Indonesia webinar: Turning hype into returns

The participants: Veronica Lukito, CEO of Ancora Capital; Eri Reksoprodjo, partner at Saratoga Capital; Doug Coulter, partner and head of Asia Pacific private equity at LGT Capital Partners; with Mark Bruny, managing partner at Hydrasia Capital, acting as moderator.

On the bright spots in Indonesia's PE investment landscape

REKSOPRODJO: As Indonesia's middle income rises we see the consumer sector as one of the brightest spots. It is not without challenges. Prices are getting a lot more expensive - Indonesia prices are at the top level in Southeast Asia at 16.2x EBITDA, with Malaysia in the 13-14x range. The other challenge is we are seeing more diversified competitors, not only strategic players but also family offices. These are conglomerates that have sold assets and are sitting on lots of cash, trying to build PE-like units in a totally different business to where they have been in the past. We see mining conglomerates looking into the consumer sector now. It's also worth noting that sellers in the consumer space know there are a few more bidders so they aren't necessarily following the sale protocol - signed letters of intent are not complied with any more. There are challenges but we believe in this space because it has so much potential in the next 5-10 years. Food and beverage, healthcare and education are the areas we are currently looking at.

LUKITO: Despite the rush into the consumer-facing sector people need to remember that the market is relatively young. If people are looking for things that are established and have scale, there are only relatively few of them and everybody else is off the charts in terms of scale. Anybody looking at this sector should see this as an opportunity to grow businesses. A lot of growth capital needs to be put in place and a lot of governance. In the next 3-5 years you are going to see a lot of companies in the $300-500 million range, but as of today those size companies are fairly limited in number.

BRUNY: One other bright spot we see is the infrastructure potential. Like all industrializing nations, Indonesia has a great need for infrastructure and we feel as a firm that it is one of the biggest growth opportunities here outside of the consumer sector.

COULTER: We would have to mention natural resources as well. Money has been made in that space, whether it is oil and gas, liquefied natural gas, or palm oil. There are all areas where one can invest.

On concerns about spiraling valuations

COULTER: There will always be investment opportunities, even in overvalued markets, but by any measure Indonesia looks overvalued right now. There was a time in the recent past when Indonesia was trading at double the multiple of the China market, and this just doesn't make sense. There has been a flood of foreign direct investment and portfolio inflows into the country, and valuations are up. One needs to be careful. The Matahari Department Store listing [a partial exit for CVC Capital Partners] was priced at 27x forward earnings - that's a rich valuation for a retailer in any country, irrespective of the quality of the company and the opportunity ahead of it. Investors would be wise not to forget that valuations do matter.
LUKITO: We have already seen some prices going up, but having said that, I also think we are at a stage where all the things you see on paper about high valuations basically point more towards large-size deals. On the smaller size deals, which are not so publicized, you can still find a good bargain if you spend the time and look closely.

On how Indonesian private equity can avoid the same pitfalls as India

LUKITO: Institutional investors discovered India in the mid-2000s and then in 2006-2008 more than $20 billion in PE capital flooded into the country. The growth expectations were never going to be realistic. For Indonesia, the LPs have probably learned some of the lessons of India and we don't see that kind of a rush.

COULTER: Sometimes they learned the wrong lessons. Right now India is out of favor, but we are quite positive on the country: Only 4-5 funds were raised last year and many of the GPs that raised first-time funds in 2006-2007 and don't have exits won't be around for the long term. If anything, that market is likely to get more interesting as the amount of institutional capital declines. Indonesia is still relatively shallow; company sizes are small and the overall economy is small, at least compared to China. So the question is how many PE funds can the market support? There are a number of first-time funds getting capital; all the big regional funds are in the country. There is clearly a lot more interest in the country so the hope is that what happened in India doesn't happen in Indonesia. It hasn't happened yet but clearly in the consumer space it's getting a lot more competitive.

On broadening your exit options

REKSOPRODJO: The most attractive exit option is still through an IPO. We have a proven track record in mining and telecom, but for current deals in the pipeline, we are putting all possible options into the term sheet. We want to make sure that the sponsors are fully aware, pre-closing, that two possible exit options have been agreed upon. The reason for this is that, in other deals, we come across situations where sponsors are only willing to look at one exit mechanism. I guess with the market dynamics now, we need to be a little bit more flexible. Trade sales are on the horizon, but IPOs are still the preferred option, although we want to pre-closing arrangements to be more transparent, and if possible agreed upon by us and the sponsor.

On regulatory and other market barriers, and the time it takes to get deals done

LUKITO: It really depends on the deal. We closed one deals in about two months, which I think was a relatively short time. But there are also been deals we have been brewing for about a year but never really get done. The reasons for this can vary. It might involve problems getting regulatory approval in BKPM [the Indonesia Investment Coordinating Board], but usually that's more of a process as opposed to whether or not the deal can get done. In relative terms, the government seems to be a lot more open in getting foreign investment into Indonesia. For example, there is now a one-stop service for new foreign money coming in. But in terms of getting deals done and dealing with entrepreneurs, it's really a case-by-case basis. It's not really a norm for us that it takes a very long time.

REKSOPRODJO: Each sector has its own regulations in terms of foreign investment coming in. For example, in the banking sector, the threshold is 49% for foreign ownership, but in other sectors it is different. As for how long it takes to close a deal, there is really no one-size-fits-all ingredient. There have been situations where it took us just six months to nail a term sheet, but then one infrastructure deal took us almost four years to sign. We will take whatever time required to get a deal done.

On LPs' expectations of Indonesia and whether they will be met

COULTER: If you are an LP that hasn't yet allocated any capital to China or perhaps India, Indonesia might be a bit of a stretch. In general, what one is finding is that in terms of the LPs that are actually investing in the country - and 2006-2007 was really the start - they are groups that have been in Asia for some years and already have reasonable Asian or emerging markets allocations as a percentage of global allocation. We came across an LP recently whose first Asian emerging market commitment came in Indonesia and we were a little bit surprised by that. But once one has built up a reasonable portfolio in other emerging markets, Indonesia is a natural place to look. You are there for an opportunity in a market that is somewhat opaque, and perhaps can generate better than average returns, in particular through local networks.

BRUNY: A major barrier is actually knowledge. In most of my first conversations about Indonesia, the current market opportunity, the demographics and the macro statistics -the fourth largest country in the world, the second-largest user of Facebook - people generally are surprised. That is the case for investors outside of Asia. People hear the China story and the wider BRIC story but they don't necessarily hear the Indonesia story when they are sitting in Europe or the US and looking to invest.

COULTER: I think on the one hand the challenges remain the same. The topic of today's session is "turning hype into returns" and essentially that's what LPs are looking for - cash returns. There has been a lot of hype and that hype is really relatively new. It's important that people look back and remember that, even though most LPs are fixated on the China story, there was a time pre-Asian financial crisis when Southeast Asia and Indonesia were the focus. Things didn't work out so well last time, so how will they turn out this time? This is really a fairly new market. A small number of incumbent managers that have raised more than one fund. There are a lot of new funds coming into the market, both Indonesia only and Southeast Asia with an Indonesia focus, because it's the largest and most important market in Southeast Asia in many respects. I think the challenges for LPs are very simple: trying to identify which managers will be able to deliver returns which may compensate for whatever risks may be in this market. That's never an easy one.

LUKITO: Right now the private equity market is still in its infancy for Indonesia. There are four incumbent players - ourselves, Saratoga, Quvat Management and Northstar Pacific Partners - and the way things have been set up in terms of legal, team organization, and so on, is reflective of what the global private equity players look like. With that kind of start, I hope we can form some kind of leadership in the industry that would be resonated to other players down the road. Once we have these players set up we believe the market will be sustainable. The second point is obviously the market itself. People are learning what the private equity industry is about and, looking at the opportunities 5-10 years from now and the trajectory on which Indonesia is headed, there is no reason why the market will not be sustainable.

On opportunities outside of Java

LUKITO: For investments outside of Java, you typically see more resource-based deals. Balikpapan [on the east coast of Borneo] is one of the highest GDP-earning cities in Indonesia and it's been an oil city for a long time. Certainly you will see a lot of people getting into that area on a resource play. Having said that, the infrastructure support in these cities is also growing - real estate is booming, there is a lot more investment in healthcare and education. This is expected given how Indonesia has been growing in the last five years, and that's mainly due to the resource sector. Certainly, the government has already identified a few key geographic areas where it would like to see more development and money from foreigners being invested.

On the implications for private equity of the 2014 presidential election

REKSOPRODJO: It should only be a concern if your investment has been in the country for several years and you are planning to exit by way of IPO in 2014. The IPO market might not be that conducive. A change of leadership will take place in terms of the political party that rules the country, but it shouldn't matter much in terms of investing in certain sectors.

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• Topics
• Southeast Asia
• Investments
• Exits
• Fundraising
• Regulation
• Indonesia
• Growth capital
• buyout
• Southeast Asia
• Fundraising
• Exit
• regulation
• Saratoga Capital Group
• Ancora Capital Management
• LGT Capital Partners