Coronavirus intensifies Asia exit, performance concerns - Bain

The “breathtaking fall” in exits identified in the firm’s latest Asia Pacific private equity report reaffirms a trend previously identified by AVCJ Research: GPs in the region generated proceeds of $73 billion from exits in 2019, down from $124 billion the previous year. While a relative paucity of mega trade sales accounts for much of this decline, public market volatility contributed to a severe drop in block trades and sell-downs. In dollar terms, exits hit a four-year low. By deal volume, it was a 10-year low.

Johanne Dessard, global practice director for Bain’s alternative investor group, noted that strong exit activity in 2017 and 2018 was the result of private equity firms trimming their portfolios – suggesting there was less pressure to offload assets in 2019 – but the overall picture is troubling. “When exits are down it’s a sign that the recycling of capital is not happening and that LPs will not get their cash back,” Dessard said. “That will slow down fundraising. It’s no surprise fundraising was down as well in 2019.”

Returns continue to hold up, with a 12% median net IRR over the past six years and top-quartile managers comfortably exceeding the 16% LPs expect from emerging markets. However, in the final quarter of 2018, contributions to Asian funds exceeded distributions for the first time since 2013. This continued into the first six months of 2019, with $0.86 returned for every $1 committed.

The emergence of coronavirus disease has significantly slowed activity. AVCJ Research’s records show $1.2 billion was generated from fewer than 50 exits in January and February as buyers were unable to conduct on-site due diligence and public markets suffered. This compares to $13.9 billion from nearly 80 in the last two months of 2019 and $7.8 billion from 70 in the first two months of 2019.

“If you have a portfolio company that you may not be able to exit right now, are there things you can do? Yes. In any kind of crisis, you will have winners and companies that won’t do as well,” said Dessard. “The question we ask of clients is how can you benefit from this uncertainty. Are there M&A opportunities that were not available in the past? Can some markets be prioritized sooner than others? Are there cost reductions you can contemplate? All these questions can make a lot of sense, especially in disrupted times.”

Even before coronavirus went from localized concern to global pandemic, Bain expected downturn and disruption to be key themes of 2020. The firm’s survey of Asia Pacific GPs found that 47% believed the market had peaked or is in recession, 59% were very worried about macroeconomic conditions – mostly financial pressures and the US-China trade war – and 96% expected a downturn in the next two years.

This suggests it will become increasingly difficult for managers to sustain returns on deals that have been trading at record multiples. Since 2016, more than 40% of private equity investments in Asia had entry valuations in excess of 15x EBITDA to enterprise value. This compares to 25-30% between 2010 and 2015. Dessard noted that most of Bain’s clients have stopped including multiple expansion in their deal models, which means they are more reliant on operational improvement, M&A and organic growth.

Bain examined how Asia’s private equity industry performed during the global financial crisis for insights into what may separate winners from losers this time around. The more successful investors emphasized control and active portfolio management, tended to focus on larger deals (although these didn’t necessarily come from larger funds), were able to pick winners irrespective of sector, and timed their investment and exit activity well.

Nearly 80% of survey respondents said they had started altering investment strategy to brace for recession. This involves an increasingly systematic assessment of disruption and recession risks during due diligence, prioritizing profitability and cost reduction in business models, and fast-tracking exits.

Dessard observed that the fundamentals of storm-proofing a portfolio are largely unchanged, but disruptive forces at work in the market are greater, so efforts must intensify. This could present a conundrum for small to mid-size GPs.

“We increasingly see the need for firms to reinforce their muscle around M&A and operational improvement," Dessard said. "The question for a mid-market GP is how do you do that? They don’t have the scale to bring capabilities in-house. Maybe they can get that through networks of experts that aren’t sitting on their cash flow. Maybe they could be more focused in their strategy so they won’t face as much disruption.”

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• Topics
• Exits
• Trade sale
• Performance
• GPs
• Asia
• Exit