The crystal ball: Predictions for 2020

ERIC XIN, MANAGING PARTNER AT CITIC CAPITAL, ON CHINA:

US dollar fundraising will become more important for Chinese GPs. China’s deleveraging push made it hard for managers to raise renminbi; meanwhile, global pension funds are shifting toward PE investments for higher returns and Asia is under-allocated. Considering the low-interest-rate environment globally and the high valuations for PE assets in US and Europe, Chinese PE funds will be able to raise US dollars more easily. Another reason is that LPs in China, especially individuals or early-stage investors, take US dollar fundraisings as a qualification indication for Chinese GPs.

In terms of sectors, 5G and the internet-of-things for enterprise services will continue to gain a lot of attention. Domestic enterprises’ management systems are usually fragmented and underdeveloped. Against the backdrop of an economic slowdown, they will have more incentive to apply new systems for cost-saving.

Secondly, healthcare will be an evergreen sector in an aging society. Services like ophthalmology and dentistry will be attractive. The third theme is consumer, especially beauty products and high-quality products. Chinese consumers are shifting from searching for luxury brands to looking for high-quality products like Muji. Lastly, there should be a lot of opportunities in industrial manufacturing due to the reconstruction of supply chains. However, the political uncertainty is huge.

For deal flows, growth funds in general deployed less capital this year due to high valuations – it might be even less next year. However, we will see more buyout opportunities. On one hand, some Chinese firms became motivated sellers due to the deleveraging process; on the other, multinationals that cannot adapt to the fast-changing business environment in China choose to quit the market. Buyout deals picked up in 2016 and 2017, and they have been on an upward trajectory ever since.

The exit environment is getting better. Following the launch of the technology innovation board, we will see reforms on the second-board market and SME board in the mainland. The Hong Kong market is also becoming more open. We will gradually move towards a connected stock market for mainland China and Hong Kong, forming a full set of rules for listing, pricing, exit and trading.

WAYNE SHIONG, PARTNER AT CHINA GROWTH CAPITAL, ON CHINA VC:

In 2019, deal flow for Chinese VC firms has decreased 30%. Software-as-a-service platforms are overheated, and we didn’t invest in any company in that sector during the past year. Many of our deals were carried over from 2018. In 2020, we expect a correction of valuations for software and the semiconductor industry.

In terms of fundraising, although the economy is slowing down, top-tier GPs are loaded with dry powder. However, they will deploy with more caution. I think there will be fewer deals in 2020.

For investment themes, 2020 will continue to be a year with no consensus, just like in 2019. GPs will continue their specialization in different sectors. We don’t see major technology upgrades either. It’s kind of a technology gap. Even though Apple is pushing augmented reality glasses, it’s far from penetrating into people’s daily lives.

The only consensus in the market is the successful launch of the technology innovation board in Shanghai. Since it opened on July 22, the shares of the 56 listed companies have risen at least 10%, and none have fallen below the issue price. If a company like Xiaomi was listed on the innovation board, its market cap might have doubled to HK$400 billion ($51 billion).

VIVEK SONI, INDIA PRIVATE EQUITY LEADER AT EY, ON INDIA:

Private equity investment has grown at almost 46% per annum for the last three years and should reach approximately $50 billion in 2019. This is about 1. 8% of GDP, which is similar to the Chinese benchmark, so the asset class appears to have come of age in India. Going forward, while our outlook for 2020 is positive, we expect investment growth to slow to about 15-20% in 2020. Therefore, total PE investment in 2020 should be in the range of $55-60 billion. 

The momentum in buyout deals continues to be driven by three factors: succession planning by family-owned businesses, divestment of divisions by conglomerates and venture capital-backed portfolio companies where the VCs have more than 51% and are looking to exit. We expect most private equity investors to continue going into the same five sectors: financial services, IT, e-commerce, retail consumer finance, and healthcare.  Infrastructure and real estate should continue to attract strong interest from real asset economy investors.  

Valuations are expected to remain stable in 2020, especially for start-ups and small to mid-cap companies. Most private companies are now open to doing growth equity trades because there has been a dislocation in the credit markets. Lenders are hesitant to increase credit to corporates due to their own liquidity and asset-liability management issues. 

We expect 2020 to be a good year for exits because a huge stock of small and mid-cap companies has built up over the past 18 months where private equity has a substantial stake. Whether or not an IPO window opens, we expect to see more secondary deals in 2020. An IPO where a private equity fund has a 20%-plus position means an exit in slow motion. Complete exits of large positions in listed companies take time because of the lack of depth in the Indian capital markets for mid and small-cap companies. 

We believe 2020 is going to be a big year for infrastructure and real estate, which now account for almost one-third of all the private capital coming into India. More money has entered infrastructure this year than the previous seven years combined, largely because of the new InvIT structures, which allow investors seeking yield to hold assets with minimum tax leakage. We hope international yield seekers will come to India to invest in highly rated asset-backed cash flow opportunities. That said, we do not expect a lot of PE investments in greenfield or brownfield risk. 

Thanks to direct and indirect pressure created by India’s new insolvency and bankruptcy laws, we also project an increase in credit investments, including structured credit for corporates and in portfolios of loans that have gone bad or are stressed. Until now, this has involved large assets that have mostly attracted strategic players. Going forward, as the average size becomes more granular, we expect to see more interest from PE firms, which sense the opportunity and are setting up credit platforms.

ALEX EMERY, HEAD OF ASIA AT PERMIRA, ON BUYOUTS:

When the economy is growing rapidly, there is a psychology around not selling businesses because they could be worth significantly more in just a couple of years. But that is starting to break down because overall growth is slowing and taking money off the table is starting to make more sense for founders.

We’re also going to see more disruptions in things like the trade war and the way businesses grow. These disruptive forces – whether they’re technological, political, or macro issues – will create a need for more businesses to change. In many instances, the founder will feel it is time to hand the baton and let somebody else take on that challenge. 

We’re going to continue seeing more succession-based buyouts in Greater China as a percentage of total deals, which is a trend we’ve seen over the last few years. That’s against a backdrop of the slowing Chinese economy and a generational shift. So many enterprises created when the country was liberalizing in the 1980s and 1990s are starting to recognize that private solutions such as buyouts make a lot of sense.

Japan will continue to be a lumpy market, but fundamentally, it remains probably the most interesting untapped private equity market. There are great businesses, great technologies, great people, and great market positions that are often not run to global best practice levels. And private equity is increasingly accepted by corporate Japan. That doesn’t mean that next year will necessarily see a rapid acceleration, but it will continue to be a very interesting area in the long view. Japan is complex and decision-making is often slow, but we will see an increasing number of corporates selling divisions to private equity. 

Across Asia, we think that competition and high price environments will increasingly require large buyout shops to have deeper sector understanding. That sector focus will be needed not only to justify the prices paid for businesses but also to be able to create value in those businesses. That’s a massive shift that’s only at its very beginning in Asia. So, we’ll see it more next year but also as part of a multi-year trend over time.

MARK CHIBA, GROUP CHAIRMAN AT THE LONGREACH GROUP, ON JAPAN:

Relative to how disordered much of the world is, Japan is well-positioned to provide a stable, executable PE environment. At the macro level, there are the risks of trade barriers, unpredictable policy, and the longer-term technology confrontation between China and the US – but I think Japan might slip through the middle of that in many respects. If there’s another global financial crisis, it could constrain leveraged lending, but I don’t see that happening easily because Japanese banks rely on this business for profits.

We expect corporate carve-outs and succession deals will continue at a steady beat although the big-cap deals could get held up given the global political environment, especially in technology. That could squeeze the capital in that space into competing for fewer deals, pushing up valuations to unhealthy levels. The mid-cap space, however, should stay below the radar of US-China tensions, very steady-as-she-goes. There is potential for a surge in deal flow, but current levels are healthy enough.

Japan will also see continued reintegration into Asia, which will create enormous opportunities for PE. We’re already seeing that in a stronger cross-border deal dynamic with China and Taiwan. Overall, we expect to see more foreign interest in Japan, as well as more Japanese companies buying globally and therefore shedding non-core assets at home to fund that growth, which creates a major source of corporate carve-out deal flow.

Meanwhile, Japan’s demographic pressures will continue to generate interesting growth areas for PE, especially in business process outsourcing, labor-saving IT, and anything to do with healthcare or aged care services. Valuations in those sectors have consequently moved up, but there will still be value-buying opportunities if you focus on companies that have not begun the journey of realizing their potential and you can acquire and drive that value transformation.

JEFFREY PERLMAN, HEAD OF SOUTHEAST ASIA AT WARBURG PINCUS, ON SOUTHEAST ASIA:

Southeast Asia first and foremost will continue to be the biggest beneficiary of the ongoing US-China trade issues. And Vietnam, specifically, will continue to be the biggest beneficiary of all. The Philippines is poised for good growth next year, some of the fruits of reforms will show up over the next 18-24 months.

Second, next year is going be the year of funding for the next set of potential unicorns. We’ve got 10-12 unicorns in Southeast Asia. There is also a large group of 600-plus early-stage companies, some of which will finally start to get that Series B and C funding next year to help them progress toward becoming unicorns. Company valuations in a way are likely going to be less elevated, partly due to the WeWork effect. But for the really good assets, where there’s a lot of competition, valuations will be as high as they’ve ever been in Southeast Asia.

Third, by the end of next year, we’re likely going to see at least one or two of the markets in Southeast Asia hit the key 5% inflection point of e-commerce as a percentage of total retail sales. Things will start to accelerate faster after reaching this point in terms of warehousing needs, parcel deliveries, and essentially all things logistics.

For most GPs, fundraising was harder this year and it’ll be even harder next year. In terms of exits, 2020 might be a tale of two halves. The first half may be pretty good, and the second half could be tough for those who are relying more on IPOs with the upcoming uncertainty around the US election.

The major concern for investors is the unknown. You have a lot of geopolitical and macro issues at play - the potential impeachment of the US president, a US election, the continued US-China trade discussions, the longest recovery ever in the US combined with a low, almost negative interest rate environment around the world. The question is, we don’t know which one of those issues – or a different issue entirely – could create a shock to the market and reverse the current positive momentum. This is what will continue to keep investors awake at night in 2020.

ANGUS CHOI, PRINCIPAL CONSULTANT AT ERM, ON ESG:

In previous years, only 3-5 years ago, most private equity investors primarily discussed ESG in terms of why it matters, but now, we’re going straight to the point on topics around what value ESG brings and how to do that. We’re at a point now where we’re implementing ESG and we have case studies, so in the future, it’s going to be less about theory and more about practice.

This will happen in two groups in private equity in Asia: the top-tier GPs that have already been through an ESG journey and the more local players that are just starting to get asked about it. The more mature GPs are already thinking about ESG 2.0, so they will not only focus on materiality. They’re thinking that everyone else is starting to do it, so they want to be differentiated going forward.

The ones that are just starting the journey will want to catch up rather fast because they feel they’re being left behind. Smaller GPs are also going to start benefiting from what the leading PE firms have already learned. That will help the smaller ones sort out ESG in less time. We have some small PE clients that don’t even have international LPs, but they still look at ESG now, so I think that will continue.

This is going to be a slow change, though. There are still some investors who are not convinced and are just joining PRI [Principles for Responsible Investment] for the sake of having it on their logo. But that’s part of the journey for the industry, and at least those firms care enough to commit to that and start with the branding. The SDGs [sustainable development goals] are part of that. More GPs are referencing SDGs in their deals, and I think that will continue because terms like “environmental social due diligence” will be seen as more about upside than liability.

I see this like the technology trend. GPs used to regard technology as an add-on for companies, but now the good investors know that every deal is a tech deal. They won’t buy a company that doesn’t have technology embedded in it, and I think that’s also going to happen in ESG. Right now, some people still think ESG is just an add-on. But the trend is that even funds in real estate, infrastructure, and technology are going to find that it’s more fundamental to their investments. Probably starting next year and for the next few years, they’re going to start saying, “Every deal is an ESG deal.”

ANTHONY MUH, SENIOR PARTNER AT HRL MORRISON, ON INFRASTRUCTURE:

Transportation assets are playing out as a theme in Asia, especially in India where a number of foreign funds are successfully deploying capital either through debt or equity, and Southeast Asia, where a number of countries are looking to build, extend or privatize airports. I think it will continue to grow as there is still a lot of need for that type of infrastructure. As long as investors can get the regulatory mechanism right and the risk appropriately quantified and managed, those assets will be increasingly attractive.

Water management and treatment is also becoming a big sector in Asia with climate change. This increasingly includes water desalination, which in Australia, has seen plants put into full production and the government is talking about the need for more desalination capacity. Water will be a key issue across Asia over time, including India and China, where there will be a lot of additional investment needed.

We’re going to see more activity as well in communications and data, which is a relatively new sector for infrastructure. While the older generations consider electricity and roads to be critical infrastructure as we understand it, what’s critical to the younger generations is internet access and the media. This sector is going to continue to grow and increasingly be recognized as investible.

We think renewable energy, however, is the biggest sector in terms of opportunity both globally and here in Asia. It’s a great example of an area where greenfield risk is becoming better understood, technology is fundamentally disrupting a traditional industry, and investors are turning to assets with differentiated performance characteristics.

With climate change now firmly established as a reality rather than just a theory, almost every country in the world will be seeing dramatic increases in demand and investment in renewable energy. That will come more into play as transmission assets upgrade and energy storage becomes more viable. Investors still need to be careful, however, to ensure that new capacity will in fact be able to be connected to the grid, sold and consumed.

There will be a lot of opportunities in Asia in renewables. Some Southeast Asian countries that were late starting in the sector will be quite attractive vis-a-vis North Asian countries in the near term simply because they have not yet come off feed-in tariffs. India will be the exception because it has gone down a path of reverse auctions, which is very commercially driven without subsidies. China is on the cusp of removing subsidies for wind and solar, but the plan is clearly articulated, so the private sector will be able to plan and manage the transition.

HASEEB MALIK, PARTNER AND HEAD OF ASIA CORPORATE & TRADED CREDIT AT VÄRDE PARTNERS, ON CREDIT:

There are three main drivers in Asia for us: shortfalls in the supply of credit or non-performing or distressed borrowers; high yield markets or capital markets being less developed and less accessible, even for borrowers in more developed parts of the region, such as Australia; and a lack of alternative credit. We have 51 people across five offices in Asia, so we can compete in multiple jurisdictions. That said, in 2019, we hit upon several different things.

 India as a system started to formulate a lot more in terms of the opportunity set. Just in the last six months it has gotten deeper and wider and I think that will continue in 2020 and beyond. The main drivers are the $180 billion in NPLs [non-performing loans] working through the system and the $300 billion NBFC market going through a liquidity crisis. The NPL opportunity will be a multi-year one, but I think 2020 will be an important year in terms of banks resolving some of the problem loans. Then on the NBFC [non-bank finance company] side, we see several different ways in which we can access that opportunity set. It might be portfolios of performing primary loans that NBFCs are selling, or company debt that you can buy up and get into restructuring. 

Even performing borrowers sometimes don’t have access to liquidity and we can provide it. In a market like real estate, which is now stressed, we can lend against performing properties that might be owned by stressed groups. The market has repriced risk. When the NBFCs were doing it, the rates probably weren’t sustainable in the long run. Now, if you are a performing borrower, the banks are capital constrained due to high NPL ratios and NBFCs are challenged from an equity standpoint. 

Another area of interest is our special situations lending business. We focus on certain markets and industries, coming in where there is a need for flexible capital, hybrid mezzanine lending. We have been doing that in places like Indonesia and Australia. 

There could be pockets of distress, but it’s still early days. There are some questions around the China market – I am seeing some companies getting into stress there – and much depends on macro issues like the trade war. For an opportunity set to become real for us, we need both credit accumulation in the system over several years and regulatory catalyst to force selling. Credit accumulation has happened in China, but you don’t see a lot of forced selling or distress in the system. Bank balance sheets are relatively healthy in Asia and banks don’t have selling pressure in yet, but 2020 could be a year in which that starts to evolve

JUAN DELGADO-MOREIRA, VICE CHAIRMAN AT HAMILTON LANE, ON ASIA FUNDRAISING:

The fundraising total for 2020 will likely be higher than for 2019 simply because some very large funds are expected to close in 2020. Pan-regional funds will probably continue to get bigger and people will worry that they are becoming too big and ask why they are taking up so much capital. We don’t have a problem with fund sizes.

Everyone is moving up a bit. The mid-market guys want to buy larger companies and then the pan-regionals know they can buy the entire portfolios of these mid-market guys. GP-to-GP transactions are growing in Asia, which is totally fine, it’s a sign of the maturity of the Asian private equity landscape.

You will have some managers with the range to do more transactions, even though their fund size has increased. This includes pan-Asian managers that want to remain flexible and able to drop down and so smaller deals if they think they can write a $100 million equity check.

A lot of money has been raised for developed Asia – you see it in Japan and Korea, over and over. But it will be a tale of haves and have nots. Southeast Asia, for example, will continue to struggle for capital. It will take longer for the market to get back to where it was in 2011-2012. The ecosystem remains shallow; there are fewer funds and fewer transactions than seven years ago. The problem is track record in some places, a dearth of opportunities in other places, and generally robust domestic capital markets and family ownership. No one sells in a down market. Whenever you have a down market adjustment, those who can hold on to assets usually do hold on to them.

China is in an interesting position because the US investors – who are big players – have become very shy. They are being very careful given the current macroeconomic situation. They don’t want to be in co-investments or in single assets for fear of CFIUS [the Committee on Foreign Investment in the US] or that their involvement might be disclosed or challenges. Some pension plans have been called into question for investing in the MSCI World Index because a component of the index is China.

China is in an interesting position because the US investors – who are big players – have become very shy. They are being very careful given the current macroeconomic situation. Some of them are shying away from co-investments or in single assets because of CFIUS [the Committee on Foreign Investment in the US] or because their involvement might be disclosed, or they face other potential challenges. Some pension plans have been called into question for investing in the MSCI World Index because a component of the index is China.

These investors haven’t abandoned China, but they are being more cautious. While they can be replaced by Asian money, there needs to be a readjustment. It’s great having a slightly less competitive dynamic in a market where we think the fundamentals are strong. We expect the returns out of China will be good and there will be some surprises in terms of China fund sizes. The recent spinouts have been very successful and then the regional funds are behind in the development of their China teams.

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• Topics
• Greater China
• South Asia
• Southeast Asia
• North Asia
• Buyouts
• Early-stage
• Technology
• Infrastructure
• China
• India
• Japan
• TMT
• The Longreach Group Limited
• Warburg Pincus Asia
• Varde Partners
• Hamilton Lane
• CITIC Capital
• China Growth Capital
• Permira Advisers