American LPs and Asia GPs: A meeting of minds

On a more nuanced level, growth drivers in Asia are different than those in the West – their modality is fast-as-possible development in almost any area as opposed to aging, service-driven economies. This brings the added bonus of diversification to LP portfolios. Kelvin Liu, a director at Invesco Private Capital, finds funds targeting the middle-market growth equity segment especially compelling.

“Many fast-growing, mid-sized Asian companies lack the professional management, proper corporate governance and well organized strategic planning that are crucial to solid growth,” Liu tells AVCJ. “So an experienced private equity investor can have tremendous leeway in adding fundamental value to these companies, enabling not only rapid but sustained growth.”

Impressive statistics

His enthusiasm for Chinese private equity opportunities, in particular, is widely shared. Certainly it is impressive, statistically, how the asset class has powered right through the global economic downturn: investment reached $15.6 billion in 2008, dipped to $14.4 billion a year later, and spiked 25% to $19.4 billion in 2010. It’s a similar story on the fund raising side: China-focused funds attracted $15.2 billion in 2008, saw it slip to $6.9 billion in the immediate aftermath of the global financial crisis, but rebounded to a record-breaking $16.7 billion last year.

Art Wang, director of private equity with prominent LP New York State Common, generally shares this enthusiasm but adds a cautionary note. “We continue to commit capital to China-focused managers,” he says. “But we’re concerned with the proliferation of funds and manager turnover.”

It is important to draw a distinction between domestic and foreign private equity. China’s pre-IPO space has ballooned in recent years as local renminbi-denominated funds look to leverage the high multiples available on the capital markets. Typically these local funds identify one or more target companies and raise funds largely through personal contacts on the basis that an exit will be possible in two years. Little thought is given to long-term planning and the division between LPs and GPs is blurred.
The approach is far removed from that of more substantial private equity investors who invest based on the 3-7 year model. As a result, there is room in the market for investors seeking a certain kind of deal, but flood of liquidity in China has raised valuations across the board. In many cases, foreign GPs are being squeezed out by domestic funds that less disciplined about price.

“Many GPs are chasing deals by pricing out competitors,” Liu observes. “And tied closely to that is the desire among GPs to rapidly grow their assets under management (AUM) by raising bigger and bigger funds.”
More than a few people have compared the current situation in China with the US dotcom bubble when poor price discipline and lax due diligence, combined with rapid fund expansion, led to a spate of failures that spooked the entire industry.

Others argue that only certain parts of the market are overvalued and that there are plenty of opportunities in areas where bidders are less concentrated. “There is a misconception in China that says that there’s too much money chasing too few deals – absolutely not,” John Zhao, founder and chairman of Hony Capital told AVCJ’s recent China summit. “You may feel like that if you’re a VC newly arrived from the US and you go straight to Zhangjiang Hi-Tech Park in Shanghai. For every deal there are 100 chasers. But if you go to the real China, there’s a real outcry for quality capital. And nobody cares about it.”

One reaction to all this has been a marked thrust by some international private equity houses into Southeast Asia, where valuations are perceived to be lower than in China and consumer markets are buoyant. In fact this has been going on by degrees for some time, because the issues driving it are global in dimension. The points made above about the Chinese market are echoed in places like Brazil. And the growing number initiatives in Southeast Asia parallel other GP probes into pockets of Eastern Europe, such as Poland, and Turkey.

In April, KKR brokered Vietnam’s largest ever private equity transaction, taking a stake in Masan Consumer Corporation for $159 million. Malaysia’s top deal came three years ago, with CVC Asia Pacific’s $1.5 billion investment in Magnum, the country’s leading gaming company. The PE firm recently part-exited its holding to Magnum’s parent company, receiving $410 million in cash plus a stake in the parent.
Indonesia is perhaps the market that generates most interest – it dwarfs its neighbors in terms of consumer market scale – and here Carlyle is reportedly close to securing a 25% stake in GarudaFood for around $200 million. CVC has also been active, spending $773 million to buyout retail chain Matahari in January and then taking a minority stake in LinkNet, Indonesia’s second-largest fixed-line and cable TV operator, for $275 million in March.

LPs keen on diversification are also looking at South Korea and India. “We feel that Korea is an interesting growth market with high productivity scores and relatively less competition,” says Wang. “India too has promising long-term potential, though we are quite concerned about the efficiency of the private markets and resulting high valuations.”

Statistically the country’s private equity investment and fund raising trajectory has followed a similar course to China’s since 2006, according to AVCJ Research – but without the stellar highs and a less pronounced post-global financial crisis rebound. Investment commitments totaled $10.6 billion in 2008, before halving to a meager $4.4 billion in 2009. The following year the market recovered to $8.5 billion. Fundraising reached $2.4 billion in 2010, still trailing the $4.1 billion figure from 2009 and the $9.4 billion raised in 2008.

According to Dr Mukund Rajan, managing partner of Tata Opportunities Fund, a slow recovery is increasingly evident. But it’s wrapped round with caution. In his view, while value creation opportunities exist across a spectrum of industries, “riding the wave” and betting on market growth will no longer suffice. Rather the way forward will be to go back to basics, which means private equity firms will have to commit their time and experience to portfolio companies, as well as money.
“Additional value can accrue to private equity platforms that can access proprietary deal flow,” Rajan adds. “Exit multiple analysis by a reputable industrial group shows that engineered deals have 60-80% higher value on exit than auction deals.”

This implies that foreign funds would be well served seeking out partnerships with established local conglomerates like Tata Group that have access to many of the best deals. A similar stratagem underlies some of the recent successes seen in Indonesia and the Philippines.
“The bulk of our portfolio pipeline consists of exclusive, off-market opportunities,” Rajan says. “In the fund’s most recent transaction we were able to deploy capital at a substantial discount to a comparable transaction in the same industry.”

Opportunities may outweigh obstacles in India, but foreign investors still have to bear in mind capital convertibility restrictions, uncertainty around taxation, foreign direct investment constraints and corporate governance issues within Indian companies.

Special situations

Rob Petty, managing partner and co-founder of Clearwater Capital Partners, adds that India holds some surprising attractions for special situations investors. As he sees it, current Indian stock market jitters and ongoing declines dispel the myth that valuations are too high. Rather they’re revealing new opportunities for distressed investments.
“Ongoing governance concerns and investigations into Indian public companies have presented realistic entry valuations for long-term investors,” Petty explains. “With a dearth of financing alternatives from the public markets, and the inflationary environment which has caused lending institutions to charge high rupee rates, these long-term investors are thus able to take advantage of their knowledge and network of sponsors and businesses.”

As for Japan, Anthony Miller, president of PAG Japan, believes special situations opportunities are “tremendous” for LPs. His firm announced last year that it would up investments in Japan by an impressive $500 million over the subsequent 12-month period. At the time the firm had $200 million invested in the country. The main attraction is the dislocation caused by Japanese banks essentially being shut down.

“Perfectly good transactions and opportunities are going begging because they can’t get bank financing,” Miller says. “If they could, they would, because they definitely need it. But since they can’t, they’re willing to pay people like us 25-30% and we’re going to demand aggressive terms; not only the high interest rate but also substantial over-collateralization.”
The opportunity gains additional luster from the fact that few are paying attention to it, and that executing deals is difficult. Miller claims to see only three to four competitors at auctions.

“As a result, we’re making nice money in Japan on a fairly consistent basis,” he says. “We’re underwriting auctions to a 20 and we’re winning maybe a third of the time. We’re also doing negotiated deals where our returns are significantly higher than that.”

The human factor

The strongest LP concern – shared by all with equal fervor – is finding and forging relationships with best-of-breed GPs and their management teams.
“It’s the most critical challenge,” Wang asserts. “That’s why we will continue to partner with experienced global managers who can attract and retain the best local teams, as well as with leading ‘homegrown’ domestic managers who have deep networks and longstanding relationships in these markets.”
Liu follows a similar strategy. He notes that while Invesco’s managerial selection process doesn’t differ much whether in the US, Europe or Asia, they particularly concentrate on experience with a cohesive team and a consistent strategy in the latter because of the immaturity of the markets. The region has seen considerable management turnover in the past decade, although it is generally agreed that GP quality has advanced considerably.

One nagging issue, however, is potential conflicts of interest where single management teams are running US dollar and renminbi funds. Each fund will have its own strategy and different sets of investors, and this naturally arouses concern among overseas LPs that their needs might not be prioritized. It comes down to what GPs are focusing on, where they put their best resources, and what the determinants are when a deal comes before them – will it be structured around a US dollar or renminbi vehicle?
“It’s really about how transparent the GPs in such structures are, how willing they are to let you participate or at least inform you candidly about what’s going on with the other side,” says Markus Ableitinger, a Hong Kong-based director with fund-of-funds player Capital Dynamics. “Unfortunately, at present there are only a few who do. 

• Tweet  
• Facebook  
• LinkedIn  
• Google plus  
• Save this article  
• Send to  

• Topics
• North America
• Greater China
• LPs
• Southeast Asia
• South Asia
• North Asia
• Clearwater Capital Partners
• CVC Capital Partners
• Hony Capital
• KKR