The crystal ball: Predictions for 2018

VINCENT NG, PARTNER AT ATLANTIC-PACIFIC CAPITAL, ON FUNDRAISING:

One concern among LPs is that there is less differentiation to be had in the region than one would like, and the extent to which that is understood and addressed is specific to each GP. We are seeing trends where they refine their sector exposure: some GPs are adding professionals with a slightly different skill set, and certain GPs are reemphasizing the nature of their value-add proposition. How much those are sufficient to help you differentiate yourself is a different story, but there are elements of that which play into it.

What we’re also seeing as a derivative of that is a lot of groups spinning out, with senior members of one firm coming out and forming a new entity. They realize that it might get more challenging for their existing groups to raise capital, so they step out with a couple of partners and try to differentiate themselves, whether by focusing on a different subsector or part of the value chain, or by finding a set of backers with a specific sector expertise.

Whenever this happens, questions are asked as to who really deserves credit for the track record, who has really delivered the value historically, who has gained more trust from the existing LP community. It’s not a matter of taking a pie and dividing it four ways – there might be two groups that are ultimately successful in generating support from LPs, while the other two or three struggle, because you can’t have four or five vehicles sharing the same track record and pedigree. So it will be survival of the fittest within those sibling groups.

Sectors like healthcare and education will continue to have a lot of interest and following. A lot of capital has been raised for TMT [technology, media and telecom], but I think the early stages of the strategy will be more enticing and draw more interest than the later stages, partly because of valuation and exit concerns. We also expect to see a lot more secondary opportunities, both in terms of straight secondaries and GP restructurings, and more activity in the GP consolidation front, as some groups that have a decent history but are not differentiated enough find it a little more difficult to raise capital and seek assistance to make progress.

We’re also expecting the China market to open up again from a capital control standpoint, which hopefully will unleash some firepower from the Chinese groups whose activities have slowed down since last year because of the capital constraints. With the improvements we’ve seen in China’s balance sheet and increased capital outflow I believe these Chinese pools of capital can start deploying again.

SIMON FEIGLIN, MANAGING PARTNER AT THE RIVERSIDE COMPANY, ON AUSTRALIA & NEW ZEALAND:

We believe that 2018 should be a solid year for both investment opportunities and exits.  The themes that have existed for the past few years remain in place – macroeconomic conditions are, while unspectacular, still solid. Drivers of that growth, however, have evolved. It is less about mining and agriculture being developed domestically and shipped offshore, and more about absorption of population growth and the impact on property, healthcare delivery, and other services.

Geopolitical uncertainty remains, and obviously that can create unforeseen events, but in general, the Australian and New Zealand economies are stable and growing. The IPO market, while open, remains tight, which means that business owners will consider other options, including trade and private equity sales.

We think that the most attractive opportunities will come from Australian and New Zealand mid-market companies that have created business models capable of succeeding overseas. The world is increasingly flatter, and as new challengers enter our part of the world (such as Amazon), we think that businesses with cross-border potential are best positioned to counter attack and win. Local asset pricing is likely to continue increasing as a wider field of potential investors chase growth in an otherwise low yield global environment. This is a double edged sword: it presents a fertile landscape for sellers and will require buyers to be disciplined or find creative ways to build their investment cases.

SUNIL MISHRA, PARTNER AT ADAMS STREET PARTNERS, ON THE LP PERSPECTIVE:

In the last few years we have seen increasing bifurcation in the fundraising fortunes of larger pan-regional GPs and local, more specialized country players. The success of larger players is driven by the growth in LBOs, and by good performance in public markets, which these GPs with scale assets can use to exit.  That has meant that at least in the last couple of years, more money has gone to the regional players – clearly many were the earliest participants of this industry, and are also the most experienced lot.

But I think this current consolidation environment will be an opportunity for some of the country funds to establish better performance, which will lead over the next few years to a market which is a good combination of country and regional funds. I don’t think the country fund market is going to go away, because some of these markets are getting deeper and broader with as an accepted form of capital injection. There is a place for regional funds, in that the larger the markets grow the more you see deals for $100 million plus or more deals, but they will continue to be the minority in many of the individual markets.

Globally the fundraising has been pretty robust, but I would say it's driven a lot by the US. Asian fundraising is steady and solid, but it's not as exciting as in other markets. One effect of that has been the shift in the dynamics of GP-LP relationships. As GPs grow in maturity, they understand that many of the questions that LPs ask and many of the requirements that they have are reasonable and adherence to these best practices help build a long-term, sustainable business. And in turn the people who had good processes, good governance, and good reporting, are all those people who are still around.

So clearly at this stage we are moving towards better accommodation of LPs' demands, and one area where that’s most visible is in co-investments. Just a decade ago, not many people paid any attention to co-investments – nobody really knew what it was. But today it’s becoming increasingly important, and clearly that requires a lot of concerted and in-sync action between GPs and LPs, especially in Asian markets where many of these situations are pretty dynamic and GPs and LPs have to work together as the deal goes along. So clearly there's a lot of improvement in the working relationships, and that is where the industry is going, at every level.

We do expect a little grey area as well, because as more LPs build active co-investment or even direct investment practices, I’m sure that will make some GPs uncomfortable. If they’re sharing the opportunity with a partner who is a fund investor then they are clearly aligned, but they might be cautious about someone who is going to be a potential competitor. So I can understand the wariness, but in general we expect better collaboration in every aspect.

RICHARD FOLSOM, CO-FOUNDER AND REPRESENTATIVE PARTNER AT ADVANTAGE PARTNERS, ON JAPAN:

I think the momentum will continue. There are two prongs – founder-owner transition deals and corporate carve-outs – and I think the current swell of activity will roll into 2018 on both fronts. This applies to the middle market, but as an observer of the top end of the market, I think you will see more larger deals in 2018 as well.

The good impression that private equity is making with assets acquired from the likes of Panasonic, Toshiba and Hitachi should drive increased deal flow. There is a growing realization in the Japanese business community that private equity can be a good steward. As for exits, the amount of cash Japanese public companies have on their balance sheets equates to 140% of GDP, three times the US figure and higher than anywhere else in the world. They are looking to use that to be acquisitive and invest in next-generation products, so the momentum we see in the exit markets should continue into next year as well.

It isn’t necessarily the same companies buying assets as divesting assets, but where that does happen some are selling businesses and investing the proceeds in their core areas or in areas they think are more relevant to their future growth. The interest from LPs in Japan is also at a high point and potentially that will continue through next year, although as we all know, a lot of funds were raised this year.

LUCIAN WU, MANAGING PARTNER AT HQ CAPITAL, ON SECONDARIES IN ASIA:

We see the Asia secondary market as similar to what the global secondary market was like five or six years ago, where high-quality assets could be acquired at reasonable prices, and if you look at the global markets in the last five or six years, a lot of secondary managers have been successful in raising larger and larger funds.

I think we’re going to see Asia-focused secondary funds coming to the market, and we’re going to see more supply coming to the market as well. Currently about 10% of the global secondary market is in Asia; I would expect this market to double in the next three to five years, hitting 15-20% of the global market, and tracking closer to the global secondary market as the Asia primary market is tracking the global primary market.

Over the last 15 years about $1 trillion has been raised in private capital on the primary side in Asia. Of that $1 trillion, more than $240 billion are in funds that are coming to the end of their 10-year stated lives, and that’s giving pressure to limited partners and general partners, for them to look for alternative exits. If capital markets continue to perform well perhaps there’ll be more IPOs coming along, but overall we’re seeing a change away from the reliance on IPO exits across the board.

There are more trade sales happening, and the secondary market is also maturing and providing a real option to GPs and LPs alike in terms of alternative exits. In any event, with the large number of funds approaching the end of their 10-year stated lives and looking for a longer runway to realize value in their portfolios, we certainly expect GP restructuring to be more commonplace going forward.

DON JIANG TAO, MANAGING PARTNER AT GOBI PARTNERS, ON TECHNOLOGY:

We find that there are still a lot of big industries that have actually not yet been impacted by the internet or new technologies. The ways that technology will transform these traditional industries will be some of the main trends in the next few years.

The car industry, the agriculture industry and the manufacturing industry are all good examples. We see some big opportunities in these areas because of their untapped potential to apply, for example, the internet-of-things and big data data-related technologies.

One of the most interesting areas yet to be developed is offline retail. When you go to a shopping mall, the experience hasn’t changed over the past five years, so we think there will be some important technological changes there in the next five years, including better integrated experience with online/mobile more internet integration.

To some extent, this will be about investment in smart stores like Amazon Go, but in Asia, the format will be different. In China and many parts of Asia, the cost of having people on staff is not that significant, so the idea will be more about improving efficiency and providing better customer experiences.

ERIC ZHANG, HEAD OF CHINA AT GENERAL ATLANTIC, ON CHINA:

China’s consumption upgrade has been the most important theme for us over the past 12 months. As domestic consumers are getting more sophisticated, their demand has moved from traditional sectors to newly rising services such as education, healthcare, and tourism. They are more aware of the brand and quality of services that those companies provide. This will be the main trend that will drive our new investments moving forward.

The second trend is the digital revolution. Technology continues to play a major role in the Chinese economy. Compared with developed markets, the offline infrastructure in China across retail, education or even travel sectors is weaker. As a result, the adoption of internet technology in traditional sectors is to a certain extent more meaningful than in Western countries. Business models which are internet-enabled and based on the new economy will attract a lot of PE and VC funding.

While valuation across the whole technology sector is relatively high, the addressable market for Chinese tech companies is huge. Investors should really pin down a company’s revenue, growth rate, and the market size of the industry that the company is operating in, to see whether the high valuation is justified. In some cases, they really are.

Most of the verticals in the technology sector are quite consolidated, with the main competitors in the same vertical combining over the last two years. But consolidation isn’t only about the main competitors, it’s also about leading companies acquiring new technology, markets, or even new customers for their existing businesses. Chinese entrepreneurs are getting more confident in using M&A as a tool to scale up their businesses in a faster way. They will be active not just domestically but also globally, attacking overseas markets like the US and Europe.

Overall, competition among Chinese private equity firms has also intensified, with thousands of GPs chasing investments. China private equity is no longer just about building a team to look at one or two sectors, but rather about how a GP can develop the sector domain knowledge and build the ecosystem in certain sectors. This allows the GP to access popular deals early on and help justify the entry valuation. The GP will take more initiative in terms of driving consolidation and M&A for their portfolio companies. Private equity is in one of the best stages now. It’ll be interesting to see how GPs revise their business model and innovate in response to the evolving Chinese economy.

SHANE CHESSON, CO-FOUNDER AND PARTNER AT NSI VENTURES, ON SOUTHEAST ASIA VC:

Healthcare, education and financial services. To us, those are three of the key sectors that are going to be extremely active investment-wise next year. The last three or four years have been about establishing the basic infrastructure of the internet economy in our region – the logistics layer, the payment layer – and essentially building a market for consumers. Now there are massive, underserved sectors that aren’t delivering what on they are supposed to be delivering on in emerging markets.

All those things being built on top of the Tencent and Alibaba infrastructure in China will be built in Southeast Asia as well. Mobile and remote health platforms can improve access, lower costs and improve quality of outcomes for patients; new online education formats will become the key growth area for education in Southeast Asia; and the adoption of online financial services like lending and insurance will reach an inflection point and slow-moving traditional financial institutions won’t have caught up. It’s all about providing the services. In our view it isn’t hard to create billion-dollar companies because you are addressing, in some cases, trillion-dollar industries.

We review about 1,500 seed-funded companies every year and in some cases, entrepreneurs get ahead of themselves on valuations. Those of us that have been in the market for a while won’t bite, but there are others – investors who are doing one deal a year or trying to do their first in the region – who might be willing to pay quite a bit more.

We are okay paying a higher valuation if a company is ramping up faster because of the infrastructure being put in place. However, we wouldn’t want to do that if the traction is the same as what we saw a year or two ago. The Series B landscape is broadening out nicely, and while there are people trying to come in and do Series A rounds, it is hard to find the best companies if you don’t have a full-time presence here.

AJAY HATTANGDI, CO-FOUNDER OF ALTERIA CAPITAL, ON VENTURE DEBT IN ASIA:

Venture debt doesn’t appear very different in any of the markets where it operates, but there are often small differences between successful venture debt businesses and those that aren’t. These include whether there is a track record to prove that certain types of approaches and lending work in certain markets, and can you build a model that defines what a good borrower is and what a good loan structure is. All of these things take time to plan out and build. It’s not something that you can just dive into with both feet and expect it to work successfully if you’ve never done it before.

I think a lot of people tend to think that as long as you’ve got the right company with the right VC, all is well and will pan out eventually and you’ll get your money back, but that is seldom the case. As in venture capital, being able to say no is more important than being able to say yes, because lending to a company that should be a no opens up your entire portfolio to credit risk and has the potential to create a big hole in your book for funds. We don’t have the same kind of return profile as equity funds, so we can’t afford the same sort of percentages that VC funds do.

Added to that is the fact that the markets are very different, and there’s no such thing as an Asia market or a Southeast Asia market. Even between Malaysia and Indonesia there are huge differences in how companies are set up and operate. The other challenge is the maturity level and the number of VC firms that operate in these markets, particularly in Southeast Asia, which is very Series A-centric, with a lack of Series B and C investors. There’s a trough in the middle that’s very deep, and that creates very serious issues for lenders, because as a venture debt provider you’ve got to be able to have a certain level of reliance on the next round of capital coming in.

Singapore is probably where we’ll see the model take hold next, because you have strong corporate governance, creditor rights, and venture capital, and a lot of the infrastructure that you need to create successful companies. How the parties will utilize those opportunities and scale it into a big market remains to be seen, but that’s the market where we see the right level of maturity to bring the next opportunity. At the moment it’s a shiny new thing, so lots of LPs want to fund venture debt businesses and a lot of founders want to create venture debt firms. Time will tell how they all stack up, but in the interim I think it’s a good outcome for companies that want to borrow, because there are a lot more options on the table today.

GAURAV AHUJA, MANAGING DIRECTOR AT CHRYSCAPITAL, ON INDIA:

We don’t expect anything to change too dramatically. India went through a transitionary period this year because of demonetization in November 2016 and then the Goods and Services Tax (GST) implementation in July 2017, but things are normalizing now and we would like to see this normalization continue next year as well. Other than that we don’t expect any major surprises next year.

The Modi government has done a great job pushing forward on various reforms – demonetization and GST were two of them, and others worth mentioning were the Real Estate Regulation & Development Act (RERA), which creates more transparency in the real estate sector, and the new Insolvency & Bankruptcy Code. These reforms have been positively received by the global investor community, which is reflected in the recent upgrade of India’s credit rating by Moody’s and the improvement in its ranking in the World Bank’s Ease of Doing Business Index.

Going forward we are keeping an eye on some of the state elections, like Gujarat, which is Prime Minister Modi’s home state. I think the entire nation is looking very keenly at those results to see whether Modi’s party will win, and if it wins, how strongly he wins. Additionally, there are three or four other states that also have state elections next year, and one could argue that these will be early indications to what might happen in the 2019 general elections.

From the standpoint of exits, I would say they have always been available to investors in India, but we are seeing a stronger exit momentum. In each of 2015 and 2016, about $10 billion was exited, especially when you compare these figures to the 2006-13 timeframe, during which the industry only exited about $25 billion. This year again has been strong – some reports indicate that 2017 could actually be even better than 2015 and 2016. So it’s good to see that as an industry there are more exits, as it puts a positive bias in the global investors’ minds when they think about investing in India.

JAMES ZHAO, FOUNDING PARTNER AT LYFE CAPITAL, ON CHINA HEALTHCARE:

As the Chinese government gives strong supports for healthcare innovation, anything related to drug discovery or medical device innovation will attract a lot of attention. We are conservative about making investments in the early stage because a lot of companies are asking for very high valuations – sometimes even higher than companies in the US for the same technology. That’s unreasonable. In contrast, growth-stage investments, which involve revenue-generative companies, are more sustainable from a financial point of view. More importantly, growth-stage companies also have innovative pipelines. And then valuations in the growth stage is also more reasonable than early stage right now.

In terms of drug investments, companies with strong product pipelines in the oncology space, coupled with established networks in China’s healthcare industry, will gain traction from investors. The other area is contract development and manufacturing organizations (CDMOs), which provide drug R&D and manufacturing services to large pharmaceutical companies. Many overseas players are looking to implement clinical trials for new drugs in China, and they tend to outsource to the CDMOs. In this context, China-based CDMOs will develop a strong platform to serve global drug development. Over time, they will also develop their own drug R&D capability.

In the diagnostics area, I am very positive about the application of next-generation sequencing in oncology, in particular in early detection and diagnosis of cancer. For medical devices, I still believe that surgical platforms and cardiovascular platforms will be the major segments of interest for investors. In terms of healthcare services, as long as companies demonstrate a good combination of management teams and doctors, as well as strong corporate governance – meaning management teams are focused on daily operations and doctors are only responsible for taking care of patients – investors will be keen to invest. However, it’s hard to find this type of combination in China.

To me, the successful IPOs of two Chinese healthcare companies – Zai Lab and BeiGene – in the US are exceptional cases. Both companies have strong management teams that are highly recognized by multinational companies – which agree to license their products to develop in China – as well as the capital markets. There are very few high quality companies like them in China now, although we will see more in the future.

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• Topics
• Greater China
• North Asia
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• Southeast Asia
• Australasia
• GPs
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