Indonesia investment: Uncharted territory

After more than four years in the job and no deals to his name, The Carlyle Group's senior managing director for Southeast Asia parted from his employer in late February. It was an amicable split. At its heart lies Indonesia, the region's largest and arguably most enticing market, but one which remained frustratingly beyond the grasp of Anand Balasubrahmanyan.

This was not for lack of effort. Industry sources identify at least three deals in which Carlyle was thwarted. Balasubrahmanyan is said to have looked at mining services contractor Buma Resources and cable TV operator LinkNet, which ultimately went to Northstar Pacific Partners and CVC Asia Pacific, respectively. Last summer Carlyle seemed poised to land a 25% stake in GarudaFood, having made a bid of around 20x EBITDA, but the deal floundered and the food and beverage producer ended up agreeing a joint venture with Japan's Suntory instead.

Carlyle is by no means alone among global and regional buyout firms in finding Indonesia a challenging market. Affinity Equity Partners opened an office in Jakarta in late 2009 but has yet to secure any deals, while the likes of KKR, Bain Capital and The Blackstone Group have so far been conspicuous in their inactivity.

As Asia's largest individual market after China and India, Indonesia is undoubtedly an attractive prospect for private equity. But as much as the market is underpenetrated it also somewhat impenetrable. Information on private companies is sparse, local relationships rule, entrepreneurs are wary of selling equity and the regulatory environment remains uncertain. Competition is also intense, with corporate strategic investors, hedge funds and the large family-owned conglomerates all looking for deals.

Local private equity players and global firms with enough people on the ground - CVC and TPG Capital (via its partnership with Northstar) - have proved lucrative deal sourcing is possible. It is up to the rest of the field to play catch-up, but can it be done at an acceptable price?

"Indonesia is increasingly important to the private equity business and we expect to see a ramp up in activity in the next 12-24 months," Alastair Morrison, global head of Standard Chartered Private Equity (SCPE), tells AVCJ. "The attraction of the country means there is an awful lot of capital chasing deals. While we are there strategically for the long term, there are some short-term concerns about the number of people entering the market and the impact this has on pricing."

Access at any price?

Private equity deal flow, while following a general upward trajectory, has been patchy in recent years, a symptom of relatively few domestic GPs and a bias towards minority investments. The previous peak came in 2008, with $2.4 billion across 10 transactions, although two accounted for over half the spending. Last year, deal volume was twice the 2010 figure, but deal value came in at $868 million, down by nearly one third year-on-year.

Nevertheless, foreign direct investment reached a record $20 billion in 2011 and M&A transactions came in at $9 billion for the 12 months to January 31, so the momentum is there. As domestic private equity firms proliferate and interest grows from overseas players, the deal pipeline will no doubt expand.

Meanwhile, Indonesia's stock market has gained close to 200% since 2009 and private entrepreneurs are benchmarking against their publicly traded counterparts as well as past M&A transactions. According to David East, a transactions and restructuring partner with KPMG in Jakarta, there is already evidence of deals breaking down due to differences over price. He cites HSBC's purchase of a controlling stake in Bank Ekonomi Raharja for $607 million in 2008, which priced the lender at 4.1x book value.

"A lot of smaller banks with questionable loan books are still benchmarking their pricing off that deal," East says.

A similar pattern is visible in other sectors, ranging from consumer goods to natural resources. Local PE firms Saratoga Capital and Quvat Management saw massive returns on their 2005 investment in coal miner Adaro when the company completed a $1.3 billion IPO three years later. Now Adaro is trading at a price-to-earnings ratio of 15.7x, setting a high entry point for potential investors in the sector.

East expects valuations to remain high for at least 12 months before seeing some headwind in the run-up to the 2014 presidential election as foreign investors assess the likely impact of a change in leadership.

Others, however, argue that prices aren't necessarily too high at all, although deal size and sector are obvious influencing factors. George Raffini, managing partner at Headland Capital Partners, notes that rapid economic expansion and rising purchasing power have catapulted local companies' growth trajectories into new realms. "You can justify paying more because these businesses have scaled up, yet they still have a strong growth trajectory," he says. "There is so much more to go."

A knock-on effect of the buoyant stock market is that it gives entrepreneurs who control listed companies options beyond selling off equity. Hedge funds are scouring the country for opportunities to provide what are effectively bridge loans: The entrepreneur agrees to pay 17% interest on a lump sum for expansion capital and pledges shares as security, betting that the stock price will continue to rise, allowing them to sell down and pay off the loan.

"If a company is growing at 25% per year in revenue terms, why would the owners want to give up equity? They would rather pay through the nose to get a loan," says Tom Lembong, a partner at Quvat. "If these PE firms are willing to take minority stakes, that's fine, but they are up against competition from the hedge funds offering debt instead of equity deals and also the large family conglomerates. They do hedge fund style lending and angel investing with equity capital."

Part of a private equity firm's value proposition is precisely that it doesn't behave like a hedge fund, and there are companies open to the prospect of minority partners, whether it is through a $10 million equity check from local player Fairways Capital or $100 million from CVC. The differentiating factor is what kind of exposure the target company requires.

It is generally acknowledged that domestic PE firms have the edge in pure deal-sourcing but larger foreign players are able to support big-ticket deals and offer access to international markets and expertise. Ming Lu, KKR's regional leader for Southeast Asia, says his strategy is to seek minority stakes in companies that see the value in introducing global best practices as well as accepting expansion capital. Sources close to TPG add that the firm is comfortable with minority interests provided they also come with significant influence.

Negotiating obstacles

Even with a clear sense of value-add, identifying and executing transactions is not easy, due to practical and competitive obstacles. There is no company search function in Indonesia making profiling "best fit" potential targets time-consuming or problematic, and getting in front of the real owner or decision-maker is often dependent on intermediaries. Once negotiations are underway, these can become protracted not only on pricing but transaction structuring.

"Assets previously never for sale are now being offered as minority stakes, or carve-outs of selected group businesses resulting In more complex transactions further complicating due diligence and deal negotiations," says KPMG's East. "Know clearly what you are buying and not buying is fundamental."

People familiar with GarudaFood's negotiations over the Suntory joint venture recall the structure changing countless times; several times it was thought that talks had irretrievably broken down only for the parties to return to the table with fresh proposals.

In terms of competition, strategic investors are an ever-present threat on larger deals. Natural resources is traditionally the most popular sector - accounting for nearly half of spending by strategic investors since 2005 - but it is rare to compete directly with private equity in this space.

Elsewhere, Japanese corporations are a familiar presence at auctions of consumer and financial assets, often prevailing due to low borrowing costs, a strong yen and a long-term vision that means they are prepared to absorb economics beyond the threshold of most financial investors. They can also boast a unique familiarity with Indonesia, Japan having accounted for most of the country's inbound foreign direct investment in the 1970s and 1980s.

More recently, Mitsui Sumitomo Insurance paid $819 million for a 50% holding in Asuransi Jiwa Sinarmas, Indonesia's second-largest insurer, in what was by far the largest foreign investment in the industry.
Other major rivals include the giant Indonesian corporations - acting either as prospective buyers of assets or protecting their own interests.

Headland's Raffini recalls investments made at the right time in the right companies sometimes haven't performed as expected because of the commercial and informal networks of these large, family-owned conglomerates.

"The position of some larger domestic groups in certain industries and their ties with regulators can, at times, be considerable, giving them a competitive advantage over smaller businesses," he says. "The end-game could be to impair the growth of smaller rivals or, possibly, to acquire them. This is obviously a double-edged sword."

It is not unusual for Asian markets to be subject to considerable influence from powerful groups and individuals. For PE they can be either obstacles or potential investment partners, although some of Indonesia's families have yet to fully reconstruct reputations torn apart by debt defaults during the Asian financial crisis.

Recent tensions between the Bakrie family and UK-based financier Nathaniel Rothschild illustrate how easily complications can arise. Rothschild's Vallar cash shell bought a stake in Bakrie-controlled coal miner Bumi last year but when the new investor called for improvements in corporate governance -questioning certain loans made to related parties - his partners took action to remove him from the board.

Leveraging relationships

To a certain extent, global buyout firms may have little option but to deal with the family conglomerates because these groups control so many attractive assets. They just have to pick their investment partners carefully.

"It's still very much a relationship-driven market," says Sigit Prasetya, managing partner at CVC. "If you are not selling control but looking for a partner to grow the business and bring in capital and experience then relationships are very important, especially with the conglomerates."

CVC's two major deals in Indonesia have both come as a result of ties with the Riady family's Lippo Group. The private equity firm acquired a 72.6% stake in Matahari Department Store from Lippo's Matahari Putra Prima for $616 million in January 2010, and restructured it into a joint venture between the two companies. Then, in March of last year, CVC paid Lippo subsidiary First Media $275 million for a minority stake in LinkNet, the asset that is also said to have interested Carlyle.

Smaller transactions might be less likely to appear on the radar of Indonesia's family conglomerates, but the relationships that underpin the bulk of commercial activity in the country are still vital. To this end, foreign private equity firms are looking to create partnerships with local counterparts, either formally or on a deal-by-deal basis.

The most innovative approach was devised by Northstar and TPG. The US private equity firm was a prominent LP in Northstar's early funds, helping the Indonesian outfit get established, and the partnership was formalized last year through a share-swap agreement. Northstar now owns around 0.5% of TPG, which has a 10% interest in the Indonesian firm. TPG is likely to remain a frequent co-investor in Northstar's deals.

According to a source, had TPG gone it alone in Indonesia, it likely would have put no more than 4-5 people on the ground. The alliance with Northstar means the US firm has access to a team of 20 investment professionals with strong local networks.

It is difficult to see the model being replicated elsewhere. "Global firms in general will see significant benefits from having local partners but the balance of power has shifted considerably," says one local dealmaker.

Still, less formal partnerships - particularly co-investments on larger deals - might be the best way for foreign private equity firms to become more familiar with Indonesia. They may also present a platform for testing and ultimately recruiting local investment professionals in a market where PE talent is in short supply. Dipping a toe into the water from the comfort of Singapore or Hong Kong is unlikely to deliver much insight - or deal flow - into a country that is really still coming to terms with this latest wave of foreign investment.

With a nominal GDP of around $800 billion, a stock market capitalization of approximately $400 billion but just $5 billion in private equity assets under management, Indonesia clearly has the capacity to absorb more capital. Effective deployment hinges on mastering the local investment environment and navigating the upturns and downturns that will surely emerge as the economy develops.

"Indonesia is a bright spot at the moment but most of these markets have inherent cycles that will test fund managers and their LPs," says SCPE's Morrison. "It isn't going to be a straight line to heaven from here."

SIDEBAR: Fundraising - Success and failure

Until relatively recently, there was barely a handful of recognized private equity firms in Indonesia, led by Ancora Capital Management, Saratoga Capital, Quvat Management and Northstar Pacific Partners. Due in no small part to Northstar raising $820 million for its third fund last year - more than seven times the size of its previous vehicle - the landscape has changed considerably.

A flood of new GPs have entered the market, either focusing on Indonesia or placing the country at the heart of a wider regional strategy. Falcon House Partners, Capsquare Asia Partners, Creador, KV Asia, Forte Capital and Mahanusa are among those looking to raise anything from $200 million to $350 million. Meanwhile, Yawadwipa Companies, a merchant banking operation started by a former M&A banker in the region, has targeted $1 billion, predominantly from high net worth individuals.

For one would-be participant, the market is just too hot. "We were planning to launch last year but we haven't done so yet," says Wicahyo Ratomo, founding partner and managing director of Fairways Capital. "Potential investors want to see the full circle of investments that we make, so we are working on a deal-by-deal basis for the next 18 months."

Saratoga is expected to announce a final close for its third fund this month, hitting the hard cap of $550 million, while Ancora is also expected to win over investors. None of the first-time fund managers, however, has yet to reach a first close and industry participants doubt whether they will all manage it. In that event, taking the Fairways approach might prove to be a wise choice.

"If it's for real like China circa 2000 there will be plenty of opportunities for them to raise money in the next five years," says Doug Coulter, head of private equity for Asia Pacific at LGT Capital Partners. "It's a smart idea to invest independently and prove their thesis."

Investors are ultimately conflicted by hopes that Indonesia will follow in the footsteps of China and fears that it might turn out like India. Both markets attracted considerable interest from LPs but India has lagged in terms of performance as a result of poor liquidity, and appetite for the next vintage of funds is markedly weaker. China remains Asian private equity's golden child.

"There is definitely capital sitting out there and looking for Indonesia exposure," says Anand Prasanna, investment director at Squadron Capital. "Indonesia will have its own path but there is a danger the market might disappoint LPs." He adds that local players such as Northstar Pacific Partners and Saratoga Capital have done well in the past because they mostly did control transactions with reasonable sized companies, thus avoiding liquidity issues.

"It's really early days for Indonesia because before 2000 all the numbers are largely irrelevant," says George Raffini, managing partner at Headland Capital Partners. "Between 2000 and 2005 they pressed the reset button; 2005-2010 was a confidence-building period; and then in 2010 things really got started."

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• Topics
• Southeast Asia
• Investments
• Expansion
• Buyouts
• Fundraising
• Indonesia
• The Carlyle Group
• Growth capital
• Standard Chartered Private Equity
• CVC Capital Partners
• Northstar Group
• TPG Capital
• KPMG
• Headland Capital Partners