First quarter analysis: Asia struggles to locate its exits groove

1) Few bright spots in Asia exits

Exits are all about timing, particularly in the current unfriendly climate. Who would have predicted that India-focused investors would get it spot on? The country is often described as a difficult market for exits, yet it accounted for four of Asia's top 10 non-IPO exits in the first quarter of 2012.

Three of these were public market sell-downs of stakes in financial services companies, as PE players capitalized on the BSE India Sensex 30 Index rising from 15,500 points in early January to above 18,400 towards the end of February, a six-month high. The Carlyle Group moved first, unwinding 1.3% of 5.2% its interest in Housing Development Finance Corp. (HDFC) for $274.4 million, supposedly for a 2x money multiple.

Citigroup - not a private equity player, so not included in AVCJ's statistics - exited its 9.85% stake in the Indian mortgage lender three weeks later for $1.9 billion, claiming a pre-tax gain of $1.1 billion on the investment.

Temasek Holdings sold 1.4% of its holding in ICICI Bank for $306 million, while Warburg Pincus completed two separate sell-downs of Kotak Mahindra Bank for a combined $442 million. Together with a $150 million sell-down in 2011, it represents the private equity firm's second-largest exit in India.

This trend was one of few bright spots in an otherwise tepid quarter. Although previously undisclosed transactions will no doubt emerge in due course, the PE-backed IPO statistics are not encouraging. A total of $2.3 billion was raised from 33 offerings, down from $10.7 billion and 76 offerings the previous three months, according to AVCJ Research's preliminary data for the quarter. It is the lowest quarterly fundraising total in more than two years.

Chinese listings dominated, but even they were muted by normal standards. There were no big-ticket offerings to prop up the numbers, with Pubang Landscape Architecture, a portfolio company of GF Xinde Investment Management, leading the way on $207 million.

Trade sale and secondary exits also neared a two-year low, with $4.1 billion generated by 78 transactions. It is barely a quarter of the $16 billion in deals seen in the third quarter of 2011, when stakes in Chinese state banks were changing hands and Australian private equity firms saw handsome returns on exits to strategic and secondary investors.

Timing is everything and we have yet to see the makings of a new wave of activity.

2) China pre-IPO deals still floundering

The startling data point in the final three months of 2011 was the drop in growth capital investments in Asia - down more than 50% quarter-on-quarter to $2.8 billion. This was, we suggested, evidence of dwindling pre-IPO deals in China, which account for the lion's share of transaction value in the region.

The downward spiral has not been sustained, as growth deals reached $3.8 billion in the first quarter, but don't be fooled. This level is still the lowest in more than two years. For the second consecutive quarter, buyouts were responsible for the largest share of investment. This only happened once before in the last two years, in the second half of 2010, when control deals topped $11 billion in each quarter.

Times have since changed. While buyouts accounted for the bulk of investments between January and March, the $4.6 billion total is the lowest in a year. Overall transaction value for the quarter came to a disappointing $12.49 billion, a level not seen since the first three months of 2010.

There is a seasonal argument here - first quarter dealflow tends to be slower, a likely result of due diligence and negotiation activity slowing over the Christmas and Chinese New Year periods. But the weaker growth transaction figures can't be ignored. Cumulative deal value was down 37% compared to the first quarter of 2011 and 33% lower than the first quarter of 2010.

Looking at China specifically, investment came to $6 billion for January-March 2012, up from $4.6 billion a year earlier. However, the number of transactions fell by more than half year-on-year, which translates into an average deal value of $83 million for the first quarter of 2012 compared to $30 million the previous year. Even examined on a quarter-by-quarter basis, average deal size has gone up by 18%.

The implication is either that China is becoming more expensive or that the smaller cap growth and pre-IPO deals are on the wane. It's probably a combination of the two, and they aren't mutually exclusive.

China fundraising data offers further affirmation of the trend. What we are seeing, quite simply, is a smaller number of larger vehicles. For January-March 2012, 11 funds raised a total of $8.5 billion, compared to 41 funds and $8.1 billion a year earlier. Average fund size for the quarter was therefore an astonishing $772 million, up from $197 million the previous year and $157 million the previous quarter.

For the region as a whole, growth capital and venture capital fundraising - by value and volume - is down significantly on a year-on-year basis. Gone are the days when it seemed that anyone, regardless of experience and track record, could attract capital on the expectation of rapid, IPO-driven returns. Demand for China is increasingly channeled into known quantities.

3) India mega-deal flatters to deceive

It is difficult to overstate the size and significance of the $2.87 billion acquisition of Reliance Infratel by The Blackstone Group and The Carlyle Group - or the distorting influence it has on quarterly investment figures. At the same time, the asset had been up for sale for so long and details of protracted negotiations with the buyers were so willingly leaked that the final closure was underwhelming.

Prior to this transaction, India's largest ever buyout was KKR and Sequoia Capital's $900 million purchase of Flextronics in 2006. The leading minority investment, meanwhile, was Temasek Holdings' $2 billion commitment to Bharti Airtel in 2007.

With India's telecom operators squeezed by rising costs and falling call prices, there is clearly a market for these tower units: GTL Infrastructure, Tower Vision and Bharti Infratel may also seek to sell some or all of their assets. Still, it is unclear how many private equity firms are really interested in buying.

Turning a profit from telecom towers is a challenge in India. It requires the scrapping of loss-making towers, the recruitment of a sustainable client base and a keen eye for consolidation through mergers and acquisitions. Perfect for private equity - provided the purchase price is fair and the regulatory baggage is manageable.

India hasn't uncovered a rich seam in new buyout opportunities. As such, the sharp jump in transaction value for the first quarter of 2012 to $4.48 billion, up 123% year-on-year and 367% quarter-on-quarter, is unlikely to be more than a temporary spike. That said, India crept ahead of China for deal volume for the first time in a year, with 104 transactions to its neighbor's 72.

Few industry observers expect fundraising to amount to much in 2012 - the previous year's total of $4.1 billion is unlikely to be matched - but the investment environment might well improve. This relies on an improvement in the economy, a clarification of the government's position on investment from funds domiciled in Mauritius, and evidence that entrepreneurs appreciate the concept of PE value-add being more than just anecdotal, which could potentially lead to more realistic valuation expectations.

None of these are certain, but Helion Venture Partners' successful $255 million fundraise (and ChrysCapital Partners' likely closure of its latest vehicle this quarter) suggests that LPs continue to have faith in leading GPs.

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• Topics
• Exits
• Expansion
• South Asia
• Greater China
• Buyouts
• India
• China
• Sell down
• IPO
• Growth capital
• buyout
• Asia