Indonesia: Out of the shadows as a private equity investment goal?
Common impressions of Indonesia are frequently a mixture of clichés drawn from The Year of Living Dangerously, memories of the 1998 riots, and the Bali bombing.
Yet the country’s standout experience among ASEAN economies post-GFC, along with a visibly free and fair presidential and legislative general election, helped convince many that Southeast Asia’s sleeping giant was finally stirring after a decade in hibernation. And to cap it all came CVC Capital Partners’ $800 million investment at the start of 2010 in consumer play Matahari – which, market players agree, however it works out for CVC, was a great deal for Indonesia, putting the country on the map again. Does it belong there now as a permanent feature, though?
A base of growth
Indonesia certainly has the scale and the growth that many Western allocators to Asia are now looking for. By World Bank estimates, the population is already 227 million, with over 27% of the population under the age of 14, promising further demographic dividends. The Indonesian economy is already estimated at some $962 billion GDP in 2009 by purchasing power parity, the world’s 16th largest, and at almost $540 billion for the same year by official exchange rate. “It will be $1 trillion within three years. So it’s going to be top 15 by GDP,” affirms Nick Cashmore, Country Head for Indonesia with CLSA.
Indonesia grew at some 6% over 2009, according to the Central Bureau of Statistics and other consensus estimates. The country’s performance attracted even more interest when the absence of overt government stimulus brought home to outsiders the robustness of the domestic growth. “After the 2008 financial crisis, the economy continued to perform, despite the fact that the government stimulus was fairly little,” notes Hanjaya Limanto, Managing Partner at Aureos Partners in Southeast Asia. “Consumption is 60% of GDP in this country; it is huge. That is one reason why the economy has been so robust,” as Kay Mock, founding partner at Saratoga Capital, asserts.
Politically, too, Indonesia’s level of risk has been gradually diminishing, to the point where Patrick Alexander, veteran Indonesia investor and owner of Batavia Investment Management, describes outside perceptions of security risk as “out of touch.” The re-election of President Susilo Bambang Yudhoyono and the concurrent legislative elections in 2009 confirmed the country’s newfound political maturity and stability. And his administration also brought in policies that “were a big help in preventing Indonesia from collapsing under the weight of the GFC,” according to Jacob Ramsay, Senior Analyst for Southeast Asia and Indonesia at Control Risks.
One of the market peculiarities of Indonesia also makes the market even more potentially attractive for private equity. “There is a scarcity of capital within the country, and that has been the case for a long period of time. It’s more acute now because you see private investment accelerating,” confirms Cashmore. “The underlying fundamental reason for this scarcity is that Indonesia’s financial wealth is stored in Singapore. That’s because the Indonesian HNW individuals have known for a very long time that the country has high inflation and the rupiah is not a store of value.” Furthermore, some of the ethnic Chinese money from Indonesia left the country in 1998 and has remained offshore ever since – though it could return to its point of origin later. Meanwhile, though, the cost of capital, and returns to capital providers, remain high.
In other times, this might have made Singapore an interesting destination for investors seeking better-protected exposure to the Indonesian growth story, just as Hong Kong used to be for China. The relationship between PT Astra and Jardine Cycle & Carriage is one example of how Indonesia can deliver value to a Singapore entity. However, as with China, most investors now seem to have concluded that it is better to go direct.
Indonesian PE then and now
And investors have indeed been coming to the market. “In the last 12 months we have had a deluge of cold calls from investors all over the world wanting to know more about Indonesia,” notes Mock. Other private equity firms and advisors report similar experiences. “There are a lot of visits from LPs from the US,” confirms
Limanto. “Everybody is here. They want to see and to meet.”
External causes are not hard to find. Mock feels the LPs are rolling in, “because China and India have too much competition and the market is overvalued, and because they are looking for growth.” Yet other placement agents and intermediaries assert that LP interest is at least developed enough to trigger a search for specific Indonesian product, with definite allocations in mind.
Existing Indonesian portfolio investments are also currently looking good by regional benchmarks. “In ASEAN right now, our Indonesian portfolio is performing better,” says Limanto. Partly, he feels, this is because “entry valuation was a lot lower compared to other countries,” as well as the resources committed to support portfolio companies and the stronger underlying growth. Exit options are the usual range, but IPOs in particular also stand to benefit from the broader economic buoyancy. “The stock market has been one of the top performers in the world, the best-performing market for two years,” Alexander observes.
To some extent, Indonesia has been there before. As the AVCJ Research figures show, private equity capital under management has still not recovered to even half the levels it reached prior to the Asian financial crisis, even if actual recent deal sizes are far larger. And the number of new funds raised for the market bears no comparison at all to the many vehicles launched to capture the buzz of Asia’s then hottest market just prior to the regionwide crash. Now, the visiting LPs, placement agents, and others, find only the same local Big Four private equity firms – Ancora Capital Management, Northstar Pacific Capital, Quvat Management, and Saratoga Capital.
“There are only four, as far as I know,” asserts Veronica Lukito, co-founder and CEO of Ancora. And unlike the mushrooming of new funds in China, only one or two other seasoned local investors at most seem to be moving to form new funds to take advantage of this sudden surge in interest.
Pan-regional funds have been scouting the market just as LPs have, and some, such as Affinity Equity Partners, have established country offices, while others, like TPG Capital and Northstar, participate through affiliations. But these, and regional players like Aureos, remain few. “The foreign funds have generally been absent for about 12 years,” notes Alexander.
Also, even domestic funds do not tend to look domestically for their capital. Not one of the local Big Four funds has any money from Indonesian pension funds, believes Mock. Partly, local LPs are new to the asset class, but also, since most pools of capital in the country are affiliated to one or other of the major business groups, the GPs may even shun this money to preserve their autonomy. “The debate is, if we take Indonesian money, whether it’s going to compromise our abilities to invest,” observes Patrick Walujo, Goldman Sachs alum and co-founding MD at Northstar.
And the industry as a whole remains small, compared both to the broader economy and to its size in other Asian markets. “If you look at the industry in Vietnam, before the bubble burst, it still has a long way to go,” concedes Walujo. “We are smaller than Vietnam or Malaysia.” Set the $939 million invested in Indonesia in 2010 alongside the $500 billion economy, and it becomes obvious that private equity in the country remains woefully underpenetrated, even by the unambitious norms of most Asian country markets.
If the private equity industry needs a new impetus to propel it to at least some level commensurate with its host economy, then perhaps the new surge of interest will provide it – if the new capital available unlocks deals. “Maybe more money will be the catalyst,” speculates Mock. “Will more money coming to this market help to stimulate it?”
The consumer is king
Indonesia’s consumer sector, as already observed, is the chief engine of domestic growth, and the main sector of opportunity for private equity. Most of the local firms are seeking to tap it, and the performance they can achieve from it can rival that seen in China and India.
“We have the largest convenience store chain, and it’s growing at about 40-50% per year,” notes Walujo. “We are most interested in the mass market, and the lower class of the population. That’s basically the scale of the country.” Limanto sees sound business reasons for preferring the lower end of the consumer proposition. “There is more opportunity in mass market than the high end. Also, demand is a lot more robust.”
And though Indonesia’s consumer sector may be vibrant and many-faceted, it is also fairly competitive, which allows another point of entry for private equity. “There are a number of Indonesian family companies that are finding their competitive environment much more challenging. And I think a number of these look at foreign interests to bring in capital and management expertise,” confirms Cashmore.
Limanto also sees the chance for PE firms to inject better management or skills to help investees differentiate themselves through execution. “Because the environment is difficult is Indonesia, because of infrastructure or regulation, the company with a better management team can distance itself from the competition.”
However, the competition is not just going to be among the target companies. “The consumer part is actually going to be incredibly crowded. Everybody’s already trying to move in there,” notes Russell Cranwell, MD for Investment Banking at CLSA Indonesia. Even with the modest numbers of PE investors in Indonesia, and the huge volume of opportunities, some are going to have to look for new angles on the theme.
One of these is the opportunity to move into higher-value services for Indonesia’s burgeoning middle class. “I actually like education and healthcare,” agrees Dennis Wuisan, Partner at Kendall Court. However, he adds, “The problem with investing in healthcare and education is scale. It’s startups.”
A strategic player already moving on this space, where an ambitious and appropriately skilled PE firm could seek a partnership, is James Riady, deputy chairman of the Lippo Group. “That new building across the road, the Lippo Cancer Centre: that’s a James Riady project,” Cranwell says, looking out from the window of his practice in central Jakarta towards a new helipad-topped skyscraper, as he cites Riady’s name.
The Lippo Group head is already familiar as the ultimate broker behind the Matahari deal. His Lippo Karawaci division already operates housing businesses and 25 malls across Indonesia, but also four hospitals. The development of more hospitals, including specialized facilities, is part of a multi-pronged bid to tap into growing middle-class demand for everything from healthcare to education. Riady is one of the few Indonesian businessmen “thinking in a more creative, strategic way” to provide the middle class with services that the government does not, from housing estates linked to first-class private schools to hotels, according to Cranwell. “I would try to partner with James in these areas. Because there’s no hotel play in this country.”
Other sectors of interest
Beyond the consumer proposition, though, other investment prospects also allow GPs to tap into the Indonesian economy’s unique advantages. One, given the country’s abundant physical riches and developed mining industries, is resources and commodities. Walujo and Lukito both give resources as their other key sector of focus besides the consumer economy.
However, for many GPs, especially pan-regional ones, this sector may be less easy to capitalize on. Part of the reason, as Mock remarks, is that, “it’s difficult to find attractive transactions in those sectors unless you’re going to bear pretty severe risk.” But according to Alexander, the problem may be more a question of skills. “Most PE managers have not done much in resources, because they don’t understand it … with the exception of the hedge funds, the PE funds have been very slow to get into commodities. They kind of missed the commodities boom.”
Compared to the consumption side of the economy, manufacturing may be a neglected but very interesting opportunity, according to Cashmore. “Manufacturing is going to be a big growth driver in Indonesia over the next ten years. Our share of the workforce that’s engaged in manufacturing today is one of the lowest in Southeast Asia. But that’s going to change as our costs are now quite competitive.” As labor costs rise in China, and even in near neighbors like Vietnam, Indonesia’s cost-competitiveness in mass manufacturing will draw more and more business, Cashmore believes. “Low-wage manufacturing generally is the area that Indonesia’s competitive on. An average minimum wage in West Java is $100 a month.”
Infrastructure is also one of the most obvious opportunities for investors, as anyone travelling on the capital’s congested highways can tell. But so far at least, the specialist infrastructure funds have tended to stay away from Indonesia, while the private equity generalists have been slow to support it. “We do stay away from direct infrastructure, mainly because the payback is very long, and there are still certain reforms that need to take place,” remarks Lukito.
Limits to the opportunity
Even with the size of the underlying economy, and the chances for private equity to play a greater part in it, the question remains whether Indonesia can deliver anything like the deal flow to justify the new level of investor interest in the market. Here, prospects look far less compelling than the macro numbers.
The pan-regional players and larger funds in particular may be disappointed. Mock notes that, “all of them are very keen and eager to enter this market,” but adds that, “it is going to be difficult for them to find transactions of size.” And Lukito confirms that, “Indonesia does have some mega-deals going on, but there’s only a handful.”
With most of the activity and the potential deals in the mid-market sweet spot that Alexander identifies in the $5-100 million range, then, pan-regional players may simply elect not to allocate to the country at all. “You spend so much time on China and India, the two big growth markets, and then all of a sudden you start hearing about Indonesia, and your resources are finite,” observes Cranwell. “How do you allocate between them?”
Common characteristics in Indonesian business may also keep many of the better companies frustratingly out of reach. As Cashmore remarks, “a lot of the very good businesses run their balance sheets very conservatively still. A lot of these guys are funding everything themselves, and they’re not aggressive. They’re not taking strategic opportunities in M&A.” Furthermore, Indonesia is palpably no longer a distressed economy, and post-GFC distress specialists are finding deals increasingly scarce.
As a result, in this turn of the cycle at least, international GPs and LPs alike may be ready to visit Indonesia, perhaps invest opportunistically, but not to seriously commit to the market until the underlying private equity environment has grown and matured at least a little more. “The longterm attractiveness looks interesting, but the near term opportunities just aren’t at hand,” Cashmore feels. This may reward early market entrants, but those will need to be patient, and not driven by disproportionate returns requirements.
Indonesia may not live up to global institutional investors’ hopes for outsize returns, then. But then, what Asian economy has? The prospects for the development of the local private equity environment, at least, look bright.
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