. LPs are looking for a compelling narrative: an established GP, a quasi-corporate fund, and a well-known spinout are among those that provide one.

3) IPOs, trade sales suffer - but will it last?

Asian IPOs still make for grim reading. There were 22 private equity-backed share sales in the fourth quarter, less than half the third-quarter figure. Funds raised also dropped substantially, from $7.5 billion to $3.6 billion.

CITIC Securities, the largest offering from the period at $1.7 billion, struggled to attract sufficient interest. Priced at the bottom of its indicative range, the company had to rely on cornerstone investors such as Temasek Holdings, Kuwait Investment Authority and Och-Ziff Capital Management to pick up half of the shares on sale. Even then, CITIC Securities' corporate finance arm was required to step in as a stabilizing manager to ensure the stock at least ended its opening day on a par with its offer price.

By the end of December, CITIC Securities was trading down 4% on the IPO price. Of the 12 largest offerings from the fourth quarter, only two closed the year at a premium to their entry levels.

While the pattern of decline is similar to that of the third quarter, the two periods show markedly different results in terms of trade and secondary sales. As trade and secondary transactions reached an eighth-month high between July and September, it was seen as a natural response to another exit channel running into trouble. Yet only 53 deals happened, considerably less than in the third quarter, and transaction values slumped to $8.2 billion.

First of all, the data are preliminary and it's possible that previously undisclosed transactions will emerge in due course. However, this will probably have more of an impact on the number of deals than on the aggregate size. Nomura's $2 billion sale of Skylark to Bain stands out in a period which saw relatively few large-scale exits.

But the expectation remains that trade and secondary exits will feature strongly in 2012, driven by capital market uncertainties and expansion-hungry corporations.

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• Topics
• Performance
• Fundraising
• Investments
• Exits
• Fundraising
• Growth capital
• buyout
• Exit
• IPO
• Trade sale
• Performance