State of the Union(s)

The Korean Peninsula and the Japanese Islands are neighboring countries whose cultures have been influenced by the other for thousands of years. The corporate culture has been similarly formed, with strict policies and hierarchies still the favored methodology. Because of the geography, each has less opportunity to make contact with other countries to seek out business growth; but as a result of their developed economies and standards in the technology industry, each also has potential to grow. Spurred on by shrinking populations - ageing people and low birth rates - Japan and South Korea present opportunities for foreign companies and private equity firms, as well as opportunities to spearhead cross-border transactions that would aid in corporate growth.

With investors focusing a heavily weighted percentage of their Asian dollars on China, they are largely putting South Korea and Japan on the back burner. However, there is limited amount of capital that global limited partners can pour into China because the current market cap for the private equity industry in the PRC is $49.88 billion. This number is still dwarfed by South Korea and Japan, which saw a market cap of $22 billion and $41 billion respectively for the first half of 2010.

Private equity numbers aside, China is still the driving force behind the global economic recovery, which has led to a sharp increase in activity post-GFC.

Derek Sulger, a Founding Partner of Lunar Capital Management told AVCJ, "We believe that 2002 through 2011 represents the first generation of private equity in China, or ‘PE 1.0'. PE 1.0 has been characterized by a passive, generalist approach to pre-IPO investments, primarily driven by multiple arbitrage. We believe that the next few years will see the end of this era, and the next generation of private equity investing will evolve in China. PE 2.0 will be characterized by more focused specialization and differentiated approaches to creating value."

The popularity of Chinese funds is shifting the dynamics of fundraising. Some GPs have noted that Chinese private equity funds have become more selective as regards the LPs they want to work with, rather than LPs choosing the GPs they wish to allocate to. One moan from an Asian fund-of-funds explains the current trend in fundraising in China: "Experienced China GPs only want one big chunk of capital from LPs and not small amounts... We were even advised by a fund to increase our fund size."

On the other side of the equation, non-Chinese private equity funds in South Korea and Japan are struggling to receive a small portion of capital from global LPs. Regulators have attempted to step in to make their respective geographies more compelling. The Industry Structure Vision documents released by Ministry of Economy, Trade and Industry in Japan sited a comparison of commercial industries in Japan and Korea, illustrating how the Japanese government has acted strongly to centralize industry to prevent excessive diversification of conglomerates since the 1997 currency crisis. The Japanese government has pushed for the expansion of domestic demand primarily through investment in the public sector, creating a structure of excessive supply since the strong yen crisis of 1985.

The case for South Korean PE

With South Korean conglomerates' penchant for non-core businesses, recently this has made them big sellers into the M&A market, with local private equity firms and some foreign players involved in these spinouts. It is notable that National Pension Service, South Korea's largest investor and the fourth largest sovereign wealth fund in the world with more than KW 300 trillion ($267 billion) in assets, plans to form a private equity fund with local conglomerates, including SK Group, GS Group, and KT Corporation, to seek returns from private investments in global markets.

The new fund will target overseas investments, but is also aimed at building a more positive international impression about South Korea's private equity industry. The government reportedly sent a team in the alternatives space to Qatar to meet investors in the Emirates last year.

NPS will be allowed to partner with local lenders to take a minimum of a 10% stake. However, NPS denied the report to AVCJ. Although, Spokesman of NPS said, "We will keep looking at investment in local alternative investment particularly restructuring , venture spaces, pipe investments and real estate, but our primary target is interest rates."

The South Korean government has been aggressively courting private equity dollars at home, and has organized events to promote local GPs to foreign LPs. The economy for 2010 is estimated at 1,140 trillion won, which roughly exceeds $1.1 trillion dollars, according to the Ministry of Strategy and Finance in South Korea.

Said one industry on-looker, "As the nation is growing from an economic perspective, I think more deals will start to happen. It is notable that government funds are becoming very active in private equity investments. Local media are no longer reporting buyouts in a negative light, 2004 -2005." All of this bodes well for the industry. Still deals come at a more cyclical pace than the open plains of opportunity perceived in places like China.

Charles Huh, a Director with Standard Chartered Private Equity, said, "There are definitely spaces where private equity investors are spending a lot of their time. We expect to see more private equity investment opportunities here because of the country's stable growth, transparent financial systems, as well as more common acceptance of Western shareholders [and shareholding structures]."

He also noted that middle market and expansion deals are happening more often. "The market needs the capital to globalize domestic companies and to assist with industry consolidation."

At the moment, "the financial segment that is going through the consolidation phase, [as are] export driven business related to the automobile and information technology segments, such as mobile and renewable energy."

Fundraising hurdles in Japan

Japan and South Korea's similar corporate culture does not make up for the fact that Japanese business owners are less open to adopting ideas from overseas markets. However, the country has been trying to attract foreign LPs to the local PE and VC markets. Due to the tightening of allocations by local LPs, Japan's PE players are increasingly looking overseas. One local LP explained that many funds in Japan could not raise more than JPY10 billion ($120 million) from domestic investors - a far cry from the boom years of 2006-2007.

While LPs that formerly invested their assets in the PE industry are decreasing their exposure, several trust banks and traditional asset managers have began considering investing into the PE space. That may be a good sign for local PE players looking to raise money.

Although it is too early to say for sure, there are signs that local PE groups may receive public funding. The Government Investment Pension Investment Fund (GPIF), Japan's sovereign wealth fund which manages JPY1.2 trillion ($14.4 billion) was said to be considering its capital allocation to PE funds in Japan. AVCJ was told that GPIF has already chosen several local fund managers to receive capital, but that a number of Japanese PE players have not seen the government fund activities in PE as positive. So far, no public information on this rumored plan has been released because the government is still debating the issues.

One LP source said that some of groups that have supposedly closed their funds are still in the market, struggling to meet their target. With a number of PE funds in the middle of fundraising cycles, the environment has become even tougher than.

At the time of publication, about 20 Japanese PE and VC groups were in Hong Kong to meet foreign LPs alongside event organizer, the Ministry of Economy, Trade and Industry (METI), with government support from the Japanese council in Hong Kong. While new inflows of capital are certainly important, having a smooth cycle of investments, exits and returns is the prevailing issue.

Risks and rewards

"Starting in the second half of last year, deal flow [in Japan] seems to have picked up, a trend that will likely continue through the first half of 2011. But, I think that there are a number of risk factors we have to [take into account] for the second half of the year, such as changes in foreign exchange rates, as well as the unstable local political situation," Masao Nakagawa, Senior Director of Nippon Mirai Capital, told AVCJ.

He noted that the participation of foreign groups is increasing the ticket price for transactions. "The price for attractive deals is becoming higher, partly because cash-rich companies are participating in the bids."

One local LP explained, "The EBITDA level was 2x or 3x in 2009, now it has become 4x or 5x; deal prices are higher than 2009. Banks that supported large-sized enterprises during the financial crisis will look for alternative ways to make returns because most of the large companies are no longer begging for loans, but able to issue corporate bonds now."

"We predict more exits made by funds that were formed before the Lehman collapse," said an anonymous GP source said to AVCJ. "While the Japanese economy has stabilized moderately, local corporates are tending to become involved in M&A transactions. It is important for the industry to see how portfolio companies will show returns for PE players."

This year, many active in the industry have said that SME deals are becoming more affordable and less risky. As a result, even billion-dollar fund operators are looking at SMEs.

In both South Korea and Japan, fundraising remains difficult, but hidden gems in the local commercial industries are showing glimmers of home. For the non-China dollar, the industry may think about moving early into these markets.

 

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• Topics
• North Asia
• Greater China
• Fundraising
• GPs
• LPs
• Lunar Capital Management
• Derek Sulger
• Standard Chartered Private Equity
• Nippon Mirai Capital Co.