Indonesia: Unrealistic expectations?

Sheer size and youthful demographics make the country a compelling destination for investors. Businesses can achieve growth and scale, propelled by urbanization and the emergence of a nascent middle class with the means to engage in discretionary consumption.

In recent years, leading global and regional private equity firms have established footholds in Singapore, dispatching investment professionals to Jakarta via the 7.40 a.m. Singapore Airlines flight out of Changi Airport. The plane arrives in the Indonesian capital one hour and 45 minutes later, but the one-hour time difference means dealmakers can jump in a cab and, traffic permitting, make their 10 a.m. meetings.

These meetings may be happening but is the deal flow as rich as anticipated? Given the hype surrounding Indonesia in 2011, the answer is surely no.

After reaching $1.3 billion in 2010 and $1 billion in 2011, investment has dropped off markedly. The 2014 total was just $354 million, according to AVCJ Research, about half the 2013 figure. Even the positives drawn from a steady increase in deal volume ring hollow: of the 30-plus investments completed in each of 2013 and 2014, at least half were early-stage (testament to the robust start-up space, but hardly encouraging for PE players). PIPE deals also feature prominently among the largest transactions.

Put another way, Indonesian GDP came to $868 billion in 2013 and private equity investment since 2009 stands at $4.8 billion. China's economy is about 10 times larger and has seen 34 times more PE investment over the corresponding period.

There are various reasons for Indonesia's weaker-than-expected deal flow. First increased investor interest sent valuations through the roof; then the economy faltered due to a downturn in the commodities cycle and volatility in emerging markets; and last year activity was muted as a result of uncertainty tied to the general and presidential elections.

Another explanation is that dividing GDP by PE investment and holding up the result as evidence of under-penetration by the asset class is a flawed exercise. Other factors also come into play.

First, there is a scarcity of assets that are both investible and accessible, which can be tied to issues of transparency and corporate governance. Second, the availability of deals is linked to the nature of corporate ownership. Many assets in Indonesia are held by a relatively small number of family-owned conglomerates that are under no real pressure to sell. They run auction processes and seek sky-high valuations, or pick their partners carefully based on potential strategic input.

While Indonesia has failed to live up to the hype, it might be argued that deal flow is more or less in line with realistic expectations. The market is tough to crack, particularly for those pursuing transactions at the large end of the scale. People movements within the global and regional private equity firms are further evidence of this.

Nevertheless, there are grounds for optimism. The Indonesia private equity story is still in its early stages. Even if the established family conglomerates retain their stranglehold on sections of the economy - by no means a sure thing in the long term - the middle market will throw up new champions that need external investors to sustain growth, offer access to new markets and technologies, and facilitate succession planning.

For any GP looking for deals in this segment, investor education will be a priority in order to overcome entrepreneurs' suspicions - including a reluctance to give up equity - and explain what PE can help them do. The hope is that if and when they achieve a critical mass of support, private equity becomes an easier sell.

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• Topics
• Southeast Asia
• Buyouts
• Expansion
• Indonesia
• Southeast Asia
• buyout
• Growth capital