The crystal ball: Predictions for 2016

MOUNIR GUEN, CEO AT MVISION, ON KEY TRENDS IN ASIA AND GLOBALLY:

There was a habit in the early 2000s of using fundraising as a barometer for the health or activity levels in the industry. Today it is very much a reflection of who is in the market - if big funds are in the market, statistics will be high - but not a reflection of activity or investor interest. Fundraising statistics also don't pick up a lot of the direct done by investors, whether it is through co-investment or direct.

The only way many investors will be able to achieve their return targets, and in a way that gives them more safety, is through geographic diversity. They are quite highly concentrated in the US and somewhat in Europe, but they are still very light on Asia. And when you look at the absorption capability of a lot of these markets, it is limited. In India, for example, the larger funds are $500-700 million in size and you can count on two hands the number of them in the market. If you go to Japan, Korea, India or Southeast Asia, there are no local funds of $3 billion or more, but they will come.

The dynamics of change coming out of Asia - for example, corporate activity out of Japan and Korea, the powerful positioning of China - are heading in the right direction. And underlying that movement is very strong asset growth within Asian institutions. Assets are growing because of the demographics in those countries and the strong consumer-related aspects associated with that. The most interesting markets over the next 12 months in terms of new capital will be insurers in China, pension plans, sovereigns and insurers in Korea, and insurers in Taiwan.

Something to watch in the US in particular is the movement from defined benefit (DB) to defined contribution (DC). A large number of corporate pension plans in the US used to be DB, with the liabilities held on the balance sheets of those institutions. By moving to DC it completely changes the risk dynamic and also comprises the return choice that the capital might have. With DC, any vehicle that allows access to private equity has to remove the j-curve effect and this requires a reliance on building exposure either through an existing listed vehicle or a secondaries pool. That structural challenge is about to be opened up.

FRANK TANG, CEO OF FOUNTAINVEST PARTNERS, ON CHINA:

I don't think 2016 will be too much different from this year. There will be a mixed views on China's economic slowdown, given the overall weak market sentiment, as well as stock market and currency volatility. On the other hand, a lot of emerging sectors are still growing, in particular in the areas of internet, consumer and lifestyle. While it's difficult to predict how many China-focused GPs will go back to the market to raise funds, there are also mixed views towards China from LPs. They are concerned about GDP growth.

Several private equity firms are making investments in late-stage technology companies and I think this will continue. In addition, there is an increasing number of China take-private deals. Hong Kong and the mainland present attractive markets for them to relist, so I expect this trend will also continue next year.

The activity of raising renminbi funds to support take-private deals is already happening, especially for companies in restricted industries such as the internet. For internet companies being taken private, renminbi funds will play an increasing role. FountainVest previously supported the Focus Media take-private. However, Focus Media wasn't in a restricted industry; it's an advertising business and 100% foreign ownership is permitted. As a result, there was no issue of renminbi funds or US dollar funds. That's the same for companies operating in the hotel business, for example. But internet companies have traditionally used VIE (variable interest entity) structures to list overseas. When they come back to China, it poses a problem because VIE structures are not allowed in China. That's where the renminbi funds will come in.

In terms of exits, I think the environment will be generally improved following the gradual opening up of the capital markets. A new listing market called the Strategic Emerging Industries Board will probably come into operation late next year. It's going to be a significant movement for China to go from the current approval-based system to a registration-based system. This will help open-up in the A-share markets, is good news for private equity firms seeking exits. Regarding the New Third Board, it is a little bit unclear to me how this market is going to develop, but it has been generally helpful in terms of market sentiment.

KYLE SHAW, FOUNDER AND MANAGING DIRECTOR OF SHAW KWEI & PARTNERS, ON ASIA MID-MARKET BUYOUTS:

There will be a relatively little growth in the overall economy. I don't think it will be bad or particularly good, I think it's just going to be kind of the same globally. Having said that, certain areas are more exciting and benefit from higher demand growth and opportunities for change. For example, logistics and manufacturing could be exciting. But it's really about making high-quality products. I am less interested in garments or sport shoes for which you rely on low-cost, low-wage operators in Indonesia, Myanmar and Bangladesh. It is more interesting to invest in places such as Malaysia, Singapore, China and Thailand, where you have some technical people making high value-added products.

In terms of deal size, I think 2016 will present good for opportunities for smaller deals. There are a lot of business owners or managers who will eventually retire and don't necessarily have a clear succession plan. If an IPO is not an option, they need to sell. Another factor is that an individual can run a business generating $20-50 million in revenue with a small team; some may put together a few good managers and get to a few hundred million. But it is almost impossible for them to go beyond that, because they don't have the right financial controls, corporate governance and other practices. We can come in and take companies to levels that they just can't reach by themselves any more.

Meanwhile, multinationals are also looking for acquisitions in Asia, so trade sales will become a good possibility. A lot of companies probably need a transition period from being controlled by an owner-manager to a private equity firm, and a trade buyer. And a trade buyer probably isn't ready to source deals on its own in the region. We see a lot of potential in terms of repackaging businesses and transforming them into attractive candidates for those trade buyers.

KARAM BUTALIA, CO-FOUNDER OF KV ASIA CAPITAL, ON SOUTHEAST ASIA:

2015 has been a difficult year to pin down deals because of so many moving parts - exchange rates have swung around, commodity prices have swung around (and Southeast Asia is a net exporter of commodities), and the China slowdown has also affected business. If you added it all together, by the time you had done due diligence on many businesses, the prospects did not justify the price. We are a lot more optimistic about 2016.

The world all over is facing a lot of liquidity and investors are being driven to more and more risk globally and in all asset classes. We have seen some kind of correction to that trend in 2015, because the risk - whether it's commodities, currency or emerging markets exposure - has come through. We try to put capital to work in a risk efficient manner and we think some of the froth has been taken out of the market. Malaysia is more fairly priced now, but Indonesia has some way to go - the risk efficiency is still not there. We are more hopeful that pricing will come in line with what is the right capital allocation. We feel the correction will come sometime during 2016.

We have four key sectors: healthcare, consumer-related, energy services, and light manufacturing or precision engineering. With commodity prices declining, we expect to see a lot of winners and losers in energy services. Another trend we see is that some countries are becoming more inward-looking. We are positive about the ASEAN economic community but the non-tariff barriers we see on the ground require a lot of work.

GEOFF HUTCHINSON, MANAGING DIRECTOR AT PACIFIC EQUITY PARTNERS, ON AUSTRALIA AND NEW ZEALAND:

We have agreed to New Zealand deals Manuka Health and Academic Colleges Group in 2015, and earlier in the year in Australia we bought Pinnacle from Kerry Group. The pipeline has been healthy this year and it is looking good for 2016.

Has deal flow been weakened by companies going IPO? That doesn't really reflect our experience. There were one or two deals at the margin in 2014 that we would have liked to invest in that ended up going public instead. The IPO market has been open for good businesses, but not those with problems - and we often look for businesses that aren't perfect because we can help fix those problems.

One quarter of the deals we have done were public to private, half have been carve-outs, and a quarter from private vendors. We are looking for businesses with strong competitive positions where we have a view we can drive profit growth. These opportunities are typically independent of market cycles. Often decisions to sell businesses are more strategic than cyclical. For example, Australia was the only place in the world Kerry made prepared bakery goods, so Pinnacle was a non-core subsidiary.

While we are sector agnostic, we would be reluctant to do mining, but maybe still mining services. We will try to minimize our exposure to any industry where there are external factors that can overwhelm what we have control over - mining and commodity prices, agriculture and grain prices and weather events. That aside, we will look at most industries. We see quite a bit in consumer, business and industrial services, and now also healthcare and education.

SHINICHIRO KITA, SENIOR PARTNER AT ADVANTAGE PARTNERS, ON JAPAN:

We have completed six deals so far in 2015 and expect another to close in December. Particularly in the mid-market in Japan, we see a lot of attractive deal flow. Two of our deals are corporate carve-outs and five are owner succession deals. Private equity is becoming more common in Japan, and so when we talk to owners about succession planning, they understand we are an option and potentially a better option than selling to a competitor given our value creation capabilities to drive future growth. These owners are concerned about how a business will grow after a private equity investor comes in, so having successful examples of past transactions is helpful. Recently, we have also seen cases of owners selling who are not at the traditional retirement ages, as well as some serial entrepreneurs selling their businesses to start new companies with the proceeds. We believe this trend will continue.

As the Japanese economy has improved, valuations in the capital markets, including private equity, have gradually increased. Lenders have also become more aggressive, leading to tighter leverage in certain situations, which is also contributing to higher pricing. We have focused on deals where we may be able to secure full or partial exclusivity, by being creative and addressing sellers' needs.

SCOTT HAHN, CEO OF HAHN & CO, ON KOREA:

There have been a lot of privately negotiated transactions among the big conglomerates as they sell businesses to one another - for example, Samsung Group with the Hanwha Group and the Lotte Group. We are starting to see more M&A activity, and I think activity will continue to be pretty brisk. Corporates are coming under pressure given downturns in a number of industries globally. Then there are major business groups making strategic decisions to sell assets. We call it "select and focus" and it's becoming increasing the strategic choice in Korea these days.

How much of a role private equity plays in all this remains to be seen. Apart from our deal with Hanjin Shipping, private equity hasn't done anything with a top-tier Korean conglomerate in terms of a full divestment. The big divestments have been by foreign strategic companies. But we are seeing some succession planning deals and potential divestments by Korean sellers that want to select and focus. Partners that offer strategic value will be sought after.

As for exits, there are certain sectors and types of business where private equity investors must decide that what they acquire is going to be of great strategic value to Korean corporates, which are the most likely source of M&A. You need to make that decision internally. It's not foreign strategic investors, foreign private equity or domestic private equity that is responsible for the bulk of M&A; it is domestic strategic players buying and selling from each other.

J.P. GAN, MANAGING PARTNER AT QIMING VENTURE PARTNERS, ON CHINA VENTURE:

The venture capital market may not be as hot as in the first half of 2015, but next year there will continue to be a lot of activity in terms of fundraising and exits - either through trade sales or domestic listings.

There are a few reasons for this. The US Federal Reserve will probably keep easing monetary policy and the European Central Bank will do the same. The whole world is flooded with liquidity and a lot of it is looking for a home in growth markets.
China's GDP is only growing at 7% but this is still relatively high in global terms. India is similar but it's a smaller economy and so investors find it harder to deploy a lot of capital into the market. If you look at China, all the internet, healthcare and technology-related business are doing pretty well. The government is also encouraging venture capital to support entrepreneurship. Overall, I believe the VC market will remain healthy and vibrant.

There will be a lot of exit opportunities in the domestic markets too. I don't expect a lot of overseas IPOs next year, because the valuations you get in China are much higher. The regulator has re-opened the market for domestic IPOs earlier this month and the first batch of companies to go public are trading very well now. Meanwhile, people are hoping to list companies on the New Third Board or soon-to-open Strategic Emerging Industries Board. If you look at the M&A market, the BAT - Baidu, Alibaba Group and Tencent Holdings - are still acquisitive or making strategic investments. Other companies will follow suit.

However, I think there will be a little bit of slowdown in the angel investment side. In the first half of 2015, everyone was flocking into early-stage investments, even though they might not have deep pockets. The market will become less crowded as people become more rational following the stock market crash this year.
In terms of sectors, I think online-to-offline (O2O) continues to be an interesting sector. We're also looking at new information technology, big data and smart devices. In addition, we are spending a lot of time on the online content creation side, such as literature, movies and animation. This segment is going to attract a lot of attention from younger generation.

There will continue to be a lot of consolidation in the internet space, given smart phone sales growth has been slowing and smart phone penetration in most Chinese cities is relatively high. For companies focusing on one business area, it will probably be difficult to get new users. They have to consolidate in order to increase their revenue as well as profit margins.

DOUG COULTER, PARTNER AT LGT CAPITAL PARTNERS, ON THE LP PERSPECTIVE:

A small group of managers raises money without working very hard at it. This is usually because they have a credible track record, they aren't raising too much money, there is a strong alignment with LPs, and maybe some differentiation in the strategy. If you have some or all of those you are going to find it easy. Otherwise, it's just really difficult because a lot of LPs are not back to pre-global financial crisis days when they were throwing money at emerging markets. Looking back, these are probably going to be good times to invest in emerging markets because so many people are afraid of them and cutting allocations to them, but for GPs that are fundraising it's difficult.

Even though we have a strong preference for China, everything we do is bottom-up so we don't think about what is interesting right now from a macro perspective. Money raised in 2016 is going to be invested over a 3-4 year period and nobody has any visibility on what the macro situation is going to be in the likes of China, India and Japan over such a long period of time. With co-investment and secondaries it is a bit different because you can value particular assets, but with blind pools of capital all you can do is decide which markets you like from a top-down perspective and then continue to allocate capital consistently through the cycle.

There is specialization in the venture space for TMT [technology, media and telecom] and then healthcare and maybe cleantech a bit. But the jury is out. We haven't seen strong outperformance by sector-specific funds in Asia. A one-off fund may do well, but if you look across the board there is no evidence to suggest that sector-specific funds do better than generalist funds. For example, most LPs like healthcare from a top-down perspective but it's a difficult sector. Even if you have some exceedingly good doctors and scientists who come together to form a fund, it doesn't necessarily mean they will do well.

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• Topics
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• Shaw Kwei & Partners