EMERGING MARKETS SPECIAL: EMERGING ASIA

China, India and Southeast Asia are all associated with exciting investment returns – and it could be argued that their attraction has never been greater than it is today. Sources say that even before credit problems started to stall mega-buyouts in the US and Europe, Asia was already attracting more attention from institutional investors in the West. With tightening credit blocking deal flow in their backyards, LPs in the West now have more reason than ever to add Asia to their portfolios.

Set against this, it is important to note that, for many of these LPs, the prospect of investing in Asia still sets nerves jangling. The risk/return ratio has never looked entirely appealing relative to the buyout markets of the West. Recent political troubles in countries such as Pakistan, Myanmar and Thailand have served to remind observers of the region's volatility.

Nonetheless, Asia-focused funds accounted for 54 percent, or $11.6 billion (€7.9 billion), of the total capital committed in the first six months of this year to global emerging markets, according to the Washington-based Emerging Markets Private Equity Association (EMPEA).

China- and India-dedicated funds alone drew $4 billion in commitments, while pan-Asian funds raised $7 billion. In addition, there are at least 21 $1 billion-plus Asian funds currently in the market, including three funds that are each raising over $3 billion. These funds are expected to close soon.

SOARING STOCKS
More and larger funds are partly attracted by the region's booming stock markets, which are increasingly presenting viable and profitable exits for private equity investors if recent IPO successes in Hong Kong, Singapore and China are a reliable measure.

China's Shanghai Composite Index and Shenzhen Component Index have made six-fold and seven-fold gains respectively in the last two years. India's Bombay Stock Exchange benchmark Sensex has more than doubled over the same period to nearly 20,000 points at press time, from 7,944 points at the start of November 2005. Over the same period, the Dow Jones industrial average and Nasdaq Composite index in the US both showed a 30 percent increase, while London's FTSE 100 rose 23 percent.

China's stock market boom has been fuelled by excess liquidity, and many commentators are of the opinion that the rally has less to do with the profitability of Chinese companies than with an increase in demand for equities. A central bank survey showed that 30 percent of respondents now considered stock and fund investments preferable to depositing money in banks.

On 5 November, state-owned oil and gas giant PetroChina became the world's first company to exceed $1 trillion in market capitalisation after a dazzling debut on the Shanghai exchange. PetroChina's share price peaked at RMB48.62, valuing the company at $1.2 trillion – or more than twice as much as Exxon Mobil, which has a market capitalisation of close to $500 billion.

WHAT ENTREPRENEURS WANT
The abundance of liquidity in Asia means that fundamentally sound businesses usually have no trouble attracting capital and that private equity must therefore fill other gaps to help companies succeed.

Wayne Tsou, managing partner of Carlyle Group's Asian growth capital operation, says: “Capital has become a commodity. Value is what we can bring to the table.” Tsou and his team are currently investing from Carlyle's third Asia growth capital fund, which closed on $680 million in June 2006.

He adds: “Entrepreneurs want different things. Private equity can lend greater credibility; instill better corporate governance; offer wider market access through our global presence and investments; attract management talent; and lend capital market and financial expertise.”

As an example, Tsou refers to an investment in Shanghai Anxin Flooring, a privately founded wooden floor maker in China into which Carlyle has injected $30 million in three separate tranches, the most recent alongside fund of funds investor Pantheon Ventures. Anxin was founded by Lu Weiguang, a businessman who, according to Tsou, had had conversations with other private equity groups before deciding on partnering with Carlyle to embark on his ambitious expansion plans.

Anxin, says Tsou, is a good example of the growth story his team seeks to back. “Often, in these (emerging) markets, we have some flexibility on how much we can inject to fund companies in expansion mode,” he says of Carlyle's most recent co-investment with Pantheon. The fresh capital raising is aimed at allowing Anxin to acquire direct rivals and related businesses.

CHINA VERSUS INDIA
China and India are the two most prominent markets for Carlyle Growth Capital Partners, but while they are frequently compared to each other, there are some significant differences between them. In India, private equity is playing an increasingly active role in developing the country's infrastructure, while in China, central government initiatives have ensured that the country's infrastructure is better developed and less in need of investment from outside sources.

As Christophe Florin, managing director of Axa Private Equity Asia, a French fund of funds manager that launched in Singapore in 2005, points out: “There are some parts of China I wouldn't consider to be still emerging. China's dependence on the outside world is far less than export-oriented Southeast Asia in the late nineties.”

Tsou agrees. “Chinese companies tend to be more domestically focused whereas their Indian counterparts are more inclined to overseas expansion.”

China is on course to overtake Germany and become the world's third-largest economy behind the US and Japan in 2008. The domestic market is an obvious draw for private equity, which continues to evolve as fast as the country's rapidly changing regulatory environment will allow.

“There are more regulatory uncertainties in China than in India,” a general partner investing in both markets says.

Chinese rules regulating realisations, for example, are prompting managers to consider local listings and trade sales instead of heading for the traditionally preferred overseas bourses such as Nasdaq.

Not that this is in any way a hardship when you consider how successful many of these local listings have been. According to Zero2IPO research, 40 Chinese enterprises that listed domestically raised $14.39 billion in the third quarter of this year during which time 33 companies that opted for overseas IPOs raised a combined $7.47 billion.

In India, meanwhile, the buoyant and longer-established Bombay Stock Exchange has been characterised by private equity managers frequently investing in public equities (PIPEs) – a type of deal seen less often in China.

Private equity can lend greater credibility; instill better corporate governance; offer wider market access through our global presence and investments; attract management talent; and lend capital market and financial expertise

Wayne Tsou

Another distinction, says Tsou, is that India is a less fragmented market where opportunities tend to be focused on Chennai, Bangalore and Cochin outside the more developed cities of New Delhi, Mumbai and Calcutta. India's less developed infrastructure explains, to a large extent, the less fragmented nature of where investment opportunities lie.

In China, the picture is different. CMIA Capital Partners, established in 2003 and raising a maiden fund, has narrowed its options down to three areas in China, managing partner Lee Chong Ming told sister publication PEI Asia earlier this year.

However, says Ming: “When we first arrived in China, we were flying all over, from Shenzhen to Yantai, to Beijing and Shanghai. We now zoom in on Shandong, Fujian and Chongqing.

With the influx of funds looking for investments in China, all these areas have started to attract funds that weren't present before, so we decided to be more sector-specific.” CMIA has narrowed its sector focus to healthcare/ medical, agri-business and mining or natural resources.

SOUTHEAST ASIA ON THE RADAR
China and India aside, Southeast Asia is fast emerging as the next most popular developing market in the region. There are, however, only a handful of countries in the ten-member Association of South East Asian Nations (ASEAN) that investors are looking at closely: Vietnam, Indonesia, Malaysia and Thailand. Singapore, not in itself an emerging market, has also become as a popular destination for public-to-privates of companies with regional operations.

Indonesia, in particular, has been making waves recently. Texas Pacific Group, which was early into Asia via joint venture Newbridge Capital – since subsumed into TPG Capital – recently appointed an Indonesian specialist in addition to sponsoring Northstar Pacific, an Indonesia-focused fund.

Indonesia has also inspired the formation of two other country-focused funds managed by Quvat Management and Saratoga Capital. An investor in both Northstar and Quvat is the Government Investment Corporation (GIC) of Singapore, Asia's most established sovereign investment agency.

When sophisticated LPs such as GIC vote with their wallets in countries such as Indonesia, it is clear that opportunities are deemed to outweigh risks even in countries where private equity is not, as yet, particularly well developed. In the booming markets of China and India, a long-attractive investment story becomes more compelling as each year passes.