Asia’s Private Equity News Source avcj.com March 21 2017 Volume 30 Number 11

PORTFOLIODEAL OF THE WEEK

What lies beneathCreativity helps build industry intelligence in Asia’s opaque markets Page 7

Change prescriptionEight Roads targets China health boom Page 14

An unexpected exitAlinta IPO nixed for surprise trade sale Page 13

Can securitization solve China’s NPL overload?

Page 10

FOCUS

Pioneer plans NZ export focus for newest PE fund

Page 13

GPs right to be wary of growth in shadow capital

Page 3

500 Startups, Actis, ADB, Ally Bridge, B Capital, Banyan, CDPQ, CMC, CPPIB, CVC, Everstone, Hilhouse, ICICI, INCJ, Mayfield, Nexus, PAG, Platinum, SDIC, Sequoia, Shaw Kwei, Vertex

Page 4

EDITOR’S VIEWPOINT

NEWS

FUNDS

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Felix LaiDirector InvestmentsGAW CAPITAL

Henry NguyenManaging General PartnerIDG VENTURES VIETNAM

Dominic PiconeManaging DirectorTPG CAPITAL

Binh TranVenture Partner500 STARTUPS

Pete VoManaging DirectorCVC CAPITAL PARTNERS

Mark MobiusExecutive ChairmanTEMPLETON EMERGING MARKETS GROUP

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EDITOR’S VIEWPOINTtim.burroughs@avcj.com

WHEN ASKED TO EXPLAIN THE RATIONALE behind a re-up in an Asia-based GP that had raised substantially more than in the previous vintage – and whether this larger amount of capital could be deployed efficiently under the stated strategy – one LP gave an intriguing response: “But [the manager] has performed so well for us. For every $1 we put into the fund we’ve got $1 in co-investment.”

Judging a manager based on co-investment allocation rather than the performance of those investments is a sign of the times: As has been repeatedly observed, LPs want to consolidate their GP relationships, placing more capital with a smaller number of managers, and getting a sizeable portion of each increased commitment in the form of zero-fee co-investment. On a net-net basis, even if the return is no more than adequate in private equity terms, for most LPs it still betters both their benchmark return and what they are getting from other asset classes.

LPs will address this in their own ways, based on investment mandate and internal resources. While some institutional investors have built up global-focused sector teams that complement work done by investment professionals in different geographies, enabling them to participate early and fully on deals as a co-underwriter, others will be restricted to downstream syndication. Speed and reliability are what GPs value the most: respond quickly to an opportunity; and if there is a desire to participate, provide the money under the agreed timeframe. Adding particular value to a deal would be considered a bonus.

A number of factors could contribute to LPs stepping back from co-investment in Asia: a few high-profile failures, a macroeconomic shift that impacts risk exposure; a substantial rise in interest rates that influences risk-return preferences within portfolios; and with longer term hindsight, perhaps the recognition that the current co-investment frenzy didn’t necessarily translate into better returns.

For now, though, private equity firms are getting used to the new normal. In the industry survey that forms part of Bain & Company’s 2017 regional private equity report, GPs were divided as to whether “shadow capital” represents an opportunity or a risk. That said, more than

three quarters of respondents already offer passive co-investment rights, about one quarter allow co-underwriting and just under one fifth run separately managed accounts. A sizeable majority expect the same amount or more of this activity in 2017.

However, it is not just about co-investment and the trade-off between building relations with prospective LPs and getting extra firepower for deals on one hand, and reduced fund economics and increased administrative headaches on the other. Shadow capital is an umbrella term that covers direct investment by LPs as well, and the risk is that investors will bypass GPs altogether. The same LP that spoke glowingly of getting $1 of co-investment for every $1 in the fund was also far more bullish than before about the prospect of club deals in Asia with sovereign wealth funds and other groups comfortable with a long hold.

And it remains a prospect rather than the reality. The Bain & Co. survey found that the three top causes for concern among GPs are a mismatch in valuation expectations, a lack of attractive deal opportunities and the ability to sustain a high level of returns. But rising valuations – and the picture really does vary, depending on the geography, industry and transaction size being targeted – are not the result of a critical mass of LPs deciding to go solo and bidding up the pricing.

Rather, it is the amount of capital entering the asset class through funds and co-investment, and through channels that fall outside the norm. In China, for example, the definition of shadow capital could be stretched even further to include corporate investment units and government sponsored investment vehicles, chiefly on the renminbi side. Recognizable and unrecognizable names appear on filings for take-private transactions and in announcements of late-stage funding rounds for technology companies, but the size, scope and ambition of this investor constituency is largely unknown.

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Stability and opportunities for private investors The first event of its kind in Vietnam, the inaugural AVCJ Vietnam Forum will offer in-depth analysis of the risks and rewards presented to private market investors looking to commit capital to the growing economy of Vietnam.

The Forum will provide a platform for attendees to showcase the latest alternative investments opportunities, share strategies for navigating the Vietnamese market whilst networking with a diverse audience of LPs, GPs and service providers.

Felix LaiDirector InvestmentsGAW CAPITAL

Henry NguyenManaging General PartnerIDG VENTURES VIETNAM

Dominic PiconeManaging DirectorTPG CAPITAL

Binh TranVenture Partner500 STARTUPS

Pete VoManaging DirectorCVC CAPITAL PARTNERS

Mark MobiusExecutive ChairmanTEMPLETON EMERGING MARKETS GROUP

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ASIA PACIFIC

OCP Asia raises $200m direct lending fundHong Kong and Singapore-based hedge fund manager OCP Asia has raised a $200 million direct lending vehicle to make private equity-style credit investments in small and medium-sized enterprises (SME). The Landmark II fund will offer Asian SMEs loans in the range of $40-70 million to be secured by corporate properties.

AUSTRALASIA

Platinum to buy Staples’ Australasia unitUS-based private equity firm Platinum Equity has agreed to buy the Australia and New Zealand businesses of office products supplier Staples for an undisclosed amount. The businesses will continue to operate under the Staples brand for a short time, but the long-term plan is to build a new corporate brand for the divested stores.

Seed investor launches $50m global fundAustralia-based VC investor Followtheseed has launched a $50 million fund to invest in global early-stage start-ups. The new vehicle joins Followtheseed’s dedicated Australia fund, which launched in 2015 with a target of A$50 million ($38.4 million). The firm expects to make 100-120 investments from the global fund.

Accelerator SproutX closes $8m agritech fundSproutX, an Australian accelerator focused on agricultural technology, has raised A$10 million ($7.7 million) for a venture capital fund. Artesian Venture Partners will act as investment manager. LP support includes domestic superannuation fund Hostplus, which committed A$85 million to an Artesian fund earlier this year

500 Startups to open Australia headquartersUS-based early-stage investor 500 Startups will establish its Australian headquarters in Melbourne after receiving financial support from the Victoria state government. LaunchVic, a government-backed accelerator, has committed A$2.9 million ($2.2 million) to the expansion effort.

GREATER CHINA

China launches $21.7b SOE restructuring fundThe Guangzhou government has partnered with China Reform Holdings and Shanghai Pudong Development Bank to launch a state-owned enterprise (SOE) restructuring fund with a target size of RMB150 billion ($21.7 billion). The RMB50 billion first phase of the fundraising will

be deployed over 3-5 years in initiatives such as asset securitizations, mixed-ownership reforms and market-oriented restructurings.

Ally Bridge backs Luoxin Pharma take-privateHealthcare-focused PE investor Ally Bridge Group will support the HK$2.3 billion ($301 million) management-led take-private of Hong Kong-listed Shandong Luoxin Pharmacy Group. Giant Star HK, a vehicle set up by Luoxin managers and existing PE investor GL Capital, will provide 67% of the capital, while Ally Bridge provides the rest.

Euronet challenges Chinese bid for MoneyGramUS payment services company Euronet Worldwide has extended a buyout offer worth about $2 billion for NASDAQ-listed MoneyGram, contesting a bid made earlier this year by Alibaba Group’s PE-backed affiliate Ant Financial. The sale will provide an exit for Thomas H. Lee Partners.

Car-trading platform gets $100m Series CPAG Asia Capital has led a $100 million Series C round of funding for Mychebao, a Chinese online auction platform for second-hand cars. The company, also known as Chezhibao in Chinese, has become profitable and completes about 10,000 transactions every month, with each deal generating about 3% commission that is collected from the seller upon completion.

CMC, Sequoia launch fund, support kickboxingCMC Holdings – a unit of media-focused GP CMC Capital Partners – and Sequoia Capital China have formed a sports investment fund and led a Series A round of funding for Wanmingyang Media, which organizes and video streams kickboxing events in China. Wanmingyang has received more than RMB100 million ($14.5 million) from the new fund.

SDIC Fund leads round for drug developerSuzhou Ribo Life Science, a Chinese drug developer that focuses on liver diseases, has raised a RMB270 million ($40 million) Series B round led by SDIC Fund Management. Other new investors include China Resources, Zhenghe Yuantong Capital and TusPark Ventures. Existing backers Legend Capital, GGV Capital and Fortune United Partners have also re-upped.

Productivity, innovation critical to a changing China China is adjusting to a slower growth model driven by consumption rather than investment, but significant gains can still be made through productivity and innovation, industry participants told the AVCJ China Forum.

“People still underestimate the potential of China to grow by improving productivity. They underestimate the potential of innovation and the commitment to this, not just from

tech entrepreneurs but also from traditional entrepreneurs and the government,” said Jing Hong, a partner at Hillhouse Capital.

Emphasizing the role played by traditional industries in this transformation, she cited the example of Kidswant, a brick-and-mortar retailer specializing in mothers and children, which has received investment from Warburg Pincus and Hillhouse. The company equips its sales assistants with mobile devices to track individual customer preferences and target them with particular offers.

In manufacturing, high-end equipment is also increasingly seen as a means of achieving more efficient use of inventory, capital and labor, bringing down costs and driving up yield. “This has a huge impact on manufacturing and consumption because it means people get the products they want as soon as they can,” said Kyle Shaw, founder and managing partner of Shaw Kwei & Partners.

NEWS

Number 11 | Volume 30 | March 21 2017 | avcj.com 5

Makeblock receives $30m Series B Evolution Media China (EMC) and Shenzhen Capital Group have led a $30 million Series B round for Shenzhen-based education and robotics start-up Makeblock. The company will use the new capital for product development, improving distribution and opening offices in Beijing, Hong Kong, North America, Japan and the Netherlands.

Ex-MBK Greater China head to launch PE firmKuo-Chan Kung, former head of Greater China at MBK Partners, is launching his own private equity firm called Nexus Point Partners. He will be joined at Nexus Point by Richard Wong, formerly co-head of Asia M&A at Morgan Stanley and Min Li, who previously led Bain Capital Private Equity’s healthcare practice in the region.

Logistics robot developer secures $14mChinese logistics and warehousing robotics developer Geek+ has raised a RMB100 million ($14 million) round of funding led by Vertex Ventures China. Existing investors Banyan Capital and Shanghai Volcanic Stone Capital also participated in the round. The two firms co-led Geek+’s RMB50 million Series A round last year.

NORTH ASIA

INCJ takes control of pharma spin-outThe Innovation Network Corporation of Japan (INCJ) has teamed up with two pharmaceutical players to invest JPY10 billion ($87 million) in the creation of a biotech spin-out known as Scohia Pharma. INCJ will hold 70.5% of the company. Parent company Takeda Pharmaceutical and its distribution partner Medipal will take 19.5% and 10% stakes, respectively.

SOUTH ASIA

PE investors part-exit India’s SLCMEverstone Capital, Mayfield Advisors, Nexus Venture Partners and ICICI Bank have part exited their stakes in Indian agricultural logistics and financing firm Sohan Lal Commodity Management (SLCM). Impact investors Incofin

Investment Management, of Belgium, and Switzerland’s ResponsAbility Investments invested $20 million. It aims to help the company expand in both India and Myanmar.

TA buys stake in Ideal CuresTA Associates has invested in Indian pharmaceutical product supplier Ideal Cures. Neither the size of the commitment nor the size of the GP’s stake in the company were disclosed. The capital will be applied to manufacturing processes, research and development and technical support. The company also hopes to

leverage TA’s knowledge and global healthcare industry connections.

Actis part-exits IDFC for $17mActis Capital has exited most of its stake in Indian infrastructure lender Infrastructure Development Finance Company (IDFC) for INR1.1 billion ($16.9 million). The private equity firm sold about 21 million shares of IDFC in an open market transaction. The buyers were not identified. The sale leaves Actis with about a 1% stake.

ADB to invest $10m in Satin CreditcareThe Asian Development Bank (ADB) will invest up to INR667 million ($10.1 million) in Indian microfinance institution (MFI) Satin Creditcare Network. It will give ADB a 4.3% stake in India’s fifth-largest MFI in terms of gross lending portfolio, with INR33 billion in assets under management as of March 2016.

CVC plans to open India officeCVC Capital Partners is planning to open its first India office in an unspecified time frame, as part of an expansion of its business in the country. The GP focuses on management buyouts, privatization and turnaround deals across a range of sectors including technology, consumer products and services, travel and retail.

SOUTHEAST ASIA

Hubert Burda seeks Series B deals in SE AsiaThe investment arm of Hubert Burda Media, a European tech and media company that has made commitments to several Southeast Asian VC funds, has opened an office in Singapore to focus on Series B investments. It recruited Albert Shyy, previously head of Southeast Asia and India at Gree Ventures, to head up the office.

B Capital adds partner in Singapore B Capital Group has hired former Eight Roads Ventures managing director Kabir Narang as an investment partner in Singapore. The VC firm – launched by Facebook co-founder Eduardo Saverin and Raj Ganguly of Velos Partners and Bain Capital – employs nearly 20 investment professionals across Singapore and the US

CPPIB, CDPQ form SE Asia logistics partnershipCanada Pension Plan Investment Board (CPPIB) has teamed with Caisse de dépôt et placement du Québec (CDPQ) and Australia-headquartered property company Logos to develop logistics projects in Singapore and Indonesia.

CPPIB will initially commit S$200 million ($141.4 million) for a 48% stake in a Singapore-based arm of Logos, aiming to seed two fully-leased warehouse facilities as well as one development opportunity. CPPIB will contribute $100 million to support a pipeline of similar

projects via a 48% position in an Indonesia-based Logos entity.

CPPIB and CDPQ will be equal partners in both ventures, with Logos holding the remaining majority stakes as operating partner. It represents CPPIB’s first direct real estate investments in Singapore and Indonesia, and will build on a similar logistics play previously made by the organization alongside Goodman Group in China.

“The logistics sector in Southeast Asia continues to grow as a result of the burgeoning middle class and the rise of e-commerce, and presents an excellent opportunity for a long-term investor like CPPIB,” said Jimmy Phua, managing director and head of Asia real estate investments for CPPIB.

NEWS

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COVER STORYholden.mann@avcj.com

BY THE END OF LAST YEAR LIVE streaming had taken China’s millennial population by storm. More than 300 million users had downloaded one of the ubiquitous apps available for viewing or broadcasting user-generated content, and investors were casting covetous eyes at start-ups like Asia Innovations. The developer of streaming app UpLive was rumored to be raising capital at a valuation of over $400 million.

But when Edward Liu, a Beijing-based partner at WI Harper Group, looks at the live streaming craze, he suspects he already knows how the story will end.

“I don’t know why people would engage in that, but there’s so much money going through it,” he says. “They’re such gigantic numbers, and I can’t get comfortable with it. It reminds me a lot of the Groupon clone space in China, and then the O2O [online-to-offline] hype in China after Uber and all the ride hailing apps came out, and all of the failures there.”

For Liu the tech fads of the past, and the investors who scrambled to profit off of them only to wind up burned, exemplify one of the most important and hardest lessons for a GP to learn: know your market. An individual company’s strong growth story so far means nothing if the industry where it operates could disintegrate as so many have before.

However, building industry intelligence in Asia is complicated by the fact that in much of the region’s data, particularly for emerging areas, is hard to come by, and what does exist is often of dubious quality. In these markets, investors who can find their own methods of gathering information and putting together an accurate picture of companies and industries will have a considerable advantage.

Dodgy numbersIt is no secret that data in emerging markets is not always reliable. China’s government in particular is often criticized for publishing misleading or outright fabricated economic data, and members of India’s investing community have complained that the authorities are similarly willing to manipulate public information to support policy goals, as in the case of the recent demonetization initiative.

Southeast Asia, with its fragmented political landscape, presents additional challenges. While some governments exhibit the same tendencies toward information control, in other cases the opposite is true: the government lacks the power or resources to collect economic data, and regulators cannot compel listed companies to release accurate information.

“We get many kinds of information from China. The reliability is a different question, but they do provide a lot of information,” says Yasunori Naito, head of consulting services at Singapore-based market research firm Uzabase. “On the other hand, I was in Thailand last week, and the government and stock exchange are

quite weak. They’re not helping to provide information to the public.”

Such highly visible dysfunction has naturally led to calls for reform, with the Organization for Economic Cooperation & Development noting in a report last year the difficulties that inaccurate information poses for economic planning and asking governments to help improve reporting standards. But such arguments, while compelling, are unlikely to prevail as long as the perverse incentives that encourage statistical misrepresentation continue.

Blaming gaps in market data entirely on policymakers and regulators would be a mistake. In many cases information deficits are due not to a conscious decision to withhold information but rather to researchers’ desire to focus on areas that are more likely to be used by their clients. This is an understandable tendency, but it often frustrates investors whose strategy requires betting on industries before they are widely known or trendy.

“If you look at industries like pharmaceuticals, cement, financial services, or IT or BPO [business process outsourcing] services, coverage is deep

largely because of the size and scale of the industry and the economics of covering it,” says Vivek Pandit, a senior partner in McKinsey & Company’s Mumbai office. “Industries that are highly fragmented, like textiles or auto ancillaries or logistics, are not that well-covered because you don’t have large companies and it doesn’t meet the needs of banks to cover them.”

Investors often turn to outside consultancy firms to supplement their own understanding of an industry, but market professionals warn that even prominent firms can slip up.

Shaun Rein, managing director of market intelligence firm China Market Research Group (CMR), recalls being asked by an investor to

verify the research it had done on a recent acquisition of a Chinese consumer goods brand. The company had claimed a 40% market share, which the investor had verified through its own research based on data from Nielsen and Euromonitor International, but when CMR surveyed consumers in department stores and retail outlets it discovered that their purchasing habits were far below the claimed figure.

“We went to Nielsen and said, ‘How did you come up with this market share?’ and they said, ‘We based it off numbers from Euromonitor the year before,’” Rein remembers. “So then we called up Euromonitor and they said, ‘We based it off of numbers from Nielsen the year before.’”

While this is an uncommon occurrence, and investors say most consultants’ information is reliable, there is still a limit on the usefulness of data that they can provide. Southern Capital recently commissioned a local research firm to report on the temporary power solutions space in Southeast Asia, but found the results disappointingly light on specific details.

“They gave us a lot of data that we didn’t have, but it was still relatively high level because

Behind the curveGaining an accurate impression of an industry is vital for investors, but this can be difficult in markets where information is patchy or unreliable. Those who hope to prosper must learn to judge data carefully

“They gave us a lot of data that we didn’t have, but it was still relatively high level because unfortunately it’s such a fragmented space that there’s not enough public information” – Eugene Lai

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unfortunately it’s such a fragmented space that there’s not enough public information. So sometimes you just can’t solve that problem,” says Eugene Lai, managing director and co-managing partner of Southern.

Out of the boxThis does not mean that investors have no means of accessing market intelligence. However, industry players say that in the absence of reliable data, creativity and outside-the-box thinking are needed to ensure that investors are making prudent decisions.

A frequently used approach to filling in these gaps is to look for parallel industries or companies in other markets such as the US and Australia. This can be particularly helpful in late stage or growth investments, such as Singapore-based self-storage business Lock & Store, which Southern acquired in 2010. At the time the industry was only a few years old in Southeast Asia, with very few players, so the firm directed its research outside of the region to areas where the industry was more established.

“We did a lot of work trying to understand this industry and what the dynamics were in the US and Australia, because we thought there were a lot of lessons we could learn from there to try to apply to Singapore,” Lai says. “The industry in Singapore isn’t 100% the same as in Australia and the US, but there are many areas of commonality which I think we benefited from.”

Another method involves investigating outside markets for data that can be correlated to the desired information. This often requires more effort and ingenuity than simply researching similar industries, but computers can spot patterns more effectively than the human eye. Finding such parallels is an increasingly important part of operations, and McKinsey devotes a large part of its staff to investigating potential data matches in markets worldwide to help fill in the firm’s missing information in India.

“Advanced analytics is helpful in identifying a bunch of non-obvious and highly predictive relationships,” says McKinsey’s Pandit. “For example, in the US you have numbers on new construction starts, from which you can regress a lot of data on things that actually get consumed by offices, such as projectors, office equipment, and office furniture. When you don’t have anyone measuring new construction starts in India, that other information might be available.”

As useful as these options are, they do have a high potential for false positives, which can pose considerable danger for investors. Basing expectations for investee companies on outcomes in other regions risks ignoring the unique aspects of the local market, and can lead to unrealistically high or low expectations.

Likewise, looking for parallel data sets can result in assumptions about relationships that seem strong but are actually simply coincidental.

Pandit recalls such a situation several years ago when investors made large bets on electricity in India, expecting loosened coal restrictions to unlock pent-up demand for power. “The coal supply was solved and companies started generating and distributing power. But while there was demand for power, there wasn’t demand for paid power,” he explains. “The estimates that suggested we were power-short weren’t wrong, but the idea that that would actually result in economic power generation investments was misplaced.”

Such risks are present in China, too. WI Harper’s Liu remembers Alibaba Group being constantly misunderstood in its early days by investors who saddled it with inaccurate

comparisons to content providers or e-commerce companies in Western markets, and missed out on the company’s explosive growth due to unfair expectations.

However, a lack of information tends to be a lesser problem in China than the question of whether to trust the data one has. Industry professionals say even when government-issued data has not been deliberately doctored, verifying its claims is still necessary – for example, official measurements of retail sales for some time did not include e-commerce companies, giving a misleading impression of consumer appetites. Verifying and correcting official data can take considerable effort.

“If we were looking at steel output from mainland Chinese steel mills, we would go and talk to competitors from outside of China,” says Chris Leahy, co-founder of China-focused research firm Blackpeak Group. “We would talk to major steel manufacturers and steel buyers in China to try to get a sense of volumes, and then to sample test it.”

Early-stage issuesEarly-stage investors face different challenges. Since they are often investing in industries that until recently did not exist, there are usually few or no valid points of comparison even in developed markets. In these cases the approach tends to be bottom-up, rather than top-down: building an impression of an industry by examining individual companies, meeting with

the founders and asking to meet their business partners and customers.

While there is often little to distinguish one early-stage start-up from another, industry participants say they can still learn a great deal from meeting these stakeholders and \finding out what attracts them to the company.

“Very often, when these people have selected this company and the product, they’ve done it because they believe there’s a need in the industry for something like that. So they have a very good point of view on what the trend is,” says Ben Mathias, managing director and head of India at Vertex Ventures. “And if their customers have jumped in with both feet then you know they’re convinced it’s something they need to do.”

An investor’s network often comes in handy as well. Vertex is backed by Temasek Holdings

and can draw on the diverse companies represented in the state-sponsored Singapore group’s portfolio, while WI Harper maintains contacts with a wide range of scientists and technology professionals including Ahmad Bahai, CTO of Texas Instruments, who recently advised on a potential investment in a sensor developer.

While investments may result from this process, that is not its main purpose. The goal is to gather information about an industry and determine whether it is a space that the firm wants to be involved in. This can lead to awkward situations if an investor decides not to commit capital to a company that has given it access to its customers, but if the business is not viable then both will be better off in the long run.

Research techniques differ from one player to another, and an approach that works for one firm might not be appropriate for one in a different segment or market. But a common factor of successful firms is the ability to see opportunity where others see a defect, and to take advantage of that opportunity.

“A paucity of data creates a slightly inefficient market, which rewards those who have the ability to construct an independent point of view and take advantage of that inefficiency,” says McKinsey’s Pandit. “Things are often mispriced and misunderstood in an environment where everyone’s dealing with the same paucity of data, so if you’re able to access better information or construct it, you generally find that that should work to your advantage.”

COVER STORYholden.mann@avcj.com

“If their customers have jumped in with both feet then you know they’re convinced it’s something they need to do” – Ben Mathias

Aik Meng EngChief Executive OfficerTE ASIA HEALTHCARE PARTNERS

Rebekah Woo CFA, CAIASenior Director, Growth Markets AsiaCDPQ ASIA PACIFIC PTE LTD

Harold TjiptadjajaManaging Director, Chief Investment OfficerINDONESIA INFRASTRUCTURE FINANCE

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BANK OF CHINA BROUGHT AN END TO eight years of inactivity last May by selling RMB301 million ($46 million) in bonds backed by non-performing loans (NPLs). China Merchants Bank soon followed suit, raising RMB233 million. There was no shortage of demand among domestic institutional investors, even though the yields on the senior secured tranches are lower than interest rates on bank deposits. As the first NPL securitizations since 2008, it was a pilot project Beijing didn’t want to go wrong.

By the end of 2016, the six banks awarded quotas to issue asset-backed securities (ABS) with NPLs as the underlying asset had raised RMB15.6 billion through over a dozen transactions. More are expected in 2017, given the overall quota is RMB50 billion and reports that a number of smaller banks will be able to participate as well.

The return of NPL securitizations reflects the severity of China’s bad debt problem, which different sources put between $1 trillion and $3 trillion. The initiative was announced last year, with the government also revealing plans for regional asset management corporations (AMCs) and debt-for-equity swaps. Whether it is rolling NPLs into products sold to third-party investors, transferring them to AMCs for resolution or sale to third-party investors, or converting them into equity, these measures enable banks to move bad debts off their books.

The rationale of NPL securitizations is sound – as it is with debt-for-equity swaps – but much rests on transaction design, and whether the political considerations that have characterized these initiatives in their early stages can give way to more sustainable, long-term thinking.

“China wants a multi-pronged approach because the volume of NPLs it needs to resolve is too large for any one solution to be the entire solution,” says Ben Fanger, founder of China distressed debt investor ShoreVest Capital Partners. “There have been a few transactions but many participants assumed that there was an implicit guarantee by the government that these would not lose money. Future transactions will require the buyers to look more to the underlying assets, which can be difficult without a lot of detail.”

Securitization in practiceThe difficulty in assessing whether or not securitizations can go mainstream is that a pilot

project doesn’t necessarily take place in realistic conditions. For example, when China embarked on its first securitization experiment between 2005 and 2008, Orient and Cinda – two of the national AMCs tasked with absorbing bad debts from the big state-owned banks – and China Construction Bank issued RMB13.4 billion in bonds backed by NPLs with an original principal balance (OPB) of nearly RMB80 billion. About 60% of the total was senior secured.

However, each transaction was heavily over-collateralized – essentially ensuring investors in the senior tranche were guaranteed a return – and the subordinated tranches were retained by

the issuers. Fitch Ratings observed that Xinyuan 2008, which was issued by Cinda, comprised RMB2 billion in senior bonds and RMB2.8 billion in subordinated bonds based on an OPB of RMB15 billion. The plan was to collect RMB5.1 billion over four years and RMB3.1 billion within 18 months. When Xinyuan 2008 was liquidated in 2010, RMB2.2 billion had been collected, which was enough to pay off the senior tranche.

According to industry sources, in the most recent transactions, the issuers have not held onto all of the subordinated tranches: they were bought by private investors, with the likes of banks and AMCs picking up the senior debt. But as in the previous cycle, the senior tranche was structured so that it would sell.

“The securitization idea was mainly driven by the central bank and the commercial banks don’t want to allow a default of these products. If you don’t allow defaults, you have to price the products very conservatively. And if that is the case the banks have to make provisions on those

loans. If the banks have enough money to make provisions they wouldn’t move the loans off balance sheet, so I don’t think this will become a mainstream method for resolving NPLs,” says Eddie Hui, managing partner in the absolute returns division at PAG.

Fitch’s initial concerns around the latest NPL securitizations focused on cash-flow uncertainty. Would it receive detailed loan-by-loan collateral information, servicer business plans, loan purchase price information, and historical workout and performance data for the issuer and servicer relevant to the securitized asset pool? The National Association of Financial Market Institutional Investors, a self-regulatory organization set up under the central bank, is supposed to offer reassurance in this area: it issued guidelines last year on asset valuation and the disclosure of due diligence procedures.

Resolution issuesHowever, a more fundamental question involves the ability to resolve NPLs once securitized. “You’ve got a bank that has made all these poorly performing loans and now they are going to securitize them, and they are going to be the guys who collect them. There are many reasons why a state-owned bank isn’t going to collect money from a private company or a state-owned enterprise, everyone gets that. Securitization doesn’t change anything,” says Ted Osborn, a partner at PwC who focuses on restructuring and NPLs. “Insurance companies and banks will be encouraged to buy these securities but they won’t go overboard.”

China’s banks have engaged in various initiatives over the years to shift NPLs off their balance sheets in order to meet capital adequacy requirements set by regulators. In the past, underperforming loans have been classified as investments, which carry a lower risk weighting, and partnerships have been established with trust companies to package up NPLs for sale to retail investors or simply warehouse them. Similarly, joint ventures with the AMCs have emerged where the primary purpose is to move bad debts off balance sheet rather than to resolve them.

Securitizations could therefore pose a problem because they serve as a means of allowing banks to delay addressing NPLs. This view is not shared by all. “If the banks didn’t shift

Pass the parcel?China wants to use securitization and debt-for-equity swaps to address its non-performing loan problem. Even without structural concerns and political agendas, they are unlikely to supplant portfolio sales

“The securitization idea was mainly driven by the central bank and the commercial banks don’t want to allow a default of these products” – Eddie Hui

FOCUStim.burroughs@avcj.com

them there’s a danger they would just sit on the balance sheet for a rainy day, but when you expose those portfolios to other stakeholders then you have a different imperative,” one industry participant notes. Nevertheless, he professes some sympathy with the argument that responsibility for collection is left in the hands of the originating bank, it might not be the most efficient means to resolution.

A paper published by the IMF also flagged up a number of disadvantages to securitizations. It warned that these transactions can make debts harder to restructure, particularly in the absence of an unclear insolvency framework in China; that they may transfer risk outside the regulated financial sector to entities less able to absorb losses; that there isn’t a sizeable domestic institutional investor base willing to buy these products; and that a viable securitization market requires strong supporting legislation.

In this context, NPL securitizations will remain a work in progress not only until political considerations become less acute and market forces are allowed to prevail, but also until there is sufficient infrastructure in place to accommodate these transactions. And this is only possible with the introduction of broader reforms to corporate restructuring in China.

A more sophisticated and better enforced

bankruptcy law – improvements have been made but most investors highlight the need for more – is a significant measure but not the only one. The IMF also advocates stronger regulatory oversight of banks to ensure proper recognition and workout of NPLs, a clear plan for addressing the country’s bad debt problem that includes multiple stakeholders, and an improved distressed debt market with more timely access to information.

Swapping inFurthermore, a change in attitude is required: the financial system should not be used to prop up nonviable companies. This is particularly relevant to debt-for-equity swaps, where there is a risk that transactions are motivated by the political expediency of keeping large state-owned employers in operation rather than for commercial reasons. Even if there is a commercial rationale, banks are not natural company owners. They often lack the expertise to run or restructure businesses and there is a potential moral hazard if they continue lending to companies they control, adding to the debt pile.

Debt-for-equity swaps were employed in the late 1990s and early 2000s to remove souring loans to state-owned enterprises from bank balance sheets. They ended up with the AMCs.

The next generation of swaps are intended to be brokered by banks and feature third-party investors. However, several deals completed last year saw debt sold to investors at face value before being converted into equity, with the target company obliged to buy back the equity at a later date if certain performance targets aren’t met.

It is unclear whether the new investors – some of whom are retail players who bought into wealth management products – will have sufficient influence over companies to the point of bringing about a restructuring. It also remains to be seen what sort of appetite there is for these transactions among institutions such as banks, which would likely only be interested in large positions where there is clear upside over a limited time period.

“We’ve been told by banks that they only want to do debt-for-equity swaps with healthy customers because they see it as a way of getting equity and making money through an IPO. They aren’t going to take debt and exchange it for equity in a zombie company – but those are the companies really being targeted for this,” says PwC’s Osborn. “Debt for equity swaps will happen and maybe there will be one or two good ones, but taking off as a way to solve the NPL crisis? Never.”

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Number 11 | Volume 30 | March 21 2017 | avcj.com 13

NEW ZEALAND IS ONE OF THE SMALLEST markets in Asia Pacific but it might be the most conducive to private equity. Pioneer Capital estimates the country has the most private economy and the lowest supply of professional capital investment in the developed world.

The Auckland-based GP sees this national profile – shaped by geographic isolation – as resulting in a sharply favorable supply-demand imbalance for investors of privately held companies. Its third fundraise seems to confirm the popularity of this view: a final close of NZ$260 million ($180 million) was achieved after only a four months in the market.

This beats the NZ$210 million target and the NZ$150 million and NZ$70 million raised for Pioneer’s first two vehicles. All of the LPs are domestic institutions and the re-up rate was 88%. Backers include New Zealand Superannuation Fund, which contributed NZ$120 million, and a growing contingent of corporations representing the country’s indigenous Maori people. Maori groups are significant land owners in New Zealand and have recently diversified into PE,

accounting for some 17% of Fund III. “Private equity has become more mainstream

since we started about 10 years ago, so there’s a lot more appetite among institutional investors,” says Randal Barrett, Pioneer’s managing director. “The track record of returns has been good, and the stock exchange is so small, the only way to actually access large parts of our economy is private equity.”

The plan is to make deployments of NZ$10-50 million to medium-sized domestic companies that are in position to rapidly grow internationally. Investments will be flexible, including minority or control stakes in businesses that could be cash flow positive or negative.

International exporters will be the primary target, reflecting Pioneer’s current portfolio, where more than 95% of the combined sales are made overseas. A stronger focus will be put on premium grocery brands that can leverage the country’s growing reputation for food safety and

environmental consciousness.The first of these investments has already

been made in a joint buyout of Havelock North Fruit alongside Oriens Capital. The two firms took a combined 55% of the company, which has been renamed Rockit after its core product – a line of specially bred miniature snack apples sold

in tubes, tennis ball-style. The simultaneous novelty

and familiarity of Rockit apples is at the heart of the New Zealand marketing opportunity. The country’s primary agricultural and mineral commodities still dominate the economy, but companies able to put a palatable twist on old trademarks

are finding a place in a new fast lane. “Last year, high-value exports out of New

Zealand were NZ$9.1 billion and outstripped our forestry, wool and meat industries,” Barrett explains. “Value-added products were second only to our dairy sector, but they’re catching up – and LPs want exposure to that.”

MULTI-BILLION DOLLAR DEALS IN Australia tend to attract media coverage well before negotiations conclude. But with the more than A$4 billion ($3.1 billion) sale of domestic power utility Alinta Energy, TPG Capital needed to plug any potential leaks. Despite the politics inherent in offshoring a major infrastructure service, the deal remained under the radar until contracts were signed.

Stealth was important because any publicity around a fizzled trade sale could have been damaging to the Alinta brand, especially in light of the gas company’s awkwardly protracted IPO process. The business had been on the market for more than a year and postponed a float on two occasions.

Joel Thickins, who joined the firm in October last year as head of Australia, called for the most recent delay based on concerns around local IPO fatigue and market noise related to the US elections. At the time, a clandestine dual-track sale process was brewing with a number of potential trade players in mind, but talks with the eventual buyer had not yet begun.

Chow Tai Fook Enterprises (CTFE), a family office-style investor best known as Hong Kong’s largest jeweler, came to the fore during this period on the back of historical relations between its top leadership and TPG’s managing partner in Asia, Tim Dattels. The company had no experience in energy, having previously focused on real estate and tourism investments alongside its jewelry empire. Nevertheless, an agreement was reached in about 10 weeks.

“They were extremely professional and well managed throughout. Their team was world class,” says one person familiar with the transaction. “The IPO really forced them to get across issues and come to terms quickly.”

The sale requires approval from Australia’s Foreign Investment Review Board, and hopes for a positive outcome are pinned on CTFE’s ability to fund Alinta’s growing renewable energy ambitions, which would sooth government headaches around balancing environmental

concerns with rising electricity needs. The environmental angle was always a part

of the TPG value-add scheme. After making a A$2.1 billion investment in the company as part of a consortium in 2011, the GP worked on

improving customer relationships and cleaning up contracts with key counterparties. But as Alinta expanded from its core market in Western Australia to the more lucrative eastern states, a cleaner vision for the company’s profile began to become a priority.

This growth coincided with the shut-down of the company’s

Flinders coal-fired power plant in South Australia and the outline of a more diversified energy production portfolio.

“Even with ongoing global market volatilities and uncertainty, we see promising opportunities for growth and development in the region,” says Thickins. “We will continue to identify ways to selectively deploy capital as we build upon TPG’s presence in the market.”

FUNDS / DEAL OF THE WEEKjustin.niessner@avcj.com

Pioneer sees PE come of age in NZ

TPG makes surprise trade sale

New Zealand: Agri exports

Energy: Australian appeal

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avcj.com | March 21 2017 | Volume 30 | Number 1114

PORTFOLIOwinnie.liu@avcj.com

LOCATED IN THE QUIET, MIDDLE-CLASS district of Qingpu, not far from Shanghai Hongqiao Airport and a one-hour drive from downtown Puxi, Shanghai DeltaHealth Hospital is intended to be a pioneering example of a foreign-owned general hospital in China. The facility is spick and span, having only been open six months, but it represents 10-year effort for Eight Roads Asia, formerly Fidelity Growth Partners Asia.

The 50,000-square-meter hospital, which currently holds 202 beds, is spread over three floors, each one characterized by contemporary design and modern lighting and furniture. The first floor is home to outpatient services and general practices functions such as pediatrics, gynecology and dental services. An intensive

care unit will open next month. Cardiovascular treatment – the hospital’s area of specialization – occupies the upper two floors: diagnostic laboratories, cardiac care units, operating rooms and inpatient wards that offer a one-stop service for everything from strokes to heart disease.

Over the past 24 weeks, doctors have performed 60 heart surgeries, with six to eight procedures taking place each week. This compares to 30-100 times per year at class-three public hospitals, the highest standard in China.

“Our desire is to capitalize on the co-existence of China’s reforms and the development of a public healthcare system in such a way that we all increase the standard. That was our vision

10 years ago, and it’s still the vision today. Nothing has changed in that regard,” says Daniel Auerbach, senior managing partner at Eight Roads, and chairman of DeltaHealth, the healthcare services group of which the hospital is part. “Previously we were very much focused on building something of the highest quality and with the highest standards. Today we’re squarely in the clinical delivery and operational mode.”

Incremental changeMoves to liberalize China’s healthcare services industry were announced in late 2013. The following year the government further opened up the space by allowing 100% foreign ownership of private hospitals in seven cities and provinces. Prior to that, an overseas investor had

to pair up with a local partner and could own no more than 70% of the resultant joint venture.

Eight Roads started lobbying for reform in Shanghai 10 years ago, arguing that it was essential if the government wanted to attract the talent, adopt the advanced foreign technologies and implement the best practices required to improve the healthcare system. The firm suggested that four top US academic medical institutions, including Columbia University, open a hospital in the city dedicated to cardiology.

“What might be unique about us is that we look way ahead. There was a bet that the healthcare system in China was going to experience a stress test. To us it was very

obvious – the government couldn’t deliver public healthcare services to the entire population with an infrastructure that was not yet modernized and scattered throughout the country,” says Auerbach.

Public hospitals – which in 2013 accounted for about 60% of all hospitals nationwide – are grouped into three classes, based on capability and responsibility levels. Each class is then subdivided into three further levels, A, B and C. A system exists to channel the sickest patients to hospitals best equipped to treat them, but it doesn’t work in practice. While a class-one hospital can treat a flu case, most patients go to higher-ranked hospitals because they believe the service will be better, which means class-three facilities are a bottleneck.

In the face of these challenges, the government decided to allow first private investors and then foreign investors to enter the sector. By 2015, of the 27,587 hospitals in China, approximately 50% were privately run. However, the public sector still accounts for the bulk of revenue, generating RMB2.09 trillion in 2015 to the private sector’s RMB203.6 billion.

“DeltaHealth is taking patients who want a different type care – and can afford to pay for it – and that releases some pressure from the public system,” says Jarlon Tsang, managing partner at Eight Roads. “As the middle class grows in China, as in many countries, patients start demanding better healthcare. Right now a lot of people leave China for treatment in Hong Kong, Singapore, and even the US. But China has some of the best doctors in the world – the volume of surgeries they have performed in their careers is far greater than for US doctors.”

Between 2011 and 2015, total healthcare expenditure, which includes government investment and individual spending, increased from RMB2.43 trillion to RMB4.1 trillion, according to Frost & Sullivan. It is expected to reach RMB6.28 trillion in 2020.

Despite this growth, there remains a mismatch between demand and supply, with cardiology a standout example. About 20 million people are admitted to hospital in China each year suffering from cardiac diseases, but only 600,000 percutaneous coronary interventions (PCIs) – a common non-surgical procedure used to treat narrowing arteries – are performed.

“The first wave of private healthcare services

Reform agendaEight Roads decided to leverage the development of China’s healthcare sector by building a hospital, but addressing the various challenges that come with a greenfield strategy requires very patient capital

China’s hospital industry by market size

Sources: National Health and Family Planning Commission; Frost & Sullivan

2011 2012 2013 2014 2015 2016E 2017E 2018E 2019E 2020E

Public Hospitals (RMB billion) Non-public Hospitals (RMB billion)

RM

B bi

llion

4,000

3,000

2,000

1,000

0

Number 11 | Volume 30 | March 21 2017 | avcj.com 15

PORTFOLIOwinnie.liu@avcj.com

focused on outpatients, with many operators building small clinics that were easy to scale in a short time frame. When you look at the second wave of healthcare services companies – some of which have now been listed – they were larger hospitals specializing in maternity care, eye care, dental care, and health check-ups. None of these specialties relate to life-threatening issues involving in complicated procedures,” Tsang says.

Building upEight Roads, recognizing the gap between those who suffer from heart disease and those who receive treatment for it, identified cardiovascular care as the main focus for its hospital. The firm established DeltaHealth and started construction on the Shanghai facility four years ago.

It has so far invested $200 million in the hospital, including a $100 million loan from China Merchants Bank in 2013. For most well-equipped hospitals, equipment accounts for 25-30% of total expenditure. DeltaHealth has bought a CT scanner, an MRI machine and an X-ray machine, as well as several ultrasound machines for heart check-ups. For heavy equipment, such as X-ray machines, which generate a lot of radiation, designs must be customized to the space in order to prevent leakage.

“We made a lot of investments not only in equipment but also in the rooms for this equipment to ensure we meet all the requirements,” says Desmond Thio, CEO of DeltaHealth Hospital, who was formerly president of Philips’ Greater China healthcare business. “When building a new hospital you can actually design it the way it has to be for that purpose, making sure all issues including safety issues are properly addressed.”

Once the equipment is in place, a hospital must attract the right doctors to use it – a challenge for any greenfield facility in China. Most highly qualified physicians choose to work at top public hospitals, typically in Beijing, Shanghai, Guangzhou and Chongqing, where the benefits are better and career advancement is clearer. Essentially working as civil servants, they are offered accommodation subsidies and insurance coverage in addition to a stable monthly salary.

However, the bottlenecks in class-three hospitals – and standardized pricing for surgeries in order to reduce state health insurance payouts – mean these doctors are overworked and feel increasingly undercompensated. This has prompted some to cross legal and ethical lines, privately charging families for better treatment, prescribing expensive and unnecessary drugs for the kickbacks offered by drug makers, or taking weekend jobs at other hospitals.

The government has responded by modifying its policies. It started by allowing doctors to

practice at cooperative medical institutions with permission from their original organizations, and now physicians in certain pilot areas can apply to work at up to three medical institutions.

Over the past three years, Eight Roads has worked closely with senior doctors in the public sector to hear their views on the evolution of China healthcare reform. It managed to recruit Professor Zhongyi Sun of Beijing Anzhen Hospital – a leading cardiovascular specialist who has developed procedures now seen as global standards – as president and chief medical officer

at DeltaHealth. Getting others to move from public to private practice has proved difficult.

“If you take a 10-15 year view on innovating and creating new drugs and treatments for the global market, China will succeed extremely well. If you communicate this to physicians who would like to participate in this journey, it works very well. On the other hand, if you say that you will pay them well and ask them to get out from the public system because you don’t respect that system, they will most likely never join you in this journey,” says Auerbach.

Although doctors are allowed to work for multiple institutions, the practicalities are challenging. Public hospitals are reluctant to see top talent – physicians they have nurtured – work elsewhere. There are concerns that it could lead to a wider brain drain at senior level. As a result, Sun started at DeltaHealth on a part-time basis and remains full-time at An Zhen so as to maintain good relations with his former employer. The transition to DeltaHealth will be gradual.

In addition to 27 full-time physicians, DeltaHealth has agreements with private and public hospitals in Shanghai and Beijing to provide mutual transfers of doctors and patients. For example, if a partner hospital receives a cardiovascular patient who requires complex treatment, it will refer the patient to DeltaHealth. The doctor-sharing scheme is at an early stage, but it is expanding.

The company has also recruited two seasoned international hospital professionals

to oversee patient care. COO David Hoidal has more than 30 years of experience as a hospital operator in the US and the Middle East, while Cecilia Ma, DeltaHealth’s director of nursing, was most recently director of patient care at New York Presbyterian Hospital’s intensive care unit. In addition, staff are kept up to speed through a training partnership with Columbia University, which sees Chinese doctors go to the US and US doctors come to China.

“My opinion is that a lot of public healthcare services providers in China are working in silos,” says Hoidal. “Our focus is very much on patient-centric care and services with a multi-disciplinary array of treatment. That approach requires a lot of training, team-building and education. All of our staff have been through that training. All of them, whatever what their position is, are committed to our patient’s safety and utmost satisfaction.”

Long-term viewBased on Hoidal’s experiences of private hospitals in overseas markets, it takes more than a decade to break even, but he believes DeltaHealth Hospital could become profitable within six years. China’s rapidly changing market dynamics are the reason for this, with Shanghai seen as particularly attractive because of its relatively wealthy population and the greater penetration of third-party insurance. (At present, DeltaHealth only accepts cash payments for treatment or private sector insurance.)

The company has already started building a network of outpatient medical clinics in Shanghai. The first one, DeltaWest Clinic, opened in 2012 and provides primary and specialty care. It serves as a platform to generate patients for the main hospital and also as an outpost for those who require post-treatment rehabilitation services.

Meanwhile, the main hospital is now in its second phase of construction, which will see the addition of 350 beds. There are no plans to recreate DeltaHealth Hospital in other cities. Eight Roads has little interest following the strategy employed by other PE investors of consolidating assets with a view to a quick public listing. Indeed, Auerbach says that DeltaHealth should not be classified as a traditional PE investment; it is a long-term project that will continue to receive capital as it develops.

“Eight Roads is very different from other investors – they are more visionary,” adds Thio. “The hospital business is a long-term investment, which could generate sustainable returns, help people and contribute to the society. In addition, this hospital is full of creative ideas, new technology, innovative services, and collaborations that are reshaping the healthcare landscape bit by bit. I am proud to be a part to drive these innovations.”

“It’s taking patients who want a different type of care – and can afford to pay for it – and that releases some pressure from the public system” – Jarlon Tsang

Asian Venture Capital Journal

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