Great expectations: Buyout firms in Southeast Asia

Catch the Singapore Airlines flight out of Changi Airport to Jakarta at 7.40 a.m. on a Monday morning and you are likely to find yourself traveling alongside the great and the good of Asian private equity. The plane arrives in the Indonesian capital one hour and 45 minutes later, but the one-hour time difference means dealmakers can jump in a cab and, traffic permitting, make their 10 a.m. meetings.

For some, this is only the beginning of a week-long odyssey that takes in Kuala Lumpur, Bangkok and maybe Manila before returning to Singapore on Friday afternoon. These trips are likely to become more common as the global buyout firms intensify their focus on Southeast Asia, using Singapore as a hub.

"The team currently sits in Hong Kong; they usually go to the region on Monday and try to come back on Friday afternoon. This means you miss opportunities to meet people on Monday mornings and Friday afternoons, plus informal networking over the weekend," says Ming Lu, head of Southeast Asia at KKR. "By actually living in Southeast Asia, you are watching local news, shopping in local malls and talking to local people - you are in the information flow."

Deploying resources

KKR's Singapore office, its seventh in Asia and 15th globally, opens on October 25. While the move doesn't signify the PE firm's entry into Southeast Asia - there have been four deals since 2006 - it is a statement of intent. Four years ago, KKR had 3-4 PE professionals dedicated to the region, but eight are relocating to Singapore and there are plans to hire at least two more.

The Blackstone Group is also said to have leased substantial office space in Singapore, while Warburg Pincus and Bain Capital are reportedly hiring for their Southeast Asia teams. The Carlyle Group, TPG Capital and CVC Capital Partners already have local operations, each with 4-9 investment professionals. TPG also has an alliance with Indonesian GP Northstar Pacific Partners, which brings additional local resources.

The message is clear: Southeast Asia is expected to deliver greater deal flow. But can it? The argument rests on the likelihood that rising prosperity, political stability and industrial consolidation will create opportunities, versus the reality that executing large deals in markets characterized by concentrated ownership of prime assets is incredibly difficult.

According to AVCJ Research, $9.8 billion was transacted across 117 deals in Southeast Asia last year, the highest level since 2007, but the pre-global financial crisis boom aside, investment has been reasonably consistent over the last six years. Indeed, 2012 is looking relatively poor, with only $2.5 billion from 73 deals as of mid-October.

Transactions of $100 million or more account for 86% of the $64.8 billion invested in Southeast Asia since 2005 but only 11% of total deals by volume. On average, only 14 transactions have crossed the $100 million threshold each year, with six so far in 2012. In 2007 there were six deals in excess of $500 million, rising to eight in 2008, but there have been no more than four in any other year since 2005.

Singapore, Southeast Asia's smallest market by geography but its most mature, can be relied upon to generate a few buyouts of reasonable size. There are high hopes that Indonesia, the largest market by geography and population, can generate sufficient deal flow. However, not everyone is convinced.

"There are very few of these large deals in the market," says Lee Taylor, partner and head of Clifford Chance's PE practice in Southeast Asia. "Competition is fierce and PE houses are looking at deals they previously wouldn't have looked at. For example, minority investments when previously they may only have considered buyouts, and transactions with higher valuations than they would normally be prepared to pay."

There are recent deals that fit in each category. Affinity Equity Partners recently closed its first investment in Indonesia, taking a significant minority stake in local auto services group MitraPinasthika Majesty for about $100 million. It took more than three years of negotiations to secure the investment. A source familiar with the situation tells AVCJ that "there probably isn't a deal that has moved in Indonesia without us taking a look at it."

An auction process is currently underway for a stake of between 20% and 49% in Siloam, Indonesia's biggest private hospital firm, with Blackstone, Bain, KKR and Abraaj Capital reportedly interested. Two different sources put the bidding at 19x EBITDA and 20x EBITDA, respectively, but the seller, the Riady family-controlled Lippo Group, is said to be seeking a valuation of 25x EBITDA.

Although bullishness on Indonesia consumer plays is justified by the fundamentals - domestic consumption is the primary driver of GDP and there are opportunities to help dominant players emerge in still fragmented markets - KKR's Lu admits that deal flow is a concern. "It is challenging despite the opportunities," he says. "We have looked at a number of consumer businesses and we could have done some deals but the valuation environment was difficult."

Lu is willing to be patient, however, noting that China's period of crazy valuations peaked in 2010 and has since faded. He is also willing to compromise on ticket size: A migration to large-size deals is expected but these will be hundred-million-dollar rather than multi-billion-dollar transactions; as such, the usual starting point of $100 million could be slightly lower in Southeast Asia, provided the target has growth potential.

KKR's first investment in the region outside of Singapore was the acquisition of a 10% stake in Vietnam-based food company Masan Consumer Corp. for $159 million in 2011. The private equity firm first identified Masan as a potential target several years ago while conducting top-down analysis of Vietnam's consumer space, but at the time felt the company was too small. After 2-3 years of rapid growth, that assessment changed.

Sigit Prasetya, managing partner for Southeast Asia at CVC Capital Partners, admits that deal flow in the region is "pretty lumpy." He picks on China as a comparative: CVC has completed three minority deals there in the last 12 months, investing in the region of $100 million for 20-25% interests in companies with $40-50 million in EBITDA. The Southeast Asia universe of mid-size opportunities is smaller.

Transaction challenges

CVC opened its Singapore office in 2007 and is generally regarded as one of the more successful investors in the region, having secured seven deals in five years, two of them in Indonesia. An analysis of its past and present portfolio uncovers two more challenges buyout firms face in Southeast Asia.

The first is intermediation. Two of CVC's investments came about through auctions, and these processes are becoming more prevalent as even smaller deals are scooped up and peddled around the region by investment banks or the corporate finance teams at accounting firms. Clifford Chance's Taylor estimates that around 70% of the buy-side transactions he has been involved in were auctions.

This approach is welcomed by sellers as it can lead to bidding wars and higher valuations, but it does little to help private equity firms, whose pitch to LPs is largely based on an ability to originate transactions where none existed before.

"With auctions, you know the deal will likely get done and it's a well-defined framework, whereas with proprietary deals you have to develop the business angle and it can take years to develop a dialogue," says Prasetya. "We prefer proprietary deals because we like to operate top-down and work with people that we know."

The second challenge is, literally, who you know. Many of the assets in Southeast Asia that fall within buyout firms' target scope in terms of ticket size, market position and growth potential are held by around 40 mid- to large-size family-owned business groups.

Building relationships with these groups is critical and it influences recruitment strategies in the region.

Although Southeast Asia's shallow private equity talent pool is often cited as a problem, efforts are made to hire investment professionals local to the markets being covered. If they have previous experience dealing with the families as consultants or bankers, even better. Ridha Wirakusumah, now a director with KKR, was previously CEO of Bank Internasional Indonesia; InghieKwik, who leads Affinity's Indonesia activities, and Prasetya both previously worked for Morgan Stanley in Indonesia.

Even in auction situations, there is plenty of anecdotal evidence of deals swinging a particular way due to pre-existing relationships.

"Larger companies are able to use advisors and investment banks that leave no stone unturned and this means assets get auctioned despite these relationships," says VishRamaswami, a senior research consultant with Cambridge Associates in Singapore. "However, all things being equal, a relationship with a particular industrial group could be a game changer."

CVC acquired Indonesian cable TV operator Linknet through an auction, but Prasetya had known the seller, the Riadys' Lippo Group, since his days as a banker. A year earlier, the PE firm sourced a proprietary deal from Lippo - a majority stake in Matahari Department Store for $633 million.

TPG's ties to Northstar - the US firm supported Northstar in its early days and now the two firms have equity interests in each other - represent another means of accessing these groups. Through a combination of family and business connections, local managers reach deep into corporate Indonesia and secure deals in sectors that are difficult for foreign investors to penetrate. For example, when Northstar acquired mining contractor Buma Group for $350 million, TPG later came in as a co-investor.

"Some families have a reputation for good governance, while certain families are not considered good partners," says KKR's Lu. "That is one of the reasons we have people like Ridha - to understand the family dynamic." Another Southeast Asia dealmaker adds that he is only interested in about 10 Indonesian family groups.

There are certain criteria upon which families can be assessed, such as their past history of working with foreign investors and their attitudes towards governance. Beyond that, relationship-building has much in common with PE elsewhere in the world. Owners and prospective investors must be comfortable with one another if they are to forge alliances of five years or more.

Patience first

While there is every reason to believe that these challenges are more easily addressed from Singapore than Hong Kong, questions will continue to be asked about sustainable deal flow. Can Southeast Asia offer even a pale imitation of the transparency and governance, sophisticated financing, succession planning issues and corporate fiscal discipline that facilitate larger deals in developed markets?

Joe Bae, head of Asia at KKR, is optimistic, based on recent progress. "If you look at Thailand today, it's an investment grade country. So is Indonesia. You couldn't say that 10 years ago," he says. "Economies are healthier, capital markets are more open and the businesses and deal sizes are getting a lot more interesting. As these businesses grow and companies expand, there will be more opportunities for players like us."

This view is broadly shared by Marc Lau, a partner at Singapore-based fund-of-funds Axiom Asia, who argues that if each buyout firm starts off pursuing one reasonably large deal each year, then there should be enough to go around.

But he also offers a view on why these firms are keen on Southeast Asia that implies more than just bullishness about its prospects. "GPs and LPs have established relatively sizeable positions in what they would consider to be the major growth markets in the region - China and India - and the next logical target is Southeast Asia," Lau says.

The danger is over-expectation and impatience: deal-makers might come under pressure to deploy capital in a shallow market and lose discipline, throwing out bids that represent large multiples of EBITDA and can't be sustained in a rational commercial environment.

As global buyout firms scale up resources in the region, their biggest asset might be an ability to go against the flow.

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• Topics
• Southeast Asia
• Buyouts
• Buyout
• Expansion
• Southeast Asia
• Indonesia
• Malaysia
• Philippines
• Singapore
• Thailand
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• KKR
• The Carlyle Group
• TPG Capital
• CVC Capital Partners
• The Blackstone Group