Asia Awards: Firm of the Year - KKR

The investment document KKR presented to Panasonic when bidding to carve-out the conglomerate's healthcare division outlined how the PE firm thought it could help develop the business over the next five years.

It was also imbued with experiences of the preceding three years: the operational progress KKR had made with Intelligence Holdings - a Japanese recruitment firm acquired from Usen Corporation in 2010 and sold to Temp Holdings in March - and the Asia-wide additions to its operating team.

"We were certainly comfortable approaching another carve-out from a larger parent. We have done it many times globally but Intelligence was the first time we had done it in Japan," says Scott Bookmyer, Asia head of KKR Capstone. "We were also comfortable in our underlying assumptions as to how to make the company more valuable. There were actual values attached to operational improvements we thought could be achieved in partnership with management."

With more resources available up front and on the ground in Japan, Capstone was able to participate fully in the due diligence alongside KKR's global healthcare unit, making it easier to establish relationships with Panasonic Healthcare's management. But perhaps more importantly, the team was just better versed in forming partnerships with Asian companies.

The acquisition of an 80% stake in Panasonic Healthcare for JPY165 billion ($1.66 billion) - agreed in September and still pending final regulatory approval - was KKR's largest buyout in Japan to date.

Making waves

However, the transaction is also significant in a broader sense. KKR closed its second pan-Asian fund earlier this year at $6 billion, the largest PE pool ever accumulated in the region. Deploying this amount of capital over a 5-6 year period means completing some significant leveraged buyouts and Joe Bae, the firm's head of Asia, has made no secret of the fact that he expects to be more active in Japan, South Korea and Australia. Panasonic Healthcare is an early statement of intent.

From a Japanese perspective, this is the first time a leading conglomerate like Panasonic has sold off a profitable business to a PE investor. According to Hiro Hirano, CEO of KKR Japan, assets were previously deemed non-core because they were losing money. Panasonic concluded that because it didn't have a global healthcare network, a third-party investor would be better equipped to take the business forward.

The parent is also retaining a 20% interest in the healthcare unit, potentially marking out a path for others to follow. "The deal is unique in that Panasonic can share in the uplift of the business and help to some extent," says Hirano. "We have done this with Phillips and Siemens in Europe but I think it can be positively received by Japanese companies."

The caveat is that a positive reception is conditional on the prospective buyer being able to add value to the target business. It is an increasingly prevalent theme across Asia, whether negotiating carve-outs with Japanese corporates or securing minority positions in Chinese family-owned businesses.

Capstone, by extension, is placed in an interesting context. When Bookmyer arrived in Asia in 2010 the nascent team comprised eight people - six in Hong Kong and two in Beijing. This hub-and-spoke model was soon jettisoned in favor of hiring local people for each market in the region. By the end of the year the team will be 18-strong, with five in Hong Kong and the rest deployed around the region.

This expansion also involved the recruitment of senior people in each market. Sakae Suzuki, formerly of McKinsey & Company and Gateway Japan, was the principal addition in Tokyo. He was a prominent participant in the Panasonic Healthcare deal from the outset.

Bookmyer describes the ideal Capstone recruit as possessing a general manager's judgment plus an analytical mind capable of thinking quickly about the major issues confronting a business. Pure industrial experience is often not enough; those offering a consultancy or professional services background as well tend to be most adept at helping existing management teams bring about change as opposed to leading it themselves.

With Intelligence, this collaborative approach was very important. A joint working team comprising KKR and company management drew up a list of potential improvements, including the development of operational key performance indicators (KPIs), implementing sales representative support and enhancing the IT infrastructure. Capstone spent 18 months helping implement these changes, which saw revenue per sales rep rise 50% in the first two years while the number of job placements per career consultant jumped by 30%.

The challenge was persuading the management team of the validity of practices it had not yet witnessed. Sub-teams were set up in the sales and consulting divisions to run pilot programs with narrowly-defined targets intended to prove the operational thesis. But a degree of trust was required to get this far.

"There was a fear that if it didn't work it would reflect poorly on the management," says Bookmyer. "We had to make clear that we were all in this together and if it didn't work then we were just as accountable as them; that we would learn from the experience and try something else. You must have the willingness to try and this can be one of the bigger obstacles. But once we got past it we gained tremendous momentum to expand the programs more broadly and rapidly."

Should the forces driving Japanese corporates to reassess their strategies hold true, this could become the norm rather than the exception.

The need to branch out overseas, tapping new sources of consumer demand in response to flat-lining domestic markets, is well established. Hirano argues that the principal contribution of Abenomics has been to place corporate failings under the microscope. A combination of the stronger public markets and a divergence in performance between good and mediocre companies has forced management teams to pay more attention to stock prices.

Beyond this are longer term considerations such as an easing of the restrictions that remain on foreign capital entering Japan. But just as important, perceptions of private equity are also moving away from the financial sector restructuring that characterized the early 2000s.

"There is a greater willingness to do operational improvement on top of financial improvement," says Hirano. "And then company CEOs and boards are changing - not dramatically, but they are moving in the right direction and starting to understand that they must work in the interest of shareholders. With market sentiment changing as well, we hope the PE business environment is getting better."

Relationship management

An operational value-add thesis is only as strong as the relationships that facilitate its execution and the due diligence process is an opportunity to assess potential partners. This is equally true for control transactions like Intelligence and Panasonic Healthcare as it is for minority investments such as Chinese home appliance manufacturer Qingdao Haier or Malaysia-based Weststar Aviation Services.

An added quirk is the amount of time Capstone spends on the ground with portfolio companies in Asia. While China Modern Dairy required two years of work, with many investments the heavy lifting takes six months and might involve a comprehensive infrastructure build-out, introducing KPIs, HR management and incentive systems, organizational structures, and financial planning and analysis processes.

Of the eight situations Capstone is involved in at present, three are approaching 24 months on the ground and two are 6-12 month projects. The rest are reasonably young but he estimates that some will be reasonably light touch.

This is in part a function of deal type. Growth investments often need more of the enterprise infrastructure build-out support, but the private equity investor's ability to reshape these companies in the event of a market downturn is also limited. There might be agreed upon contingencies - Capstone's preferred arrangement is to be invited in as a resource for management to draw upon - but when an investment is not going according to plan it can place a strain on the relationship with the entrepreneur.

"You look for overlapping areas of consensus and hopefully those are the most important. If that overlap doesn't hit the key issue you bring to bear as much influence as you can without blowing up the relationship," explains Bookmyer. He adds that differences often come down not to strategic intent but time horizon, with the majority shareholder taking a 10-15 year view on an issue while KKR sees swifter action as better for ultimate value creation.

As such, in minority deals there is more pressure on the investor to get the industry and macro thesis right. It is also important to pick the right kind of entrepreneur and make sure he knows what he is getting himself into.

"You have to be transparent with your majority shareholder as to how you can help them and make sure they agree and that is what they would want in their business," Bookmyer says.

SIDEBAR: Strategic evolution

The trends in KKR's China investment strategy can be traced back nearly two decades to when the present China team was at Morgan Stanley Private Equity Asia (MSPEA). They include a tendency to move along the value chain in tried and tested industries in search of new growth.

Earlier this year the firm partnered with CDH Investments to commit $140 million to Asia Dairy, a greenfield farming joint venture with China Modern Dairy that will supply premium raw milk to downstream dairy products manufacturers. Five years ago the team invested in Modern Dairy, another milk supplier, and in 2002 it backed China Mengniu Dairy, the country's leading dairy brand and as of May a significant shareholder in Modern Dairy.

"The industry has consolidated significantly and the top 2-3 players control about 60% of the market," says David Liu, CEO of KKR Greater China. "The room for growth is still there but it's not as great as it once was. That's why we moved upstream to milk supply. We think this is the next wave of growth because the upstream dairy farming business is so fragmented and there is a lack of expertise and scaled players to provide the high-quality raw milk supply that Chinese consumers demand."

A similar pattern is apparent in financial services. In 1993-1994, Liu's team invested in Ping An Insurance, which at the time was a fraction of the size of market leader China Life Insurance, and helped the business grow. In 2009, KKR was among the first PE firms to enter the financial leasing space, backing Far East Horizon, a specialist in lending to small- and medium-sized enterprises.

Liu adds that the investments also track evolving consumer preferences in China. Modern Dairy and Asia Dairy address food safety concerns, water treatment business UEL is an environmental play, and blood bank China Cord Blood benefits from increased spending on healthcare.

"People are moving towards a higher quality of life in general," he explains. ".Ten or fifteen years ago, the consumer businesses we invested in put food on the table and met basic consumer needs. These days we are moving beyond that. People aren't satisfied with just having milk to drink or food on the table, they demand better quality goods as living standards improve."

KKR's acquisition of a 10% stake in home appliance manufacturer Qingdao Haier for $552 million - its largest investment in China to date - arguably represents another step forward, with the private equity firm expected to help facilitate expansion both at home and overseas.

Scott Bookmyer, head of Asia for Capstone, KKR's operations division, identifies supporting global expansion or the improvement of existing international businesses as one of the key emerging themes in his work. "If you want outsize returns you have to find additional paths to profitable growth and we think the ability to help people span the region or the globe is going to be a critical part of that in the next 5-10 years," he says.

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