AVCJ at 25: George Raffini of Headland Capital Partners

The recent wave of economic and political reform in Myanmar has prompted talk in private equity circles about a new addition to Asia's clutch of frontier markets. But this isn't the first time Myanmar has appeared on the agenda. For about two years in the mid-1990s the country became a destination for investors in timber and tourism before disappearing off the map.

"Many firms were beating a path to Myanmar but the window closed almost as soon as it opened," says George Raffini, chairman at Headland Capital Partners who at the time was heading up HSBC's private equity unit in Asia. "We had colleagues who went there but they said, ‘Not in my lifetime.' It was the political situation but also the corporate mind-set. We all wanted to invest in businesses that weren't just a bunch of guys who felt the wind at their back, were raising a few dollars and then saying, ‘See you later.'"

Other countries in the region were able to sustain interest for longer periods, but private equity's brief flirtation with Myanmar says much about the asset class in the years leading up to the Asian financial crisis.

The industry was less global and institutionalized and there was far less legal and regulatory certainty, whether it involved Indonesian underwear manufacturers or asset-light Hong Kong traders establishing factories in Shenzhen. Nevertheless, there was a sense of opportunism as Asia simultaneously became acquainted with private equity and enjoyed its "economic miracle."

From the mid-1980s, Hong Kong, Taiwan, Thailand, Malaysia, Indonesia, Singapore and South Korea saw annual GDP growth of at least 7%. Little attention was paid to the rising levels of foreign debt.

Plain vanilla

"Between 1989 and 1994, there were two primary geographic themes: first, Southeast Asia," says Raffini. "It was small companies, low-cost exporters of relatively low value-add goods, and trying to ride that horse into a pretty small IPO. Second, you had Hong Kong companies transitioning their manufacturing into China, predominantly Guangdong province. It was usually a bumpy transition but those that pulled it off were often attractive listing candidates for the Hong Kong Stock Exchange."

The companies would be considered un-investible by present day standards: manufacturers of everything from calculators and eyewear to furniture and fabrics. As the decade progressed, Taiwan became more prominent with the emergence of its electronics industry. HSBC invested in two Acer Group companies - Acer Peripherals and Acer Sertek - securing returns of up to 10x.

But it was still small scale. According to AVCJ Research, between 1990 and 1997, Asia-focused private equity and venture capital firms raised 472 funds with a cumulative disclosed value of $2.5 billion. For purposes of comparison, that is equal to three quarters of what China alone raised over the three months to September 2012 - and by recent standards it was a poor quarter. As for investments, a total of $4.1 billion was committed across 329 transactions.

HSBC's first fund, raised about the time Raffini joined the firm in 1989, had a corpus of $35 million - its most recent vehicle came to $1.4 billion - with the parent committing around one-quarter of the initial fund and the remainder contributed largely by Japanese institutions, such as Dai-Ichi, Nomura and Nippon Life. It wasn't until 1994-1995 that fund sizes started stepping up to $250 million and more as the wider investment community started to catch on to the potential of the Asian Tigers. Indonesia, with its scale and resources wealth, was also targeted, but Raffini estimates there were only 20-50 deals per year, each one $5-25 million in size. 

Although there were frequent gatherings of Asia's nascent private equity community in its Hong Kong hub, and a lot of note-swapping, the relative paucity of investment opportunities meant that industry participants often ended up chasing the same assets.

"Yes, it was more familiar and had the trappings of a less crowded market, but this was superficial," recalls Raffini. "It was intensely competitive and limiting in terms of the nature of deals that could be done. There was no India, no real China investing. We didn't see ourselves as pioneers, it was just early days in the region. The industry already existed quite substantially in much of the rest of the world."

One deal that stood out in a sea of minority investments was the buyout of Singapore-based Britannia Holdings, which operated snack brands throughout Asia and was part of RJR Nabisco. Following KKR's acquisition of the company, Britannia was sold off; HSBC was one of several private equity firms that picked it up alongside a strategic investor, BSN Group. When the company began to struggle in the face of greater competition, corporate governance issues and macroeconomic headwinds, BSN moved aggressively to assume complete control over the asset.

"I learned a lot through that investment and it carries through to today," says Raffini. "Private equity was less established, more insecure in its skill set, and so there was a tendency to invest alongside corporates, but they can be difficult partners. Britannia turned out fine, with a 2x money multiple, but that's less than it might have been. Now we most often would rather bring in corporate talent than invest alongside a corporate."

With hindsight

However, the steepest learning curve was created by the Asian financial crisis of 1997. Hindsight is a wonderful thing. It was apparent that Thailand's finances were becoming stretched and that countries across the region had built up large capital and current account deficits as they embarked on massive spending programs to expand export-oriented manufacturing industries, arguably adding far more capacity than required.

Private equity investors also recognized, largely through the deals they were executing, the mismatch between local currency-denominated revenues and US dollar-based liabilities. Few companies had the ability or inclination to deploy hedging strategies given that their domestic currencies were pegged to the US dollar.

The risks were there: Should Southeast Asian countries experience a decline in exports and a rapid exit of hot money - through devaluation in the renminbi and the yen plus an increase in US interest rates - they would no longer have the foreign exchange required to support a fixed exchange rate.

Investors weren't deterred due to a combination of optimism and pragmatism, as well as the fact that they tended to have minority positions and couldn't dictate policy to CEOs. With the Asian Tigers growing so rapidly and aggressively creating wealth, no one wanted to call time on the party. Then there was the need to be competitive. A portfolio company drawing down local debt at 20% per annum would have to charge customers a certain price to remain profitable; the guy across the street enjoying US dollar rates of 6-8% could get away with lower prices.

"We look at businesses with a strong bottom-up focus. It's hard to anticipate top-down pressures, which means everyone is going to be blindsided by macros at certain times," Raffini says. "We were rarely embarrassed by the rationale underpinning our investments prior to 1998. There were a handful of situations where we invested with bad partners, and of course I would revisit these. Like a lot of other investors, we usually did strong due diligence on deals but many firms were swamped by poor macros."

Although Thailand is blamed for starting the crisis when it was forced to float the baht, Raffini argues that Indonesia - which was far more opaque than its neighbor - took investors by surprise. The currency dropped from INR2,000 to the dollar to INR18,000, crippling companies that had racked up US dollar-denominated debt financing. Suddenly investments on course for a 2-3x return were wiped out.

Yet many of these companies exist to this day, in one form or another. HSBC backed Anwar Sierad, an Indonesian poultry firm, and got out before the crisis hit, securing a 3x return on its investment. After skirting bankruptcy, Anwar Sierad announced in 1999 that it was close to clearing $160 million in debt through a restructuring and equity swaps.

"This was a good company in a good industry, it managed its farms well and grew on the back of domestic consumption," Raffini says. "It's a shadow of the company it was because sorting out the finances took so long, but it's still there." HSBC was less fortunate with the likes of packaging company ImpackPratama and underwear manufacturer Ricky Putra Garmindo as they were hit by the crisis while the PE investor was preparing to exit. However, both remain in business.

Families first

There is a clear link between present day corporate health and the speed in dealing with the carnage created by the Asian financial crisis. "In the rubble of 1998, the big got bigger and it took small- and medium-size enterprises a longer time to recover," says Raffini. "They often had their lunch eaten by larger corporates that had greater management infrastructure and were better able to manage their relationships with bankers."

Even those that defaulted on their debts did so quickly, which meant they got a jump start on rivals when it came to reorganization and returning to growth mode.

It remains a familiar theme in Indonesian private equity. Large, family-owned conglomerates have considerable influence by virtue of commercial might and informal networks that traverse the power spectrum. Raffini has seen investments made at the right time in the right companies fail to perform as expected due to larger rivals exerting pressure on regulators.

For private equity, these groups can be either competitors or partners, although a number of them have yet to fully reconstruct reputations damaged by defaults during the Asian financial crisis.

In the mid-1990s, Indonesia was one of few Asian markets that represented a viable domestic consumption play, although private equity firms weren't able to marshal the resources required to build distribution chains on par with those of local incumbents. In Raffini's view, this is now changing across Southeast Asia as both the PE community and the target companies mature.

"The businesses were so much smaller and management teams didn't have the benchmarking you see today as a result of globalization. Companies were less well equipped to handle PE capital and the PE firms were less well equipped because of the complexities of Asia," he says. "The expectation was there before but I don't think the value-add or depth of management was there yet. You were often backing one compelling individual, not a team. It is different now."

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• Topics
• Southeast Asia
• Greater China
• North Asia
• Expansion
• Headland Capital Partners
• HSBC
• George A. Raffini
• Southeast Asia
• China
• South Korea
• Growth capital