Fund focus: Safe hands

Speaking to AVCJ in the summer of 2012, Joe Bae (pictured left), head of Asia at KKR, cited Japan as an example of the need to play the long game and wait for cycles to turn. Over the previous seven years, the firm had deployed $5 billion in the region, half of it going into China and Southeast Asia. Japan accounted for 6%.

Two years on from that interview, KKR had closed its second Asia fund at $6 billion and bought an 80% stake in Panasonic Healthcare at a valuation of JPY165 billion (then $1.67 billion). They were, respectively, the largest PE vehicle ever raised for the region and the firm’s largest-ever buyout in Japan.

Fast forward three more years and both those records have been broken. KKR closed Fund III last week at $9.3 billion, less than three months after securing a JPY498.3 billion ($4.5 billion) buyout of automotive components maker Calsonic Kansei Corporation. Calsonic is one of four Japan buyouts announced – three have closed and another is pending – since Panasonic Healthcare. KKR has now deployed about $2 billion in equity (excluding co-investment) across six deals in the country since 2010.

“We see significant structural change and reform opportunities becoming available in Japan. Corporates are looking for value-added partners to enhance their operations and expand internationally. Perception of private equity has also evolved, and we are now seen as a partner of choice which can help companies achieve their growth ambitions,” says Ming Lu (pictured right), KKR’s head of Asia private equity.

A thesis proven

Panasonic Healthcare is significant in that it enabled KKR to prove its thesis. The GP’s pitch to Panasonic – which retains a 20% stake – was that it could drive expansion domestically and overseas. The clearest manifestation of this was the $1.15 billion bolt-on acquisition of Bayer’s diabetes care business in 2015. Lu notes that the deal has touched every facet of KKR’s value-add proposition, including the Capstone operations division, the capital markets team, and the global platform.

Mitsui & Co. bought a 22% interest in Panasonic Healthcare last year at a valuation of JPY245.9 billion, enabling KKR to make a partial exit. This success story has opened up dialogues with other corporates considering divestments and also driven returns at fund level. As of March, Fund II had generated a net IRR of 20.6% and a multiple of 1.5x. The net IRR and multiple for the first Asian fund – which closed at $4 billion in 2007 and compares favorably to other funds of a similar vintage – were 18.9% and 1.8x.

“Success in Japan was clearly important,” says one LP who invested in the fund. “If you compare all the large international funds over a period of time, there’s not a huge differential but you could probably argue KKR has outperformed the others. It’s also an easy decision for an institutional investor to back KKR, particularly for investment committees that sit outside of Asia.”

This sentiment is reflected in the LP base. The $500 million and $200 million checks written by New York State Common Retirement Fund and New York State Teachers’ Retirement System were the largest they have ever written for an Asian fund; Minnesota State Board of Investment’s $150 million commitment represents its first to a pan-Asian vehicle. LPs from the Americas accounted for 53% of the corpus – up from 45% in Fund II – while 24% came from Europe and 23% from the rest of the world.

Ardian has backed all three of KKR’s Asian funds. Explaining the decision to re-up, Benoît Verbrugghe, head of Ardian USA, points to the firm’s stable performance across deals with very few losses, leading cash-on-cash returns, ability to hire and develop local talent, and integrated global platform. “It has been a very successful working relationship for us, with strong returns on the fund commitments as well as a steady deal flow of co-investment opportunities,” he adds.

The implication is that KKR represents a safe pair of hands and has demonstrated the ability to originate large-cap deals with co-investment for those that want it. LPs expect more of the same, and KKR believes it is well-positioned to deliver. First, Asia’s emerging economies continue to see strong domestic consumption growth and urbanization. These are fostering the development of a middle class that is becoming more discerning in its demand for higher-quality products and value-added services.

Second, structural change and reform is expected to result in more control buyout transactions, at larger sizes, as companies pursue cross-border expansion and operational improvements – factors that underpin the rise in Japan carve-out deals. “Already, we have seen strong momentum in the larger-size end of the market, and have deployed over $2.5 billion in the last 18 months,” Lu says.

Competitive markets

It remains to be seen whether this strategy plays out as planned in an increasingly competitive environment. Lu believes the larger end of the market is where the opportunity lies: he argues that competition is less in this segment than in others, valuations are attractive at this point in the cycle compared to other geographies, and KKR can leverage its substantial resources – in terms of people and capital – to turn national leaders into global leaders.

But is KKR’s proposition differentiated enough at a time when capital is pouring into the asset class from institutional investors searching for returns? Since the start of 2015, six GPs have closed pan-Asian funds: Baring Private Equity Asia, RRJ Partners, MBK Partners, Bain Capital Private Equity, PAG Asia Capital, and KKR. The average increase in fund size on the previous vintage is nearly 50%. Strategies may vary, but regional funds have a lot of dry powder to put to work, and that’s without factoring in co-investment.

“We are not obsessing about it too much as a firm. There is concern about high valuations but any GP or LP can choose not to participate in those auctions,” says the aforementioned LP. “The opportunity set is going to keep growing, deals will get bigger and there will be more control transactions, debt is cheap, and the flight to quality is helping the big guys. These probably won’t be the greatest vintage years, but we are still seeing some reasonable deals being done despite all the money coming into the market.” 

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• Topics
• Buyout
• Fundraising
• Greater China
• Australasia
• North Asia
• South Asia
• Southeast Asia
• KKR
• Asia
• GPs
• LPs