Friday Letter Don’t let due diligence falter

The Asian markets remain red hot for private equity, but have exhibited some of the bad behaviours that developed market managers used during the credit bubble years, not least of which is a shrinking of the time devoted to performing due diligence on potential investments.

The Asian private equity market has grown to the point where this year, Asian firms have the second largest representation on Private Equity International’s list of the 300 largest private equity firms in the world by fundraising. [See the website on Monday for full coverage of the new PEI 300].

The only region above Asia on the list is North America.

The growth is astounding, though hardly surprising for anyone who has watched local firms spring up seemingly overnight, and developed-market managers also flock to the region.

As with any rapid expansion, it’s a story not without its warning signs. At the PE Asia Forum this week in Hong Kong, delegates discussed a somewhat alarming trend that once held true in the developed markets and led to some busted investments made during the credit bubble:

Heightened competition for deals, in China and India for instance, has led to a shrinking of the time managers have dedicated to completing due diligence on potential investments.

“A lot of money has been chasing too few deals [in Asia’s key markets] and people have to take shortcuts. I highly recommend not to do it,” Miranda Tang, managing director with CLSA Capital Partners, said at the conference.

Indeed, the rush for deals can lead to some unwise practices. In the US and Europe during the bubble years, when debt was cheap and banks were willing to lend enormous amounts of debt into buyouts, the time available for due diligence also shrank. Partly to blame in some instances were the companies available for purchase, which set hard bid deadlines that forced potential players to scramble.

The relatively young private equity markets in Asia and Latin America have seen raucous deal environments where multiple bidders get in line for a chance to acquire desirable companies. And if delegates at the PE Asia conference are correct, GPs active in the region have on occasion not had enough time to diligence their targets sufficiently effectively.

Needless to say, the better you know an asset at the outset, the less time you need to examine it when it becomes available. But any bidder with too little knowledge of the exact make-up of an investment opportunity is well advised to walk away when a tight timetable doesn’t allow for sufficiently thorough homework. Given that other people’s money is at stake, rushing in is not a smart way to operate. Nor is it something the LPs will forgive once a hastily assembled investment begins to fall apart.