IPO woes: Looking for an exit

Imagine you're a private equity fund manager in Asia. You hold a 15% interest in a string of companies located across the continent. None of the entrepreneurs behind these firms has any incentive to exit and, as a minority investor, you have no way of forcing them to do so. Your investment horizon was five years, and it's now year seven. What are you going to do?

For most private equity investors, the exit route of choice has always been an IPO. Stock market offerings have accounted for 44% of Asian exitsf in the past five years, largely because the market is dominated by minority growth capital investments in companies that see a public listing as logical step in the development process.

The pricing of these deals has often been so high that it is a case of IPO or nothing. China, for example, has seen many investments in which the economic rationale hinges on the high exit multiples available on domestic stock exchanges.

While the vast majority of deals - approximately 92% at the last count - continue to involve minority stakes today, the IPO market has soured over the last six months. Plenty of private equity firm have seen their exit plans thrown into disarray as investors shy away from equities in the face of global economic volatility.

According to AVCJ Research, $72.3 billion was raised through private equity-backed 192 listings in the first half of 2010, fbut this sunk to $20.6 billion from 146 offerings in the subsequent six months. Between June and November 2011, it dropped even further to 82 offerings and $13.7 billion in capital raised.

CITIC Securities, China's largest brokerage, was supposed to lead the industry out of the depths in October with the largest IPO in three months. However, it met with a poor response, raising a less-than-expected $1.7 billion, and its shares plummeted on their trading debut before a stabilizing manager was brought in.

Timing is everything with an IPO and, according to Tim Sims, founder of Pacific Equity Partners (PEP), which took Collins Foods public in Australia's only PE-backed listing of 2011, not all participants have the stomach for it.

"Listing is expensive, time-consuming and has asymmetrical risk associated with it, " he explains. "If anything were to go wrong, after the PE firm ceases to have anything to with operating the company, there's a structural risk that the firm will be reputationally blamed for it. These factors will all be weighed in the mix."

A host of other factors in different markets could be blamed for exacerbating the poor IPO climate. While China's stock markets, which are to a certain extent protected from any global fallout, have struggled less than most, the China Securities Regulatory Commission recently announced that it intends to cut domestic listing approvals by 30%, and take steps to reduce overinflated valuations. This may impact on Chinese firms looking to list locally.

Similarly, in the US, the once strong appetite for Chinese IPOs has dried up following a spate of corporate governance scandals at small to mid-cap China-based firms listed on American bourses.

Show me the exit

The trade sale is one alternative that appears to be holding more appeal for many PE and VC backers. AVCJ Research found that Asian M&A activity in 2011 totaled $41 billion, up from $38 billion in 2010 and $17.2 billion in 2009.

Standout deals in this category included Lazard Asset Management's sale of Australian infrastructure firm Connecteast Group to a consortium of overseas firms for $1.4 billion and Pacific Equity Partners and Unitas Capital's exit of New Zealand's Independent Liquors to Asahi for $1.3 billion.

Many of the transactions to date have involved companies located in Australasia and Japan, where PE firms are more likely to have majority shareholdings and mature strategic buyers with considerable M&A experience are aplenty.

But Derek Sulger, partner at China-focused Lunar Capital, believes investors throughout the region should be placing more emphasis on trade sale exits when devising their valuation methodologies "rather than always assuming an IPO at frothy valuations is possible." One motivation for this, he argues, is the likely paralysis in the public markets that would arise from the potential breakup of the euro. The odds for this happening have risen to as high as one in four.

If private equity firms don't choose to change their strategy deliberately, they could be tempted to do so by the increasing availability of corporate cash. Companies from low-interest environments like Japan and Southeast Asia are looking to Australasia for potential trade buys, particularly in the consumer sector.

"There has been important interest coming from countries which are still in expansionary mode," says Sims. "These companies have a lot of confidence and keenness to consolidate basic industries like beverages and food and to build on the associated distribution opportunities in Asia."

In July, once month prior to buying Independent Liquors from Unitas, Asahi also agreed to buy Permanis, Malaysia's second-biggest soft drink maker, for $273 million, proving that its demand for food and beverage firms extends to other geographies as well.

Corporate China's potential to embark on a spending spree, but to date there has been more talk and less action as far as mega-deals are concerned, with companies preferring to start small. Chinese conglomerate Bright Food Group lost out on numerous acquisitions before picking up CHAMP Private Equity's 75% stake in Australian food producer Manassen Foods last August.

US companies are also strong prospective acquirers. Many are sitting on large balance sheets and are keen to buy into the Asia story, as Joy Global did with its $584.6 million acquisition of 41% of International Mining Machinery from The Jordan Company last July.

Second-hand goods

Australasia and Japan are also the likeliest locations for another exit route expected to gain traction in Asia. Secondary sales - replacement capital deals and secondary buyouts (SBOs) - have yet to make their presence felt on any scale, with a paltry 33 completed in 2011, compared to 167 trade sales and 241 IPOs.

Despite accounting for two of the region's largest SBOs - Bain Capital's $1.3 billion acquisition of MYOB from Archer Capital and HarbourVest Partners and Archer's $474 million purchase of Quick Service Restaurants from Quadrant Private Equity - even Australia failed to see significant numbers of these so-called pass-the-parcel deals. This is in part explained by the concentrated nature of the local market.

Few are willing to argue that secondary sales won't play a more significant role in the future. "As the number of buyouts in Asia continues, there are going to be more and more SBOs," says Marcus Thompson, managing partner of Headland Private Equity. "PE investors will be looking to cash in and move on, and other PE funds will be an important source of capital. We will see how LPs in Asian funds react to the practice."

Going in direct

A lesser known path which could start to create liquidity avenues for investors in the future is the direct secondaries route. The first deal of this kind was seen last April, when Bank of America Merrill Lynch's private equity business spun out to form NewQuest Capital Partners. The NewQuest team then acquired around 21 assets from its former parent, providing a convenient exit for BoAML, which had been looking to scale down its private equity book.

Having gained experience in the field before it was even launched, NewQuest now dedicates itself solely to direct secondary investments - buying portfolio companies and other assets from GPs looking for liquidity. It sees this as the most logical business model possible in a market in which investors acquire stakes in companies at a premium but then struggle when it comes to the exit.

"We estimate there's close to 5,000 un-exited deals in Asia today," says Darren Massara, managing partner of NewQuest. "You have all this money that's been invested, but the realization rates are quite low - less than 25% on capital deployed since 2005. Frankly everyone's waiting for these exits to happen. That's where the secondary market needs to pick up and provide liquidity for investors."

Paul Capital is another firm that offers to buy in bulk from willing vendors. Having backed NewQuest in launching its $400 million first fund, the firm claims it is seeing strong dealflow from other captive PE teams looking to spin out and become independent. This is driven, says Lucian Wu, the firm's co-head of Asia, by the uncertainty created by the Volcker Rule and Dodd Frank Act, which limit banks' exposure to private equity to no more than 3% of their Tier One capital.

"We're seeing a lot of this, driven by the banks and the captive teams wanting to spin out, because of all the uncertainty around them," Wu says.

He points out that there are other entities looking to offload their portfolios, such as hedge funds hoping to sell the illiquid PE assets they acquired before the Lehman crisis, or managers of 2007-08 vintage funds that want to hit the fundraising trail again. Secondary investors can come in and buy the underlying portfolios and retain the vendors as managers.

The silver lining

Despite the increasing availability of sophisticated liquidity mechanisms, the trade sale remains the only realistic alternative to a public listing for most traditional Asian investments. And while numbers are expected to increase, even that option will be out of bounds for many until deal structures evolve to the point that PE backers can achieve control positions and therefore exert more influence over exit routes.

So with the IPO window closed for the immediate future, one could surmise that investors will need to sit tight and concentrate their efforts on portfolio management until it re-opens. There is no better time to merge portfolio companies, create synergies, cut costs and drive profits than during a period of limited exits, after all.

Indeed, a greater understanding of what makes portfolio companies tick could be an unexpected benefit of the difficulties, and help bring about changes to a market which is so often driven by price alone.

"A consolidation phase of lack of exits might not be a bad thing because it distinguishes the boys from the men in terms of people providing PE capital," says Paul Capital's Wu. "There have been so many cases when investee companies' decisions on who to choose as their investors are simply driven by price, instead of what value the investors can add. When the markets are tough, the PE investors might start providing more help to companies in addition to financial engineering expertise."

For some it will be a comfort to know that the exit environment which has left so many would-be vendors in stalemate may also confer certain benefits.

SIDEBAR: Asian IPOs - Good, bad or cancelled

Despite the gloomy outlook, the IPO hasn't quite died a death in Asia, and a number of private equity-backed firms did succeed in going public in 2011.

Yonghui Superstores - Headland Capital Partners won the IPO of the Year prize at the AVCJ Awards in November for its listing of the Chinese hypermarket chain just over a year ago. Yonghui raised RMB2.64 billion ($418 million) on the Shanghai Stock Exchange and was trading this week at 33% premium to its IPO price. Due to the 12-month lock-up period imposed on existing shareholders in China, Headland is yet to sell down its 21% stake in the company however, so it remains to be seen how the exit will fare.

Qihoo 360 - The Chinese software firm raised $175.5 million on the New York Stock Exchange in March and then saw its stock soar 134% on its trading debut. Many listings by Chinese technology companies in the US have promised much before fading away, General Atlantic backed Renren, which raised $743.4 million but now trades about 70% below its IPO price. Qihoo, however, remains at a small premium to the offering price. Investors in the company include CDH Investments, Highland Capital Partners, Redpoint Ventures, Sequoia Capital, Trust Bridge Partners, IDG Capital Partners and Matrix Partners.

Samsonite - The floatation of CVC Capital Partners' portfolio company Samsonite in Hong Kong in June was seen as a sign of things to come: An international brand choosing to go public in Asia due to the liquid capital markets and a desire for wider brand recognition in the region's emerging consumer markets. However, the offering struggled. The number of shares on offer was reduced due to weak investor demand and it was eventually priced at the bottom of a revised indicate range. Samsonite ended up raising $1.7 billion, earning CVC Capital Partners $550 million.

Collins Foods - Coming at a time when numerous other PE-backed IPOs were cancelled, it is impressive that Pacific Equity Partners managed to get fast-food group Collins Foods off the ground. Nevertheless, the offering was priced at the bottom of its range, raising $216.6 million. It is currently trading close to 50% below the IPO price.

It's worth noting though that all of these deals took place before the end of the summer, when the economic uncertainty brought the market to a near halt. Since then, New China Life Insurance priced at the bottom of its range in its dual Hong Kong and Shanghai listing in December, while Haitong Securities, China's second-largest brokerage, delayed its planned IPO from December to the first quarter of 2012.

• Tweet  
• Facebook  
• LinkedIn  
• Google plus  
• Save this article  
• Send to  

• Topics
• Australasia
• Greater China
• Southeast Asia
• North Asia
• Exits
• Exit
• IPO
• Trade sale
• Asia
• Pacific Equity Partners
• Lunar Capital Management
• NewQuest Capital Partners
• Paul Capital Partners