Asia PE firms must get smart, integrated on due diligence - Bain & Co

“Most people don’t expect valuations to come down significantly in the coming years, so the question becomes, ‘How do you create value?’ Multiple expansion is no longer realistic given the current valuations. It comes down to top-line growth and margin improvement,” said Elsa Sit, a vice president at the firm.

Against a backdrop of record investment levels across all key Asian markets in 2021, dry powder reached USD 654bn – more than twice the 2018 total – and enterprise value-to-EBTIDA multiples rose to 13.2. This extends a resurgence that began after multiples dropped sharply from 14.5 to 10.6 between 2018 and 2019, according to Bain’s latest Asia Pacific private equity report.

Two-thirds of GPs participating in a survey accompanying the report named top-line growth among the biggest driver of returns in investments they have exited, with 54% opting for multiple expansion, 42% for cost improvement and capital efficiency, and 36% for M&A.

Five years from now, top-line growth will become even more important, but the significance of multiple expansion is set to plummet. Fewer than one-quarter of respondents expect it to remain one of the biggest return drivers. Meanwhile, cost improvement and capital efficiency and M&A will rise to 62% and 55%, respectively.

These considerations already underpin investment due diligence conducted by many GPs, with approximately half saying that operational diligence, commercial capabilities assessment, and value creation opportunity assessment feature in every or nearly every deal. Digital marketing assessment and advanced analytics tools are much less commonly utilised.

Bain argues that focusing on one or two elements doesn’t give a complete enough picture of how growth prospects can validate an investment thesis and build confidence in financial projections. Rather, GPs should become digitally smarter and more integrated in their approach.

“Historically, people took a simple approach to due diligence. Instead of looking at a spectrum of things, they would only do commercial and strategy diligence, and possibly put together a value creation plan. But what about operational diligence and the interrelationship of operations and strategy? What about digital marketing and IT and digital readiness?” said Sit.

“All those elements are interrelated, and you must look at all of them to make a realistic determination of what value you can create. That’s the biggest challenge for a lot of GPs.”

Environment, social, and governance (ESG) considerations are becoming an integral piece of the puzzle – in line with LP preferences, regulatory action, and general stakeholder engagement on issues such as climate change. Over 57% of GPs surveyed said they would increase ESG efforts considerably in the next 3-5 years, compared to 41% in 2020 and 30% in 2019.

While 66% claim to have set ESG ambitions, only 38% have embedded ESG into their broad value creation strategies, and only 42% have teams dedicated to ESG and governance oversight.

“Ten years ago, ESG was check-the-box. In markets like China, all you needed was an environmental assessment by a local agent. Now, you must look at ESG capabilities in due diligence,” said Sit.

“We see large GPs building teams, developing strategies, embedding ESG into due diligence, and addressing decarbonisation across their portfolios. But there is more to be done. And there is a lot more that small to mid-size GPs could do.”

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• Topics
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• Advisory
• Asia
• Due diligence
• ESG
• Bain & Company