Crystal ball: Predictions for 2014

DAVID GRAYCE, MANAGING DIRECTOR AT PACIFIC EQUITY PARTNERS, ON AUSTRALIA

We expect a number of important currents to continue into 2014 as the environment for mid-market buyouts in Australia and New Zealand shifts back from what have been constraining conditions, towards more favorably normal ones.

On the new acquisition side, momentum has picked up materially. Australia and New Zealand is the fifth biggest M&A market in the world, however after an active 2012, activity in the first half of 2013 was well below average. That lull may have related to vendor uncertainty created by the unusually long eight-month Federal election campaign which ended in September. Since then, we have seen above average activity levels. Companies with solid business models and good market positions but misaligned incentive structures that struggled in the multi-speed economy are coming to market.

Leverage markets have changed and are increasingly supportive. Through 2013 we saw a number of globally active, fund-based leverage providers enter Australia and New Zealand for the first time. Predominantly but not solely focused on the middle tranches of the capital structure, these funds are expected to bring product breadth and pricing tension to an already healthy debt market, as always underpinned by the reliable AA-rated Australian banks.

Also during 2013, sponsors with high-quality assets were able to access the US Term Loan B market for the first time, bringing additional financing flexibility and quantum into local markets. However, this development is less likely to be a persistent feature.

The outlook for operating conditions for the 90% of the economy that is non-mining will continue to improve. Post-crisis, the economy has been more resilient in Australia than in other markets though the intensity of mining activity did crowd out some other sectors. As the mining boom continues to move through the capital expenditure stage into the production stage, the outlook for businesses outside that sector has improved.

While there will be a delay before the full benefits of lower interest rates and a more competitive currency flow, that expectation is already being reflected in higher levels of business confidence and improved consumer sentiment.

Similar forces support equity capital markets, which will likely continue to afford liquidity into 2014. Australia has the third largest equity market in Asia capitalized at $1.4 trillion, and flows from the mandatory superannuation retirement savings scheme drive growing demand for equities. Market valuations are above long-term averages and investors are receptive to IPOs from sponsors.

The level of structural competition for assets in mid-market buyouts will continue to be subdued. A long established segmentation exists in the local market and a number of previously active players have exited in recent years.

RICHARD FOLSOM, CO-FOUNDER OF ADVANTAGE PARTNERS, ON JAPAN

For Advantage Partners, 2013 has been a record year in terms of exits. We have also done four new deals, and our pipeline looking forward is fairly solid. We anticipate a continuation of the momentum seen over the past year both in terms of exits and new deals. While I think public market performance over the past year is going to be a benchmark for seller pricing expectations, I don't think it is an indication that deals are going to be overpriced. If we look at the most recent deals we closed in October, both were at reasonable 4-6x multiples.

On the other hand, public market conditions will likely have a positive impact on new deal flow in that entrepreneurs who have been thinking about exiting businesses are more likely to do so now. They see that pricing, market conditions and the performance of their company have come to a level at which they are more willing to do a deal.

When we do see higher acquisition prices in the market it is usually in the context of heavily auctioned deals, but those are still in the minority. Most of the small and mid-market deals are more closely shopped, if they are shopped at all. Local financial advisors will talk to two or three potential buyers, work with the seller to identify the best fit - and not only in terms of price - and then move things forward under that process. In such cases people are not necessarily paying 8-10x EBITDA, more like 5-7x.

We will continue to see a lot of succession deals with founder-owners as well as a few public-to-private deals, and some secondary activity. Another pillar of the market has been large corporate divestments. I am sensing right now, with the public markets up and large corporate earnings up, the sense of urgency to move forward with these divestments is dropping off. So I think, if anything, in the current environment we will see more ebbing again instead flowing in terms of activity from the large corporates.

FRED HU, FOUNDER OF PRIMAVERA CAPITAL GROUP, ON CHINA

The outlook for China in 2014 has improved significantly compared to previous years. From a macroeconomic perspective, the investment climate has improved on the back of the recent Communist Party Central Committee meeting, which has brought about the most ambitious reform program seen for several decades. This is set to generate some attractive investment opportunities in the Chinese economy.

The capital markets reform and the resumption of IPOs will be very important in the coming year. In addition, the significant reduction in government approvals needed to make business decisions will be a big plus, streamlining investments and reducing deal uncertainty.

Given the large backlog of companies waiting for IPO it will not be an overnight change. But over the next year we will experience a rare and robust IPO environment. A lot of companies will come to the market, creating excitement among public investors and providing private equity investors with essential exit routes. As the capital markets develop at a faster pace, and in line with global standards and practices, it will bring about more confidence among LPs.

Issues over regulation, economic and political uncertainty and depressed public markets have made it difficult to invest in China in recent years but 2014 could well prove to be a crucial turning point. Structural reforms, better transparency and more confidence in the business community should all provide a positive backdrop for private equity investors.

We will continue to look across many sectors and industries and the number of opportunities is going to expand significantly. Not just next year, but over the next 5-10 years, China will be one of the most crucial and most active private equity markets. My only big concern would be slippage in executing the reforms. That would be a huge disappointment - not just for private equity but for all investors.

JAVAD MOVSOUMOV, EXECUTIVE DIRECTOR AT UBS PRIVATE FUNDS GROUP, ON FUNDRAISING

The most important factor is how much capital LPs will have to allocate private equity in the next year. If you look over the past years, a big chunk of the capital that went into Asia came from North America - either directly or via a fund of funds. The good news in that there has a been a lot of capital coming back to North American LPs from their North American PE funds, so my hope is the amount of capital available for investment in PE on a global basis will increase.

The stock market in the US has also performed very well this year and the "denominator effect" will now work in favor of allocating more capital to private equity.
How much of that will filter down to Asia is still a question mark, as there are concerns over what has been happening in terms of liquidity and exits in China. I see a lot of LPs starting to reassess whether it would make sense to commit to straightforward China growth equity funds or whether they need to find a different strategy or look to different geographies.

The fascinating thing is that, despite PE being a long-term asset class, the change in LP appetites towards different geographies and strategies occurs rapidly. The China growth strategy has for many years been by far the largest capital raiser in Asia. However, given the lack of IPOs and exits in the last couple of years, there has been a bit of a rethink.

Despite the slowdown in interest, China will continue to be an interesting market simply by virtue of its size. LPs are just being a bit more discerning in terms of what kind of strategy they are backing in China. Without a doubt there are a lot of opportunities to make good returns and the economy is still growing at a good pace.

Southeast Asia has been attracting significant amount of investor interest recently, translating into larger funds raised by established firms and a number of younger private equity teams getting established. Japan has got quite a bit of interest this year, although I do not know to what extent interest at a conceptual level has translated into funds getting closed.

India continues to be a market that has proven to be difficult to make returns in and mangers continue to have a difficult time in raising capital. Australia and Korea as developed markets are in the middle of the pack in term of attractiveness.

PAK-SENG LAI, MANAGING DIRECTOR AND HEAD OF ASIA AT AUDA INTERNATIONAL, ON FUNDS-OF-FUNDS

I think there will be more consolidation among funds-of-funds - particularly Asian funds-of-funds. There have already been a number of acquisitions in recent years. Too many Asian funds-of-funds have evolved over the last 4-5 years and I think going forward only two kinds will sustain. The first will be the global players offering global solutions - like us - that help provide solutions for those entering the asset class for the first time.

Basically, it is the one-stop shop model that will prevail and players with global scale will continue to grow as more people enter the asset class.

On the other extreme, there are funds-of-funds with niche strategies that will fill a certain gap in a global portfolio. Investors from the US, for example, may have good knowledge of Europe and Latin American but they don't know much about the small players in Asia. Even if they do, they often cannot invest because of minimum ticket size constraints. Creating a niche sector of smaller funds in emerging markets could potentially be attractive to global investors. Funds-of-funds are more driven by investors' needs than by investment opportunities available - so a tailor-made solution will be important.

In terms of fund selections, five or six years ago it was very story-based. Everyone was too young to be proven so it was investment by faith - you listened to their story and made an investment decision. Now GPs can no longer say it is too early to tell, they need to deliver numbers.
There is also a polarization of the fundraising market. I see managers that have good teams and track records getting oversubscribed before they have even launched. On the other hand there are managers who will take two years to get a first closing - so there is a flight to quality.

TIM FLOWER, PRINCIPAL AT HARBOURVEST PARTNERS, ON SECONDARIES

I would expect GP restructurings to gather pace. Some GPs have struggled to generate sufficient liquidity to raise interest in their next fund, so they are trying to do something that might provide liquidity and help with fundraising.

The question over Asian private equity is whether the additional risk has offered sufficient rewards. I think you will have smaller teams that are probably going to fail to raise their next fund. It will take them a bit of time to realize that they are running short of options. Many GPs are wary of doing secondaries but I think they will get to grips with that. Eventually I expect as much activity in Asia as in any other part of the world.

I don't think it is unreasonable to say India has been the most dysfunctional private equity market. We have looked at a lot of things in that country and there are still pretty unrealistic expectations on things like growth rates and valuations.

I think the market has been larger this year, straightforward LP deals in particular have been trading at incredible prices as a result of relatively low supply. What has been interesting is that we have seen proportionately more trading in country-specific funds and perhaps less well-known names, whereas before there had been more activity in the pan-regional funds. People are paying very high prices for first- or second-time funds and not discounting the franchise risk as much as they should.

I think pan-regional funds all did reasonably well over the past 12 months and as people have seen quarter-on-quarter improvement in NAV they have thought "Why am I selling?" There have been more portfolio management sales rather than any liquidity-driven sales so I think LPs have therefore started to look at selling off their B and C managers.

DAVID BROWN, TRANSACTION SERVICES LEADER AT PWC CHINA AND HONG KONG, ON DEAL ACTIVITY

In China, there are two factors to drive transactional activities higher in 2014. Firstly, demand for capital from China's private sector companies meets supply of capital in the private equity community, and the desire to spend that capital. The second driver is the backlog of exits, which I think is the single most pressing issue for the private equity industry in China. The latter will drive more IPO activities, albeit coming off a very low base, and it will drive more M&A exits.

There will be a move to secondaries although this is still very small at the moment. There will also be a move from growth capital to buyout deals, at least partly because of the perception that exiting minority stakes will continue to be difficult in China.

However, a limiting factor will be GPs' ability to find control deals. I think that the good quality, professional GPs will deploy more money, but perversely the overall deal numbers are going down because of the trend from higher-volume lower-value growth capital deals to lower-volume higher-value control deals, and also because we continue to see consolidation with many of the more peripheral players dropping out of the market.

Nevertheless, the number of PE M&A engagements we're advising on currently is more than double the same period last year.

Another nascent trend is an increasing interest in outbound investment. Several Hong Kong and China-based GPs are looking to invest in foreign companies where those companies have China angles. They will usually be in partnership with foreign GPs and are looking for deals. China GPs will bring some capital but also know-how and relationships to help foreign companies grow their business in China. Partnering with foreign PE firms is important in order to make sure they pay the right price for the overseas assets.

Over the medium term, there is potentially a huge amount of institutional capital becoming available to domestic managers. Some of this capital will look for diversification opportunities in overseas markets. While global PE firms like Bain Capital, The Carlyle Group or TPG Capital raise capital overseas and invest in China, large local PE firms such as Hony Captial, CITIC Private Equity and Sailing Capital will raise capital domestically and invest some of it overseas.

China will have its own local mega private equity firms. It will take a few years, but that's the direction.

SHASHANK SINGH, PARTNER AT APAX PARTNERS, ON INDIA

We expect a good investment climate relative to this year. It looks like the economy is turning a corner, with the macro improving. Let's see what happens in the general elections - if there is a clear mandate in one direction that will be helpful in terms of giving direction to policy.

From a global macro perspective, things are improving as well. The US employment report last week was positive, and Europe seems to be turning the corner. Those are all positives for the Indian investment climate. Certainly in our sectors of operation there has been a correction in valuation. It will be interesting to see if the correction persists when there is a sharp upswing in sentiment and flow of capital.

The Bombay Stock Exchange's Sensitive Index (Sensex) hit new highs this year and the key phenomenon is how that flow of capital concentrates, because over the last 12-18 months a lot of capital came into the largest companies, to the Sensex constituents, and a lot less into the mid-market. This is where we saw opportunities and the ability to get better valuations because the mid-market was starved of capital, whether equity or debt capital. So providers of capital like us, who did have money to spend, were getting better opportunities.

While the Sensex is at 21,000 points, representing the largest companies, the BSE index for mid-caps is in the 6,000 range, 40% down from its peak. If that difference persists in terms of the nature of capital flow, then we will continue to see good valuations. If the capital ends up across the board then perhaps the lower valuations may not persist and people will benchmark more off of the rise in the index. Having said that, if LP appetite for India continues to be restricted this would perhaps signify that the separation will continue.

In terms of deal flow, our pipeline is much more weighted towards buyouts at the moment, which I think will be a continuing trend. We're seeing a lot more secondaries from other funds looking to exit portfolio companies and that will continue to be an opportunity.

PAUL KANG, SENIOR PARTNER AT HEADLAND CAPITAL PARTNERS, ON SOUTHEAST ASIA

Southeast Asia as an investment destination continues to be very interesting. We've announced three transactions and closed two this year. The pipeline continues to be extremely healthy.

From a regional perspective, everyone says they have spent a lot of time in Indonesia and they probably haven't been able to get very far. In the near term, at least over the first 6-9 months of next year, that's likely to continue. I think the market has become overheated. There is a lot of liquidity chasing relatively fewer opportunities in Indonesia. That imbalance will be likely corrected out.

In the meantime, I expect that deal flow to come out of Malaysia, Singapore, as well as some from the Philippines. We closed our first deal in Vietnam recently and we think that is a very interesting market going forward. Myanmar is probably still too early for us - also, bear in mind we are looking to deploy $50-100 million in capital per transaction. We're looking to do smaller transactions here only if corporate governance doesn't become so much of an issue.

The vast majority of deals we've done recently in Southeast Asia have been buyouts, and overall they have been significantly increasing in size. I expect to see this trend continue in 2014. It can be probably categorized like this: Out of more developed markets, including Malaysia and Singapore, we will see more buyout transactions, as you have families dealing succession issues or shareholders transitions; other markets will continue to be more growth capital-oriented.

Generally, the opportunity is more for pan-Asian funds the single-country funds, because of their ability to shift geographically in response to interesting dynamics emerging over time. The Philippines, for example, may have some interesting opportunities because of its growing middle-class and rising consumer expenditure.

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• Topics
• North Asia
• South Asia
• Greater China
• Southeast Asia
• Australasia
• Fundraising
• Advantage Partners
• Headland Capital Partners
• Primavera
• Apax Partners
• Pacific Equity Partners
• UBS
• PwC
• HarbourVest Partners