Stepping into the AIA Tower in Hong Kong’s Central district, the aggressively air-conditioned lobby was a welcome relief from the sweltering August heat. Upstairs, in the offices of Debevoise & Plimpton on the 27th floor, Private Equity International found its six roundtablers chatting amongst themselves about their latest activities in Asia-Pacific.
As their thoughts, hopes and concerns unfolded during the two-hour discussion that followed, it quickly emerged that the stark contrast between street and lobby was something of a metaphor for the region’s private equity markets. In Asia, some places are hot, others are not.
In recent years, there has been widespread LP disillusionment about the performance of Asia funds: the returns GPs have delivered are, on the whole, barely a patch on what investors had been expecting.
That doesn’t mean that LPs have written off the region as a no-go zone – but they have learned some important lessons.
According to Martin Mok, a partner at EQT Partners Asia, which advises the EQT fund, there is now a “smarter breed” of LPs, who know how to question their fund managers. They’re asking questions like: ‘Can you really make money without control?’ – a common concern for investors in Asia.
Happily, their questions are being answered increasingly honestly by GPs – most of whom argue that you need to be doing buyouts or at least significant minority deals for an investment to be worthwhile. Our three GP representatives – EQT’s Mok, Headland Capital Partners chief executive Marcus Thompson and Bruno Seghin, partner at Navis Capital Partners – all hailed the importance of control deals, while Gavin Anderson, Debevoise international counsel and the legal expert at the table, agreed that buyout funds have been becoming more popular.
Nevertheless, investors continue to be cautious – perhaps even cynical – towards strategies in the region.
THE BIG BUYOUT QUESTION
Markus Ableitinger, managing director and co-head of Asia investment management at Capital Dynamics and Michael Lukin, co-founder of ROC Capital Partners (formerly the funds of funds unit at Macquarie Bank), offered an LP perspective, talking about investors’ ability to spot the real, credible managers (operational capability is seen as one of the most important factors here).
They agreed, however, that history suggests investing in minority deals is not always a feasible strategy.
“I think over the years most have realised that … it is extraordinarily difficult to divest a minority growth capital deal – to get out of those deals where you have e.g. 8, 10 or 20 percent, in particular in China and India,” Ableitinger explains. “We are always looking at GPs and thinking about what their credentials are in exiting companies and [how much] experience [they have] in this. That is always one of the most important things to find out during due diligence.”
GPs acknowledge these challenges. “If you’ve 10 percent or 20 percent of a company, it is hard work generating an exit if the IPO markets shut down,” Headland’s Thompson says. “You can’t expect a fairy godmother to arrange for a strategic investor to turn up and say, ‘OK that’s interesting, we’ll [buy] it.’ As a result of our 25 years of experience of investing in Asia, our focus outside of China has very much switched to control deals. For minority deals, you have to be highly selective in terms of the type of companies you’re investing into – because the IPO markets do ebb and flow, and you really need to have a compelling story to take a company to market [with] the IPO markets as they are today, [i.e.] selective. Unless you are also selective, it could be very difficult getting out. It’s been an evolution, because the development of the buyout market has been quite slow. But we’re seeing it take off today.”
Navis, which has a strict buyout-only policy, has noticed a growth in the number of control deals available due to the increasing number of corporate carve-outs in the region, as well as entrepreneurs facing succession issues, Seghin explains. “The market has evolved a lot and we’ve had to adapt a lot. Now we invest in bigger companies, so we had to raise bigger funds. If you don’t grow, you die.”
Nevertheless, Asia’s private equity model – minority stakes with less leverage – can be a welcome change for LPs, says Mok. “In Europe you’re growing at 2 percent, but you’re levering up by 6x, 7x or 8x EBITDA. In Asia, you’re only levering up one to two times and the exit is very different as well. [But LPs] know it’s a very different animal.”
However, there are concerns over whether there are enough buyouts for the pile of money that has been raised for Asia in recent years.
Kohlberg Kravis Roberts raised its $6 billion Asia fund last July, precipitating 14 months of big fund closes. CVC Capital Partners, The Carlyle Group and TPG Capital all closed their funds at between $3 billion and $3.5 billion during this time, while pan-regional players Affinity Equity Partners and MBK Partners raised $3.8 billion and $2.7 billion respectively.
That may sound like good news. But it also means Asia’s level of dry powder has jumped to record highs.
At the end of 2013, Asia’s dry powder totalled $138 billion, 9 percent up on the $127 billion remaining at the end of 2012, according to data by Bain & Company. China accounted for a large proportion of that bulk: its domestic market was sitting on about $65 billion in undeployed capital as of the end of 2013, up about 20 percent on 2012.
The general feeling in Asia is that buyout supply has been lagging demand. However, Thompson believes this is changing. “The bright spot that we see is the growth in buyouts across the region – [though] less so in China, I have to say. This is being driven by two main factors: one is family or shareholder succession issues and the other is corporate spin-offs of non-core business assets. To LPs investing in Europe and North America, these drivers will be familiar – but in Asia, it’s historically been somewhat of a taboo for a family company to sell control.”
Debevoise’s Anderson agrees, with the caveat that firms generally reserve the right to do minority deals. “I think there has been a move towards buyout and control-oriented transactions. Obviously different managers have different strategies but I think there is definitely a move towards that.”
However, Ableitinger argues that in some cases, GPs are just adapting their messaging to please LPs. “There comes an element of marketing as well. People realise it’s difficult to take growth capital deals to the end – not investing into them, but exiting them. The reality is simply that it is difficult and the return expectations are, [based on what has] come across over the past few years, unmet on an average basis.”
As such, it’s hard for growth capital funds to raise money in the current climate, he says. “So often, the manager goes back and thinks about what they can do. And we all understand private equity is very inventive, [so GPs/managers] right now are trying to market ‘buyout’ strategies. That’s what we find many growth capital managers have tried to do in the recent period, in many cases purely because it appeals to the LP better. LPs in general like managers doing more buyout/control investing.”