New horizons in Southeast Asia

To invest in truly emerging markets is to learn whole new dimensions of flexibility. Hard data is seldom available. And what is, is unreliable. The same is true about most local laws and regulations. And there's always corruption to deal with. These markets also tend to be illiquid, especially in troubled times, and are often subject to sudden change. As such, they require a long-term, very hands-on and almost visceral engagement. Obviously it's not for everybody.

Some markets, like Indonesia and Vietnam, are substantial, and have been for some time. Others, like Cambodia and Sri Lanka, are much smaller and perhaps more on the ‘frontier' end of the spectrum, but according to insiders they are promising. And at least one, Mongolia, seems to offer the last great gold strike - literally and figuratively - in the scaling up of efforts to extract its wide-ranging mineral wealth, and transform a centuries-old herding society into a modern, industrial nation.

Leading lights
Presently, Indonesia is front-and-center in the pack, very much an emerging market; perhaps too much, some say.
Patrick Walujo, co-managing director of North Star Equity Partners, an Indonesian-focused fund which manages about $400 million of equity and has deployed some $1.2 billion in the country since 2006, explains, "The big theme is that we are not China and India, where people have been focusing their attention over the past decade. But up to 1996, Indonesia, as a country, attracted more foreign direct investment than China."

That was a result of a population of 200 plus million, vast natural resources and 32 years of political stability under Suharto, which consistently delivered 7-8% year-on-year GDP growth. All that collapsed in the Asian currency crisis of 1997-98. In its aftermath the country lurched from autocratic control to full democracy, and it was far from painless. With the re-distribution of power, the military was weakened, and border controls as well, which led to a serious brush with terrorism.

"I'd argue the inflection point was 2004 when we got a new government that provided more stability and better priorities as to what they were trying to achieve, most notably in a serious effort to combat corruption. [The Indonesian government have] proven themselves genuinely reform minded. They have delivered disciplined macro-management."

Walujo recalls that when he returned from Japan in 2003, GDP-per-capita was about $1,100 per annum. Today it's pegged at approximately $2,200 and is projected to expand to perhaps $4,000 by 2014. Similarly in 2003, the government had a debt-to-GDP ratio of some 70%, a legacy of the Asian crisis. Presently this has been reduced to 28%, with a target of 22% next year.

Andrew Yee, Managing Director, Principal Finance is based in Singapore with Standard Chartered Bank -Asia provides 70% of its business - works as a private equity infrastructure specialist and investor region wide.
On Indonesia, he concurs that they have done a commendable job in engineering a bounce back from a serious FX problem in which their currency took a pounding because all of the government's loans were in US Dollars.

"One of the biggest issues about private equity investing now in Indonesia is that many transactions are overpriced. It is hard to find good value there," he contends. "Within the infrastructure sector, the potential is huge, but a lot of it is still undelivered. That compares to China, with its likewise huge potential, which has arguably already been substantially delivered, and India which is somewhere in between."

Particular target areas
North Star's Walujo says three investment theses are au courant: the first is how to best capitalize on the much-increased commodity demand (especially for coal) from China and India; secondly there is the ongoing development of a young and increasingly affluent population; and third is trying to calculate how to benefit from all of this by ramping up infrastructure plays.

Referencing North Star's experience, he adds, "There are certain non-regulated infrastructure plays we see as very attractive."

That is enabled by the nature of their fund to do larger deals, which is in turn a result of strong relationships with their LP base and a corollary connection with TPG; together this has fuelled $1.2 billion worth of equity investment since 2006 with only $230 million of their own capital.

"We've generated a lot of co-investment opportunities, and therefore our style is opportunistic. We tend to like buyouts, the bigger deals, because it's easier for us to attract management to come with us."

But he candidly cautions, "While there is a control market in Indonesia, not everybody can do it. If you look at the track record of those who have done buyouts and LBOs, it's only a small handful. At the risk of sounding elitist, it's not for everybody."

Other drawbacks include sharp institutional memories of the events - and losses - of 1998, especially in the context of upcoming elections in 2014 in which President Susilo Yudhoyono is legally barred from running.

Some on the ground believe this concern is overrated. They note that the various political power groupings are predominantly centrist these days. That can only bode well for the continuation of pro-business policies.

Currently, Walujo estimates there are three to four noteworthy local private equity funds with collective total funds under management of less than $3 billion. That said, all of the big international names, including some Chinese players, are on the ground in Jakarta.

In terms of market dynamics, the days when a Jardine-led consortium could buy major motor vehicle manufacturer and plantation business Astra International for $500 million and see that investment grow to $30 billion in less than 10 years, are long gone.

Vietnam
According to Son Nam Nguyen, founder of VN Capital Partners (and former head of investment banking in Vietnam with Citi) the country's market index went from 250 in 2005 to 1250 in 2007, only to sag back to 450 in November 2010.

"Prospects are hard to predict because there's no track record. But there's been a lot of money lost," he told the Asian Venture Forum frontier markets panel in Hong Kong. "Very few exits materialized even though there was a lot of investment. Mostly what we've learned is that Vietnam is a market of extreme cyclicality. If you understand these cycles and what drives them, I still think you can make money. But if you don't, well I can only say that's the lion's share of what success is about."

What caused the marked spike was excess inbound foreign capital (about $4 billion yearly), combined with an approximately 40% yearly increase in bank lending.

Nearly $8 billion of that went into the stock market, "keeping in mind that the entire market cap of Vietnam in 2005 stood at about $100 million, with a daily trading volume of only $200,000 per day." About $15 billion of capital was added over 3 years, and a huge bubble developed, "perhaps proportionately the biggest in the region over the past decade."

Not surprisingly, when it burst it left a very sour taste. Still, Nguyen reckons that considerable fund raising efforts are still in play, and with good reason.

A new era?
"I think this is a good time to be investing because the excess liquidity is gone. People are now all focused on China and India, and to some extent Indonesia in Southeast Asia. So valuations that used to be 40x P/E and 8x price-to-book are now 9x P/E and 1.5-1.8x price-to-book; or half that of Asia overall," he explains. "Among the people I'm talking to in the private equity shops, two years ago they were chasing deals. Now deals are chasing them, and in a guise, say PIPEs, they haven't seen before. Of course that's also driven by a decline in bank lending."

This doesn't imply a cloudless sky, though. Nguyen cites three particular concerns going forward, the first being simply macro-economics. "Vietnam has a 10% inflation rate while the currency [the dong] has be declining at about 10% per annum. That concerns a lot of people."

Beyond this fiscal deficit risk and trade deficit risk, it's less than clear how to invest in the country and where the best opportunities are. Private equity? He hasn't seen many deals. Public equities? The market is too illiquid.

Size matters
"The broader answer is that Vietnam is not the right destination for, say, $50-100 million. It's a place to invest $20 million. You don't want to invest in a fund that has more than $100-200 million, because it's too big for the size of the market."

That aside, he believes that there will be opportunities over the next couple of years, for example in privatization, because it is already about 5 years behind schedule and is bound to churn at some point.

He also points to distress as being a likely area. Leading companies are now doing private deals because of excess real estate investments over the past 24 months or so, with the extra fillip of some bank restructuring of a sort and on a scale not seen for a decade.

Another investor who asked to remain unnamed takes a somewhat less sanguine view. "A real limiter, as with China, is a government which has done a reasonable job, yet over-regulates to the extent of driving down returns thereby deterring further private equity investment. And there is the perennial issue of how to do business effectively without graft."

According to Andrew Yee of Standard Chartered, good value has returned to Vietnam and his firm is bullish, although risks remain. "The great unknown is execution risk," he says. "Most of the infrastructure private equity opportunities, for instance, are greenfield. It's quite hard to invest private equity in operating assets which are generally owned by the SOEs. So you've just got to take substantial greenfield risk and build new assets with the hope of generating substantially enhanced returns."
A plus is limited competition - for now - which is in no small part why his firm is looking to put money to work.
Corruption, or the cost of doing business?

A big, and perennial, issue for would-be investors in frontier markets is corruption. AVCJ's sources were refreshingly matter-of-fact about it.

"One development in Indonesia over the past few years is a now effective internal commission against it," says Patrick Walujo. "You now see ex-ministers, governors, assistant governors serving time in jail because of corruption. Plus we now have a free press and direct elections. So as a politician it's not a good thing to appear in the media on corruption charges when you're aspiring to be elected. In other words things are getting better. But the fight against corruption will be generational. It's not going to be won overnight."

Nguyen adds, "As somebody told me, in China corruption is wholesale. You pay and it gets done. But in frontier markets, corruption is retail; you can find yourself paying everybody and it still doesn't get done."

 

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• Topics
• Southeast Asia
• Standard Chartered Private Equity