Unleashing Malaysia

When Creador launched its second fund in May of last year with a target of $250 million, the Southeast Asia and India-focused GP was realistic in its expectations of Malaysia. Indonesia would get the lion's share of the corpus - 60% - with the rest divided between India and Malaysia. One year on and Brahmal Vasudevan, Creador's CEO and founder, now expects the country to surpass previous expectations.

"When we first started, our expectation was that we would deploy about 20% of the fund in Malaysia," explains Vasudevan. "But it has actually surprised us and in our current fund we are now expecting as much of third to be invested in Malaysia."

Creador has already completed three investments in the country from its first two funds - with another deal yet to be announced - and there is more in the pipeline. Vasudevan cites the performance these investments as part of the reason for his optimism.

Old Town White Coffee, the PE firm's first partial exit, is chief among these. The GP took a 10% stake in coffee house and restaurant chain for MYR45.7 million ($15 million) in April 2012 and sold just under half its position in May last year for $15 million, generating a quick-fire 2x money multiple and IRR of 101%. Similar returns are expected from fashion brand Bonia and payment solutions provider GHL.

At least from Vasudevan's point of view, Malaysia - where PE deal flow has historically been muted - is starting to show promise. The question is whether broader investment community is likely to benefit and, if so, where deals can be found.

Unrealized potential

Given the size of Malaysia's economy compared to its neighbors, its proximity to one of Asia's preeminent commercial hubs - Singapore - and the broader regional growth story, one would be forgiven for expecting the country to be flush with PE opportunities. However, the reality is quite different.

According to AVCJ Research, just $44 million has been invested across two deals so far in 2014. This follows two consecutive years in which transaction volume was on the rise, with 20 and 26 deals in 2012 and 2013, respectively. But the sums deployed have slipped from the decidedly heady - nearly $6 billion in 2011 - to the disappointing. Nearly $2 billion was invested in 2012 and $758 million in 2013.

Needless to say, deal flow is lumpy. The 2011 peak can be traced back to a couple of large buyouts: a CVC Capital Partners-led consortium's $1.6 billion acquisition of QSR Brands and KFC Holdings, and Aabar Investments' $1.9 billion purchase of a 24.9% stake in financial services player RHB Capital.

These transactions are not characteristic of a market that is largely dominated by growth capital investments in small and medium-sized enterprises (SMEs). In fact, last year buyouts accounted for less than a quarter of deals; early-stage investments, PIPE deals and growth transactions commanded a handsome majority.

"The large control investment universe is smaller compared to that of expansion capital," says Lew Oon Yew, managing partner with mid-market GP Proventeus Capital. "The whole Malaysian economy - around 80% of the GDP - is driven by SMEs. There is a lot of opportunity for consolidation and companies to grow market share, while family owners are a significant source of deal-flow."

Malaysia has demonstrated strong growth over the past decade. The Asian Development Bank put the country's economic expansion at 4.7% last year, the fourth-highest of the Association of Southeast Asian Nation (ASEAN) members, after the Philippines, Indonesia and Vietnam. GDP growth is expected to come in at 5.1% this year and 5% in 2015.

On the other hand, some of economic factors work against Malaysian private equity. Firstly, the low interest rate environment means borrowing costs are low, making private equity less attractive compared to other source of capital, notably bank loans. According to the Central Bank of Malaysia, interest rates averaged 2.93% between 2004 until 2014, reaching an all-time high of 3.5% in 2006 and a record low of 2% in 2009. Indonesia's interest rate is currently about 7.5%, with Vietnam and the Philippines on 6.5% and 3.5%, respectively.

"Malaysia is market that has been flush with liquidity, it has never been capital starved," explains Vasudevan. "Then you have large government funds and a number conglomerates with plenty of cash. They are active investors in companies, in terms of minority stakes and control transactions."

Double-edged sword

Government involvement in particular has been something of a double-edged sword for Malaysian private equity. The two biggest state-linked players are strategic investment fund Khazanah Nasional - which was established in 1993 and has around $41.1 billion in asset under management - and private equity fund Ekuinas, established in 2009 with the remit of supporting Bumiputera companies (firms run by ethnic Malays).

Both engage in direct investment, but in 2011 Ekuinas took on a developmental role by establishing an outsourced program. So far it has backed seven GPs, committing MYR640 million across two tranches. A third tranche will be allocated in 2015-2016, taking the total investment to MYR925 million. While Khazanah and Ekuinas have made a significant contribution to the industry as dealmakers and capital providers - in a co-investment and outsource capacity - some say this level of government involvement is counterproductive.

"Part of the reason the markets is small is because a lot of the activity is internal and the vast majority of local funds raised are actually government-linked entities so they have the lion's share of the investment and not all of them are made public," says Nicholas Ashby, founder and CEO of Celadon Capital. "So most non-government linked funds are doing the big buyout deals or looking at very early stage."

He adds that cheap borrowing and domestic competition are not only the issues facing private equity investors looking for mid-market opportunities. The capital markets also serve as attractive alternative for entrepreneurs. The Securities Commission of Malaysia recently reported that the capital markets swelled by 10.5% to MYR2.7 trillion in 2013 - with equities market capitalization reaching MYR1.7 trillion, making it one of the top performers in Asia.

"It is relatively easy to list companies on the Malaysian stock exchange because the threshold is quite low," Ashby says. "The IPO route is also more attractive, particularly because valuations are higher."

Therefore, successful deal-sourcing in Malaysia largely depends on GPs being able to build relationships with founders and educating the market on the benefit s of partnering with private equity firms. In that respect - with some notable exceptions - the most successful investors are those with an on-ground-presence.

"The market is relatively closed in a sense that you need to have a very deep relationship base, because people take time to open up," says Vasudevan. "They want to deal with known entities and known individuals. It is a difficult market to penetrate with fly-in, fly-out approach."

He recalls a recent deal where he got a call from a founder on a Thursday, met him at home the following Saturday evening and had a term sheet drawn up for Monday. This speed of action would not have been possible without an understanding of the market and with an investment committee in New York that must sign off on investments.

Proventeus' Yew cites the family-owned enterprises as a significant source of deal-flow. In particular, he sees succession planning opportunities as an area in which a private equity firm can seize the initiative over other potential investors. As is also increasingly the case in other markets in Asia, company founders find that members of the second generation in their families either have no interest in assuming leadership or lack the capabilities to take the business to the next level.

"In that case you need an institutional investor like a private equity firm, who can come and bring new resources and new talent to widen your network," says Yew.

Creador portfolio company GHL is identified as another example in which only a private equity investor would fit. The PE firm took a 20% stake in the payment services provider last October through a private placement of new shares. GHL required financing to support its acquisition of Australian Securities Exchange-listed e-pay Asia, and in addition Creador will help devise future expansion plans.

"One of the reasons they chose us was because they not only needed capital but also we were able to use our operational experience to help them grow the business, reduce costs and expand into neighboring markets," says Vasudevan. "That is why they came to us instead of going to someone else, like a conglomerate."

Regional play

This deal illustrates that while a local presence might be desirable, a regional strategy could be essential. The future of Malaysia as an attractive PE destination could pivot on the potential for greater regional integration. ASEAN's economic community blueprint, which is expected to substantially reduce barriers to trade and facilitate the movement of people and capital, should in theory make it easier for private equity firms to take companies into new markets.

Vasudevan sees Malaysia is ideal place as a platform for regional expansion. "When you look at Singapore compared to Malaysia, they share a very similar culture," he says. "Indonesia is also a natural path for Malaysia, as it one of the only countries with which Indonesia shares a similar language."

This is the kind of cross-fertilization that Headland Capital Partners was looking to exploit when it took a significant minority stake in Malaysian snack and beverage firm Mamee Double Decker - makers of Mamee Monster brand of ramen noodle snacks - in February last year. In addition to product extensions and improving distribution, the plan was to maximize the company's value by trying to replicate its domestic success overseas. Manufacturing was set to be moved to Indonesia, there were discussions of seeking marketing synergies with other neighboring countries, and the company was said to be looking at regional expansion through M&A.

Proventeus' Lew already claims to be experiencing the positive effects of greater integration. "We have not seen a lot of cross-border labor movement as that is still restricted," says Proventeus' Yew. "But our businesses have already benefited from increased exports within the region." Five years ago, one of the firm's portfolio companies, medical equipment manufacturer Hospitech, used to ship 80% of its goods to the Middle East; now Southeast Asia accounts for 70% of business.

It will take years before the full impact of ASEAN integration on Malaysian private equity becomes apparent. But irrespective of what the future holds, Yew adds that the country still has much to recommend itself based on existing advantages.

"While it has never been a market to deliver a 10-20x return, it has always been a lot more stable than others in the region," he says. "So on average we see 2-3x from Malaysia and that balance will not move very much. The market has matured and the overall macro environment is strong."

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• Topics
• Southeast Asia
• Buyouts
• Expansion
• buyout
• Growth capital
• Creador
• Malaysia
• Southeast Asia
• Ekuinas
• Khazanah Nasional