Auctions: The new normal

The last time Navis Partners bought a company via auction was 11 years ago, when it acquired Malaysia-based diaper manufacturer Drypers in a deal that was worth $22 million. The process was distorted, though, because the PE firm won over senior management at the very beginning. Three years later, Navis exited the asset to Sweden-based hygiene product group SCA for $90 million through a limited process, yielding almost 7x its original cost and an IRR of 103%.

"As a seller, I quite like auctions because they usually provide better prices," Nick Bloy, Navis' co-managing partner, tells AVCJ. "But from a buyer's perspective, we rarely participate in auctions. Our goal is to break an auction, as opposed to struggling over the finish line ahead of multiple other parties. To do this, you need an information advantage or some sort of asymmetry between you and the other buyers, so you can reach a bilateral agreement with the sellers as early as possible."

Navis is certainly not the only private equity firm that stays away from auctions. Weijian Shan, chairman and CEO of PAG, has yet to emerge victorious from an auction after 14 years in the industry simply because he has never participated in one; CVC sees around 80% of its portfolio companies in Asia come via propriety transactions.

It is not difficult to understand why private equity players don't like auctions - by definition they imply someone has to outbid others to acquire an asset. These processes inevitably open up the universe of bidders, and it is challenging for financial sponsors to overcome strategic investors that typically have a longer term outlook and a willingness to pay a premium for potential synergies with the target company.

"For auctions that undertake a well-organized marketing process, most of the deals can be completed successfully," says Chris Laskowski, head of the financial entrepreneurs group and COO of global banking for Citi in the Asia Pacific region. "But if you ask me how many auctions have private equity investors participating, most will just take a look, and only a few of them end up bidding aggressively."

Due diligence is another concern for private equity investors. Given that most auctions are run by investment banks and corporate finance houses, the formal process is often conducted rigidly and at the seller's behest. Even if bidders are allowed to meet the company management several times, building intimate relationships is challenging. The presence of investment bankers, who often write the presentation materials, routinely rehearse the sellers, and then sit in on every meeting, makes the process even more difficult.

Of course, sellers are to some extent in the opposite position. Given emerging Asia's rapid economic growth, strong interest from foreign investors, and the limited number of large assets that come to market, entrepreneurs are increasingly aware of the merits of leveraging the supply-and-demand gap. And even if they aren't aware, there are plenty of intermediaries willing to set events in motion and take a fee for the trouble.

Auctions, already prevalent in developed economies such as Australia and Japan, are becoming more common in emerging markets M&A. Private equity investors may not like to look at auctions, but for certain kinds of deals, they must accept that it has become a sellers' market.

Bidding universe

The proliferation of auctions comes as global buyout firms probe deeper into developing Asia in search of larger-ticket deals. For various reasons, not least entrepreneurs unwilling to give up control or state-owned enterprise officials unable to do so, China and India have yet to become strong buyout markets. Southeast Asia, however, is another matter, and investors are building up a presence in the region.

KKR, The Blackstone Group and General Atlantic have all opened offices in Singapore since the start of the year to serve as bases for private equity activity in Southeast Asia. The Carlyle Group, TPG Capital and CVC Capital Partners are already well established there, each with 4-9 investment professionals. Regional players such as Affinity Equity Partners and Navis already boast more than one location in Southeast Asia.

If more deals of size are forthcoming, based on recent form, they are likely to come via auction. Private equity suitors can expect to face competition from a growing number of multinationals looking for inorganic means of expanding their footprints in the region.

"The last couple of private equity deals I was involved were all run by some sort of auction. The trend is towards that and it's all about the value threshold: if the value is significant, I would expect an auction," says Robert Ogilvy Watson, managing partner of Ashurst in Hong Kong. "One of the reasons you see auctions on the biggest deals is that running the process requires quite a lot of upfront investment, but if you have a good asset and get good attention, you can get a higher price."

At the same time, investment bank and corporate finance houses - which previously focused on more mature markets - are also running around the region, pitching company founders on the hidden benefits of having a third-party transaction organizer. Apart from providing modern governance and transparency, these entrepreneurs also appreciate that a top-tier investment bank is able to bring an auction a host of international strategic investors that would otherwise be out of reach.

"When you look globally, the country with the most auctions is the US because regulations require them," says Stephen Seelbach, managing director and head of Morgan Stanley's regional financial sponsors division. "But as China and other emerging countries develop, I think there is no question that there will be more auctions."

While entrepreneurs are becoming more sophisticated and the capital markets are more developed, a dual-track process - in which an IPO and a private auction process are pursued simultaneously - is a popular option for sellers wishing to preserve flexibility while maximizing prices. If a public market exit is ruled out and the asset is sold via auction, the competitive pressure of a feasible IPO process can drive bidders to put more money on the table.

"Even if there is just one guy who is serious at the auction, if he knows there is a viable IPO as an alternative, the deal dynamics change," Citi's Laskowski says. "When entrepreneurs put their projections together, their net income tends to go up and they genuinely believe in it. I'd say company owners are very optimistic about their future growth and now see value in creating price tension in order to obtain the best terms in a fairly rapid manner."

Given these high expectations on price, there is often a significant valuation gap between buyers and sellers - and this is particularly obvious in Indonesia. In August, Blackstone, Bain Capital, KKR and Abraaj Capital were said to have reached the second round of bidding for a significant minority stake in Siloam, Indonesia's biggest private hospital firm. The seller - the Riady family-controlled Lippo Group - is looking for a valuation of up to 25x EBITDA, according to market sources. The deal has yet to close.

Last year, Carlyle was the frontrunner for a 25% stake in Indonesian snack and beverages producer GarudaFood. The private equity firm seemed poised to land the asset for around $200 million, having reportedly made a bid of 20x EBITDA that overcame the likes of TPG, Affinity, 3i Group and Japan's Suntory.

AVCJ's sources were skeptical, saying that such a high valuation might kill the transaction. In mid-July, Suntory duly announced that it would set up a joint venture with GarudaFood and take a large minority stake in the company's distribution arm.

"From a buyer perspective, the key is to be disciplined on valuation and not get influenced by the fact that there is an auction going on," says Ogilvy Watson of Ashurst. "Try not to be affected by the tension that sellers want to introduce because it's much more likely that you will overpay if you think you are in a competitive process."

Relationship building

Despite formidable challenges in the bidding process for private equity players, some industry participants argue that it is possible to emerge victorious from auctions by following the Navis-Drypers approach: establish personal relations with management before the formal process starts.

Relationships are especially helpful when companies are looking for partners to provide expansion capital instead of selling their entire interest in a business. Given that the first phrase of an auction is mostly non-binding, there is a chance that a level of intimacy with management is worth more than the price on the table.

"In reality, auctions - often time - are a winner's curse because you have to overpay to win. We only participate very selectively, if we have a distinct angle or relationship"SigitPrasetya, managing partner at CVC, tells AVCJ. "There are a number of our successful deals from auctions that we were not the highest bidder."

In March, the private equity firm bid $275 million for a 33.94% stake in LinkNet, Indonesia's second-largest fixed-line broadband and cable TV operator, with the option of increasing it to the 49% foreign ownership ceiling. According to a source familiar with the transaction, the deal originated from a pre-existing relationship with the seller, the Riady family's Lippo Group.

A year earlier, the PE firm had sourced a proprietary deal from Lippo - a majority stake in Matahari Department Store for $633 million. CVC acquired a 72.6% holding in the asset, which accounted for the bulk of parent company Matahari Putra Prima's majority stake. The two parties agreed to enter into a partnership structure, with Lippo Group-controlled Putra Prima placing its entire holding into a joint venture, of which it owns 20% to CVC's 80%.

"When CVC was trying to do invest in LinkNet, the company thought there was a valuation gap," says the source. "LinkNet subsequently launched an auction and CVC participated. The private equity firm was the third highest bidder but the relationship with the Riady family finally won them the bid."

Deal certainty

While strategic investors may hold the advantage in terms of cost of capital, they are generally slower to close transactions because of long and complicated internal decision making processes. In some cases, corporate investors also demand that additional conditions be attached to the deal, ranging from corporate governance requirements to social responsibility licenses.

As such, deliverability - minimizing conditions and time to closing - is often a critical factor in private equity investors winning auctions. This is particularly the case during transactions when a company is seeking urgent debt refinancing or restructuring.

Bain's A$1.3 billion ($1.3 billion) acquisition of Australian business software firm MYOB represents an interesting case study in the importance of deal certainty. UK software manufacturer Sage had emerged as a late frontrunner for the asset, which was put on the block by Archer Capital and HarbourVest Partners. The strategic buyer was said to be willing to pay as much as A$1.4 billion, beyond the comfort zone of Bain or rival KKR and well above the original asking price of around A$1 billion.

However, Sage then ran afoul of the global markets. Its share price dropped 11.5% in between the initial bid and confirmation of the potential acquisition, while foreign exchange rates turned against the pound. This meant the acquisition could amount to more than 25% of Sage's market value, requiring a shareholder vote for it to go through. The company abandoned its bid.

Another threat to deliverability comes in the form of regulatory requirements that might be attached to a transaction.

This was the reason a group led by Primus Financial Holdings and China Strategic Holdings failed to secure AIG's Nan Shan Life Insurance unit last year despite its $2.15 billion bid being accepted. The Taiwan authorities vetoed the deal, citing concerns over the buyers' financial capability and long-term commitment.

RuentexGorup, a Taiwanese family conglomerate eventually picked up the asset for the marginally higher price of $2.156 billion after receiving guarantees from the regulators.

"Sellers often have a fair value in mind," says Navis' Bloy. "If someone overpays it, it is bonus, but ultimately if you can get fair value, you would want the sale to be done in a way that is quick and clean."

SIDEBAR: Keep it small - Limited auctions in Asia

While a full-scale M&A auction in the US usually involves as many as 10 bidders in a room, Asian companies usually preferred a limited process. It starts with 5-6 prospective investors, which are subsequently trimmed down to the 2-3 that express the most aggressive interest.

There are numerous reasons why limited auctions are popular in Asia, including the inability to run a big process, a wish to avoid too much publicity, as well as unwillingness to disclose financial data to unfamiliar investors.

"Auctions are more prevalent in the US, Europe and Australia as these markets are more regulatory-driven at this point," says Stephen Seelbach, managing director and head of Morgan Stanley's regional financial sponsors division. "But if you are dealing with more developing markets in Asia Pacific, often first or second generation entrepreneurs may not want the publicity an auction generates."

However, Nick Bloy, co-managing partner at Navis Capital Partners, argues that limited auctions have their merits as drawing the attention of a few potential buyers brings with it a sense of exclusivity.

When the private equity firm hired J.P. Morgan for the sale of King's Safetywear, the investment bank initially sent out information memoranda to 20 investors. The list was narrowed to three bidders within four months and Honeywell International finally secured the asset for S$430 million ($338 million) last November.

"You don't throw it to everybody and present the same set of materials 20 times," Bloy explains. "You are selective about whom you bring in. As a seller, I also feel a little bit more comfortable because if I put the best buyer in a three-horse race, they might think it's worth it and put in the effort."

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• Topics
• Buyouts
• Southeast Asia
• buyout
• Navis Management
• CVC Capital Partners
• KKR
• TPG Capital
• Bain Capital Asia
• Indonesia
• Southeast Asia