Financial investors in financial services

The first standout exits from Asian investments came after some pioneering GPs brought distressed banks and other financial institutions that they had taken on after the Asian financial crisis to market, yielding successes such as Ripplewood Holdings and JC Flowers’ 2004 listing of Shinsei Bank, David Rubenstein’s proverbial “most profitable private equity deal of all time”. The recent exit by TPG Capital from Shenzhen Development Bank, and the Carlyle Group’s notional gain of some $4.7 billion in the listing of China Pacific Life Insurance in Hong Kong last December have reinforced the gains realizable on some Asian financial services deals. But with regulatory developments worldwide in the sector advancing fast, it is worth considering whether such assets – and such returns – are still on the cards for private equity.

Private equity’s role

Financial services have dominated recent Asia Pacific private equity investment, at least by dollar value. And statistics suggest that the sector’s prominence has survived through the financial crisis. This was the single biggest investment sector in both 2008 and 2009, according to AVCJ Research figures, at 20.2% of all investments and $11.4 billion in 2008, and 27.1% or almost $14.8 billion in 2009.

“The fundamental thesis is pretty much in tact,” remarks Sunil Kaul, Senior Director and head of the financial institutions group at the Carlyle Group, as well as former Citibank Japan President. Observing that the macro trends driving greater financial services uptake across the region remain strong, he adds, “It’s an effective way for us to participate in the growth of the economy as a whole.”

However, industry-watchers should bear in mind a few provisos around those figures. For one thing, financial services investment figures over the past couple of years have been inflated by the huge pre-IPO PIPE commitments made into the Big Four PRC banks, typified by Hopu Investment Management and Temasek Holdings’ almost $4.6 billion May 2009 investment into China Construction Bank – for a stake of just 4%. Such deals not only distort the data, they also can give a false impression of the practical and operational difference that private equity makes to Asian financial services groups.

This is not to say that private equity is insignificant. Looking back on 2009’s financial services M&A environment, “the largest deal was the acquisition of the stake from TPG by Ping An in SDB,” observes Matthew Phillips, Transactions Partner and Head of Financial Services M&A for Asia Pacific with PricewaterhouseCoopers. However, its contribution has been notably patchy across the region, as well as volatile.

As AVCJ sources point out, Shinsei Bank, well-regarded even a couple of years ago, is now struggling after a failed merger with private equity investee peer Aozora Bank, and seen as anything but the poster child for Asia Pacific financial services private equity it once was. “You have to look at it from both the absolute financial returns side as well as the talent and operating infrastructure left in place once the private equity firm has left the scene,” notes David Hui, Head of Asia Pacific and MD for Financial Services at J. Robert Scott.

Also, the importance of financial services deals to private equity in Asia can obscure the fact that private equity just has not been very important to financial services as a whole in the region – so far. “Up until now, there have been relatively few private equity transactions across the region in financial services,” Phillips affirms.

Deals: where are they coming from?

With many of the marquee financial services successes of the last ten years left over from the Asian financial crisis, market players may well ask whether such opportunities will come again. Certainly, the post-2008 environment is markedly different to the post-1997 situation, and ostensibly less target-rich.

“There are some big themes – like leasing, securities and asset management in Greater China, and non-core businesses being sold by the Japanese main banking and securities groups,” observes Mark Chiba, Group Chairman & Partner at The Longreach Group. “But issues like true balance sheet quality and earnings power in the post-2008 environment are paramount.”

Also, some of the biggest investment stories in the sector right now concern private equity only in the broadest sense. The substantial pre-IPO commitments from Asia and MENA sovereign wealth funds in the Hong Kong tranche of the Agricultural Bank of China listing, including China Investment Corp (CIC), Singapore’s Temasek Holdings (cited as committing up to $300 million), and the Kuwait Investment Authority ($800 million), may account for up to 40% of the $13 billion that the bank seeks to raise in the HKSAR. However, they do not fall within the classical definition of private equity.

Furthermore, Asia’s financial health post the GFC has relatively reduced deal supply. “The vast majority of the recent trades have been in the US and Europe given the level of financial distress in those markets,” notes Christopher Laskowski, MD and COO for Global Banking Asia Pacific and Head of the Financial Entrepreneurs Group Asia Pacific at Credit Suisse. “Asia has been relatively healthy and has witnessed less transactions.”

That said, on the exit side especially, the new environment looks rather more attractive, with many global strategics reassessing their Asian growth plans, and a new class of “super-regional players” emerging to boost activity. Phillips defines these as “Asian institutions who are basically looking to build out their franchises in a number of territories, taking advantage of the opportunities created by the crisis.”

By the same token, relatively few players in the region, whether local or multinational, are looking to divest assets this year. This does create an exit window for private equity. Phillips highlights “a significant increase in the imbalance between demand and supply for deals, which is likely to have a significant impact on pricing in the coming year, with buyers outnumbering sellers more than two to one.”

The difficulties emerging around some financial services exits, notably Lone Star’s efforts to sell its stake in Korea Exchange Bank, do not necessarily reflect overall market trends. “These are truly one-off deals,” says Daniel Kim, Corporate Partner and Vice Chair of the Korea practice at Paul Hastings. “It’s by no means an easy time to be doing a deal of this magnitude, despite the fact that Korea seems to be doing very well.” And Chiba believes “we will see private equity-held financial services assets in markets like Taiwan and Japan move to strategic buyers within a reasonable time-frame.”

Value-add? Prove it.

One school of thought holds that private equity firms are actually able to contribute little value – at least in the banking turnaround situations they have often been associated with in the region to date. Private equity groups, its proponents say, are often derived from the same banking and financial backgrounds as the targets, and so can seldom bring added expertise to the investees.

Many industry practitioners dispute this, though. “Private equity players have been able to bring in the right management, focus on the right risk management and delivery systems, and bring in the capital,” says Kaul. And raw numbers as well as independent opinion tend to confirm that private equity firms’ “track record in turning round financial institutions in the region actually stands up pretty well,” in Phillips’ words. “By and large, the institutions that have investments from private equity have actually demonstrated the value that can be brought by the private equity players in bringing in top-quality management and turning them around.”

Private equity may also help build new platforms or extend existing ones, especially in non-bank financial services. Roderick Haire, MD for Financial Services at J. Robert Scott sees private equity supporting the Asian buildout of niche insurance plays, such as reinsurance. “They have been actually adding value in those specialty lines of the insurance world.”

But the bar for genuine private equity contribution to a bank’s business remains high. “A GP must bring real sector expertise that can support astute deal structuring and risk/return judgment, and drive real strategic, operational and management improvement of the business,” confirms Chiba. And he dismisses the characterization of banks at least as simple proxies for an overall macro growth story. “They are in fact well-established but highly-leveraged franchises that can yield great shareholder returns – if their business is done right.”

In the case of Primus and Nan Shan in Taiwan, Haire observes, “they will be buying that with the management team in place. Nan Shan’s got a strong management team.” Chiba affirms that, for new investments, “getting the right operational grip with an excellent management team is probably the core issue, assuming a fair entry valuation.”

Plain capital supply is also not to be sniffed at. “When a financial services firm gets into distress, it gets into trouble with both its regulators and customer base,” observes Laskowski, pointing to the resultant shrinkage of both permitted business and deposits. “The ability of private equity to fill a capital shortfall greatly increases the survival rate for such institutions.”

One market where private equity could significantly contribute to the entire sector, some believe, is China. Dr. Fred Hu, former Head of China Investment Banking at Goldman Sachs, sees great potential for the industry “to help revamp and rationalize China’s lopsided financial system. China may already boast many of the world’s biggest banks and insurers in terms of financial capitalization and market cap,” he notes, but it has inadequate channels for raising financing through equity and bond markets. Private equity could help reduce the preponderance of bank lending in China’s financial system, and deliver financing that actually supports and rewards enterprises.

However, even the smaller provincial and city banks in China now appear to be more discriminating and less in need of purely financial assistance. “Banks say, ‘we don’t need the capital,’” says Ivy Ng, also MD for Financial Services at J. Robert Scott. But, “if you can bring in a strategic partner… a bank with international standing, or [a firm that] can bring in international standards,” that is different.

Regulation: friend or foe?

Private equity’s success in past financial services deals has in fact somewhat hampered subsequent activity. “There are always political issues around the size of some of the gains that they made,” cautions Phillips. And regulators have legitimate reasons for a sharp focus on financial services investments. However, they still appear receptive to private equity investors – at least, in principle. Phillips cites the successful outcomes of past investments in Korea and Taiwan, as well as the positive signs around the Nan Shan situation. “I think that is a trend that will continue right across the region.”

Regulatory shifts are one of the main reasons for private equity’s interest in smaller Chinese provincial banks, where, as Phillips confirms, “previously private equity players had tried to make investments and had struggled to get them approved. There are signs that, particularly for domestic private equity funds, they will be allowed to make acquisitions.” However, he characterizes this as “a gradual relaxation.”

The broader regulatory environment has created new problems – as well as some opportunities – for investors. “Especially after the crisis, the regulators are gently but in a fairly focused way driving up the capital requirements of insurance companies and banks up,” Kaul points out. “That creates opportunities for us.”

However, along with this comes stricter and closer oversight. “The regulatory level is tightening right across the board,” Haire asserts of the insurance sector. And regulators, however accommodating, are not necessarily comfortable with private equity’s fund-driven time cycle. “They are definitely more accepting, but in an ideal world, especially for control transactions, they might in some cases prefer an investor with a much longer time horizon,” notes Kaul.

Finally, private equity’s involvement in some very large and well-publicized financial services deals in Asia may have obscured some of the more basic underpinnings of the investment process. “Perhaps private equity investment in financial services needs to be demystified,” says Chiba. “It is really all about strategic focus and execution excellence, like nearly all businesses.” 

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• Topics
• Financials
• Regulation
• Performance
• Investments
• Primus Pacific Partners
• TPG Capital
• The Carlyle Group
• The Longreach Group Limited
• Mark Chiba
• Goldman Sachs
• Sunil Kaul
• Lone Star Funds
• J.C. Flowers & Co.
• Ripplewood Holdings
• Hopu Investment Management
• Temasek Holdings