Q&A: Hamilton Lane's Collwyn Tan

Q: In the first quarter, 2020 was projected to be a slow year, but that hasn’t quite played out…

A: This has been an exceptionally active year for Asia. Given how Asia has historically contributed about 60% of global growth and where Europe and the US are right now, we expect that percentage may increase in the near term. Asia is getting to the point where it’s just too important to ignore, even in light of the pandemic. Hong Kong and Seoul were some of the first places to go through lockdown and testing measures, and as a result, they were also the first to recover. On the direct equity side, for example, by the end of September, we were receiving deal flows that were 30% higher than last year. That’s $1.3 billion of deal flow for the first three quarters compared to the $1-1.2 billion we normally see annually.

Q: How has that translated into investment?

A: We’ve continued to be very selective and kept our hit rate quite low to less than 10%, investing just north of $100 million directly into Asian companies this year. So, there has also been an element of caution. There’s still quite a lot of dry powder and assets under management that’s been raised, and many private equity practitioners are taking advantage of the climate, but fundraising has been slow. It’s been very challenging for first-time funds to come to the market. Most of our sponsors are being cautious. Even though they might be willing to pay a higher purchase price for an asset they like, they are not deploying more quickly this year. If anything, some entered the year with the expectation to deploy more slowly.

Q: What have you seen in terms of valuations?

A: Currently, you really have to be mindful about entry valuations, which actually have not come down at all in Asia. Since 2019, when there was talk of a top for asset prices, they have continued to go higher. But buying higher doesn’t necessarily mean a lower return. Quality assets command a premium, and we have found that valuations are not always a very good correlation to performance. What really concerns us is the pace of contributions. If we see a lot of sponsors start deploying money at a very fast pace, that can have an inverse relationship to performance.

Q: How has the mix of deal types evolved?

A: Most Asia private equity managers have pivoted to a buyout strategy, but deployment has been mostly venture and growth equity. That phenomenon has been driven by the opportunity set. Sponsors are essentially coming to market saying they want to have control because they can have more operational impact, but they don’t want to miss out on the next big thing by being inflexible with their mandates. This trend has been in place since around 2018, but has been accelerated by the pandemic given growth within tech, enterprise solutions, and e-commerce verticals. There are now many sponsor-backed companies in the healthcare and software sectors listed on the Hong Kong Stock Exchange.

Q: Has your ratio of buyout versus growth exposure changed this year?

A: Not materially when it comes to dollars, but it has in terms of the number of manager relationships. We have been adding more venture and growth equity partnerships simply because there are so many more proven managers now in Asia, especially China. We now have a deep rolodex of  local sponsors here that are cycle-tested in these growth sectors and operating opportunistically.

Q: How have you benefited from the shift to growth?  

A: The risk-reward is different. In buyouts, managers today are often very hands-on and looking for a 2-3x return, whereas in growth, maybe there isn’t as much influence, but the manager will target more like 3-4x. On the directs side, we are starting to partner with sponsors on some of these late-stage growth deals as well, and have been tracking that space since 2018. China has comprised about 70% of our APAC deal flow, then Japan and Korea are 20%, and Australia and Southeast Asia are the remaining 10%.

Q: How is COVID-19 impacting the sectors you’re watching?

A: In 2018, when the average prices were generally around 10x EBITDA, our CEO Mario Giannini suggested the music would stop with a crisis in 2020. He called it, and he essentially challenged us to look through about 4,500 active funds in our system spanning the global financial crisis, the dotcom bubble, and the Asian financial crisis. The one thing we found in common across all these disruptive events is that certain consumer sectors experienced a short period of negative growth and then returned to normal. These included grocery, tobacco and liquor, pharmacies, and even color cosmetics, to name a few. We started tracking sponsors that had exposure in these areas early, and that has carried into 2020.

Q: Have there been any surprisingly promising areas?

A: I think the market may have overlooked traditional grocery. If everything comes back to normal with the pandemic, and supermarkets can fend off some of the pure online grocery platforms, they may have a surprising upside in terms of the conversion from offline to online. Many start-ups in this space are essentially situations where the venture capitalist is subsidizing the customer. To sustain that user base, you really need offline density. That’s a better way to address the online market than burning cash. The market has not realized this is a game of density as opposed to merchandise volume. It’s capital intensive for start-ups to buy small cold storage spaces, but supermarkets can literally just draw out a section of their existing storage space to address certain proximities.

Q: Have you made any commitments in this area yet?

A: We came across a possible investment in one of the leading grocery operators in China on the back of a very large acquisition in 2019. We’re not only buying it because grocery is viewed as defensive and resilient across cycles – we’re also buying it for the potential upside. Offline grocery is about as unsexy a space as you can find, but because it’s often overlooked, the entry prices have been very reasonable, and there’s still a playbook here. There is a very real risk of losing market share to online platforms, but because we have been tracking this space for two years, we could see a different way of getting that technology return.

Q: What areas of concern have you identified?

A: We’re tracking the whole education space very cautiously. There are just so many of them right now. There are a few big names with valuations in the tens of billions of dollars, which mainly do online tutorials. That has every reason to exist, but we’re also seeing online arts and crafts, and we’re not so sure that all of those are going to be around in the future. These apps require a lot of investment in technology, and the cost of customer acquisition is very high because the number of tutors is finite and there are so many competitors. Ballet and piano lesson apps might have been nice to have during Q2 lockdowns, but we don’t know how sticky that behavior will be.

Q: What are you seeing in terms of exits?

A: Even in the equity markets, we have seen quite an influx of capital. There are over 200 PE-backed companies that have gone public this year, about 55 of which are listed here in Hong Kong. We’re seeing more trade deals, but that hasn’t increased dramatically this year. Asia has been more reliant on IPO exits, but we don’t think that’s a bad thing in macro terms. There has been a lot of regulatory reform that has generally made the capital markets more sophisticated and stable. Hong Kong has adopted standards that were not allowed historically. There are more flexible rules in Shanghai and Shenzhen that mirror NASDAQ and the New York Stock Exchange by allowing dual-class shares. Global hedge funds are paying more attention to Asian capital markets. These are all positive signs of increased maturity.

Q: What other signs of maturity have come to the fore this year?

A: We are seeing an increase in direct secondary deal activity, with sponsors exiting to other sponsors. That game has been played for a decade or longer in the US and western Europe, but it’s only now where some of the sponsors in Asia have managed multiple vintages and have assets that are long in the tooth. Instead of selling them to trade sale buyers, they’d rather run a process with some of the financial investors that are similar in terms of understanding the business and knowing the diligence process or the back-and-forth of the transaction dynamics and timetables. There have been a handful of those in 2020, especially in Japan and Korea.

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• Topics
• Greater China
• LPs
• Investments
• Exits
• Fundraising
• Hamilton Lane
• Education
• Food
• Direct investment
• covid-19