2009: crisis what crisis?

Macro recovery seems well-entrenched worldwide, though fears of a double dip linger. Asia Pacific private equity, some would argue, saw more recovery than dip through much of the year, especially as sentiment improved during 2H09. And industry-watchers seem to be looking to long-term consequences, but not necessarily at lasting damage. The industry may never be the same again, but at end 2009, it seems not to be in bad shape.

Macro background

Lest we forget, though, Asia Pacific private equity, the region, and the global economy as a whole, have rebounded from fairly dramatic depths. “We’ve gone from a world crisis widely described as the worst crash since the Great Depression to a global economy where we’re seeing modest signs of improvement,” Neil Arora, Executive Director and Head of Infrastructure for Asia at Macquarie Bank, remarked recently.

Signs of global recessionary impact were manifold, and Asian hopes for Western consumers to hang on looked very much disappointed. “The US economy was shedding jobs very deeply over 2009,” recalled Glenn Maguire, Chief Economist for Asia at Société Générale, while his colleague Klaus Baader, Chief Economist for Europe, added that, “the Euro area experienced a pretty dramatic decline in GDP.” Asian economies saw their export sectors heavily hit, and the overall macroeconomic picture was only alleviated by the concerted, intensive government stimulus packages that look set to continue into 2010. As Dong Tao, Chief Economist for Non-Japan Asia at Credit Suisse, pointed out, “the story of this recovery is liquidity.”

Despite its vaunted claims of counter-cyclical characteristics, private equity was anything but immune to the impact of this situation, especially earlier in the year. AVCJ sources pointed to an LBO market that “has entirely cratered” in the West and elsewhere: “the buyout market is dead.” Though the corpse may be showing signs of revival post some of the recent large US deals, such at TPG Capital and CPP IB’s acquisition of IMS Health and General Atlantic and Kohlberg Kravis Roberts & Co.’s acquisition of TASC, both investment and fundraising in North America are still way off their historic heights.

Asia ahead

One key upside for Asia Pacific private equity post the crisis was, as Frank Tang, FountainVest Advisors’ Managing Partner and CEO, puts it, “the emergence of Asia as a relatively more attractive destination for private equity versus the US and Europe.” Not as attractive: more attractive.

GPs and industry participants can be forgiven for not feeling this way at the beginning of the year, however. Pak-Seng Lai, Managing Director and Head of Asia at Auda International, charts 2009’s investor mood swings. “The Asian private equity community has experienced three stages of psychological change in 2009: despairing and helpless in Q1, skeptical but hopeful in Q2-Q3, and cautiously optimistic in Q4.”

Furthermore, the relative performance of Asian private equity, driven by markets with either little dependence on bank leverage or comparatively stable domestic lenders, needs to be set against some absolute difficulties on the deal side. George Raffini, Managing Director at HSBC Private Equity Asia, instances “the rapid rise in valuations commencing in April. This had the effect of slowing down deal flow as valuation gaps widened. The result, he notes, was “entry pricing increased amidst the earnings uncertainty – not an easy scenario.”  Tang confirms that

Luckily, as public markets regionwide recovered, this trend emerged not just on the dealmaking side, but equally – and perhaps even more significantly – on the exit side. “A few firms (including ourselves) were able to generate significant exits this year, at very attractive multiples, which was likely contrary to expectations at the beginning of the year and a definite contrast to the US and European markets,” affirms Chin Chou, MD in Hong Kong with Morgan Stanley Private Equity Asia. Tang confirms that: “the rapid recovery of public markets made private equity entry more difficult, but allowed for some exits.”

LPs may have expected, more or less optimistically, that their GPs could find bargain-basement investment opportunities: far fewer, it seems expected significant returns from funds. As Chou adds, “in this respect, Asia has been a standout.”

Looking forward, Lai expects a continuing “increase in confidence in Asian private equity, especially in emerging Asia, due to its relative better performance during the financial crisis, as compared to the US and Europe.”

Investments and industries

The investment picture in detail, other AVCJ sources confirm, was that Asia saw less of a falloff in leverage supply than in Western markets, although large buyouts were impacted to some extent. Small-to-midsize buyouts, the historic sweet spot of the buyout asset class in the region anyway, saw continued leverage support in the mature buyout markets of Japan, Korea and Australia, though at less aggressive levels than hitherto. Furthermore, sources emphasize, China and Japan, the region’s key growth capital markets, are little impacted by shortage of bank leverage, as deals there are predominantly growth transactions with little or no leverage.

“As expected, buyout activity dropped significantly, save for the deals in Korea and Japan,” Chou says, adding that, “growth opportunities continue unabated, with China and India the focus as usual.”

Some interesting developments took place in key target markets. “The China private equity market has become increasingly similar to India, with PIPEs emerging as a common strategy for large funds,” notes Lai, underlining the continued dominance of deal value numbers by the kind of large-target minority-stake play that Hopu Investment Management, for one, seems to be specializing in. In sheer value terms, at least, these seem to be substituting for big control buyouts in other markets.

Also, Asia’s growth capital markets did have to digest at least some of the widespread pain during 2009. Raffini points to: “the broad lack of visibility on revenue and earnings for many portfolio companies, given the global downturn. This clearly had a much greater impact on export-oriented businesses, especially in certain sectors, e.g. electronics, and heavy plant and equipment.”

Emphasizing this concern with performance, despite the relatively forgiving public markets, Jie Gong, a vice president in Morgan Stanley's Alternative Investments group, remarks that, “the downturn in late 2008 and early 2009, though relatively short in duration in developing Asia, has led many GPs into a higher degree of operational engagement with portfolio companies. The focus has been on helping them weather the storm, and to stand out in a more discerning public market.‬‪” However, as Raffini adds, “it was also interesting that Asian domestic, consumer-oriented businesses, particularly in China, where earnings largely haven't missed a beat, generally turned in strong performances.” 

Raffini sees the upsurge in valuation expectations, as against actual performance, as, “probably a reflection of the widely-held view that financial markets moved ahead well in advance of most economies.” This coincides with other AVCJ sources’ observations that private equity tends to lag the public markets by about a year to suggest that recovery in investment volume may be slow.

All the same, Lai sees the overall balance of the rebound of public stocks as very positive longer term – most of all in one of 2009’s most disappointing area, fundraising. “The surge in public markets in Asia since March has not only improved global investor sentiment, but also provided exit opportunities for private equity firms, which further enhanced LP confidence in the asset class. A virtuous cycle has begun which will be conducive for fundraising in 2010, if public markets remain strong.”

“We’re certainly starting to see a recovery in activity, both in terms of demand for proposals for leverage finance, and starting to see movement on the exits, especially for some of the China growth capital portfolios,” confirms Angus Barker, Managing Director at Deutsche Bank Securities.

Fundraising comeback

Fundraising and fund formation saw some bell-wether developments over 2009, but much of the new activity in fundraising was not necessarily so attractive for international LPs. Jie Gong avers that “2009 saw a liquidity bifurcation. While Western LP capital for private equity was in short supply, 2009 will be remembered as the year of abundant liquidity flows to Chinese RMB private equity funds.‬‪”

For GPs addressing international investors, industry sources confirm, the regional fundraising climate was very tough, irrespective of whether they relied on local institutions for capital, as in Australia and Japan, or sought wider LP participation, as in China and India. With this trend, unsurprisingly, came a renewed focus among funds in the latter markets on their domestic LP bases as sources of capital.

The major extra dimension to this, in Tang’s view, was “the emergence of the RMB fund in China.” As Lai adds, “the RMB fund has emerged as an alternative fund source for China GPs. This will have long-term implications for foreign LPs who invest only in USD.”

Some international, especially US, LPs have responded to the RMB fund challenge with a straightforward blanket refusal to invest into any GP with an RMB fund. Postures like this are pregnant with issues for GPs, and important considerations over how much true concern such an LP really has for the development and commercial future of a GP. Sources suggest that conflicts of interest in a dual investment process can be managed, and are being managed, by GPs and advisors. Recalcitrant international LPs, perhaps, should be prepared to be more flexible and engaged as they tackle their oft-remarked, increasingly out-of-step, historic under-weighting to Asia.

Tang also remarks that one other, related, key development over 2009 was, “the acceptance of country funds like markets like China and India in recognition of their significant market potentials.” Even without the RMB effect, it seems, Asia’s major growth capital markets are now being targeted as important components in large private equity portfolios.

Boots on the other feet

Beyond the cyclical trends in investments and exits, the oft-repeated rebalancing of power between GPs and LPs is probably the most lasting contribution to the private equity industry worldwide. Some would argue this is just as cyclical, and just as likely to swing back in GPs’ favor as markets and leverage providers recover. Yet others feel that the pressures of the post-crisis working out of imbalances in the GP/LP relationship have pushed private equity into new territory. Of the “resurgence of investor vigor and determination to change some terms,” Andrew Ostrognai, corporate partner and Chair of the private equity practice in Asia at Debevoise & Plimpton, says, “that’s an enormous development. That’s not just Asian: it’s worldwide.”

Grant Kelley, Managing Partner at Holdfast Capital, also expects “the return of institutional investors, accompanied by more stringent economic terms, revised governance mechanisms, and an incessant focus on performance,” to continue into 2010. And GPs awaiting even this qualified recovery in the fundraising market may flinch at the prospect of further regulatory pressures on their fund and legal incorporation structures, with, as Chou warns, “clear focus from tax authorities on private equity investments (i.e. exits) throughout the region, with Australia leading the charge.”

That was the year that was?

GPs and LPs alike who end 2009 with a sigh of relief may be due for a disappointment if they expect to settle back down to business as usual in 2010. As Tao recently asserted, “We certainly had an exceptional year. It has been a heck of a ride up and down …Are we really back to the starting point? The answer is no.”

The problem is that successful crisis management has led people, perhaps especially in Asia Pacific, to forget, in Dong Tao’s view, that “the global financial system was this close to completely collapsing.” Such a close brush with catastrophe does not come without consequences – and 2010 promises to be, in many respects, uncharged territory.

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• Topics
• Funds
• GPs
• HSBC Private Equity
• H. Chin Chou
• George A. Raffini
• Frank Tang
• FountainVest Advisors
• Morgan Stanley Private Equity Asia