Private Equity in Southeast Asia: On the Middle Ground (PEI Asia, Oct 2009)

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October 2009 Issue 34Cover story: Southeast Asia

On the middle“Private equity activityin Asia began in thisregion. Indonesia,Thailand andSingapore were thefrst countries to seeprivate equity deals.”



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October 2009 Issue 34

Sandwiched between

China and India, SoutheastAsia is fragmented, viewed asrisky and often bypassed infavour of the more developedprivate equity marketsof its enormous neighbours.But for investors with the

right appetite, and managerswith the right skill-set, theregion presents a uniquelycompelling investment case.Siddharth Poddar reports.

Cover story: Southeast Asia

Buttressed by Asian economic behemoths China and India

to the north and west respectively, Southeast Asia is often

overlooked in discussions on private equity in the Asia Pacific.

This could perhaps be due to the fact the region has not seen

the same spike in activity as other Asian markets such as China,

India or even Australia, in the past four to five years. But – as Nick

Bloy, co-managing partner of Kuala Lumpur-headquartered Navis

Capital Partners, points out – the number of deals getting done

in Southeast Asia is ultimately a “function of how much capital

investors are willing to allocate to the region”.

With the tremendous growth story taking place next door

in India and China, many investors’ focus has been on getting,

or building, exposure to these two economies. And while

Southeast Asia as a whole has a sizeable economy, the fact

remains that while it is one region, it is not one market: it is

instead an amalgamation of different economies, at varying

stages of development.

Much of the capital invested in Asian private equity comes

from Europe, North America or the Middle East, and many LPs

simply do not have the specialist knowledge to target Southeast

Asia. Instead, they tend to follow the law of large numbers and

make their first foray into Asia with commitments to funds

investing in India and China, because these are simpler – and more

accessible – markets to invest in.

Bruno Raschle, managing director of Switzerland-based fund

of funds manager Adveq, which is currently raising its second

Asia-focused fund of funds, says there are “a few excellent” fund

ground



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managers in Southeast Asia, but adds that as an investor, one has

to decide how to make money. “In Southeast Asia, the markets

are smaller and I think for the crowd of investors, it is just more

convenient to concentrate on India and China,” he says.

It is only in the next phase of their investment in Asia thatwestern LPs might look to Southeast Asia, says Bloy, by which

time they might have developed a more granular understanding

of the region.

In his words, Southeast Asia does not “lend itself to easy

categorisation”. It is

a fair point: looking

around the region,

China and India stand

out as a growth

capital markets, and

the more mature

economies of Japan

and Australia as

buyout markets.

Southeast Asia,

however, which

you might expect

to fall into the

growth capital

bracket, is a territory

of mixed approaches,

dominated mostly by

control investments (see box on page 17).

Alun Branigan, Singapore-based partner at Actis, sums it up,

saying the region’s disparity poses challenges.

“It is one of the reasons why private equity has not yet truly

taken off in Southeast Asia. Southeast Asia is much more complex

and nuanced – it is far more difficult to understand than other

single markets.”

That said, he and other managers point out that the difficulties

of the markets benefit those firms already investing in the region,

as the lack of fund managers targeting the area makes it easier

to get proprietary access to deals.

No zero-sum game

Although the fragmented markets of Southeast Asia remain

overshadowed by those of India and China, living in the

shadow of such relentless growth engines does not necessarily

detract from Southeast Asia’s growth prospects; in fact, it may

enhance them.

Pote Videt, a Bangkok-based managing director at Lombard

Investments, a Southeast Asia-focused firm which manages assets

of about $750 million across three funds, says that while people

seem to think Southeast Asia loses out to India and China, the

reality is it is far from “a zero-sum game”.

In his view, one of the theses behind investments in this region

is that its growth patterns are linked to China and its domestic

demand growth. “Many Southeast Asian countries have a sizeable

trade surplus with China,” he says. This is through the export

not just of raw materials and basics like food, but also

intermediate and end-products.

And while most Southeast Asian economies do not havethe same rates of growth as China, as long as China’s growth

continues apace, their companies stand to benefit.

Branigan agrees that the region’s location can be an advantage.

“It sits right in between China and India and while trade flows

between those two economies are strong, trade and investment

flows are actually stronger between Southeast Asia and India and

China respectively, than they are between India and China,”

he says.

No exit

However, while its neighbours might provide a boost to Southeast

Asia, there are other factors besides the area’s heterogeneity and

complexity which play a significant role in limiting private equity activity

there.

“A major factor curtailing private equity activity in Southeast Asia

has been the lack of exit opportunities,” says Lachmi-Niwas Sadani,

a Singapore-based director at fund of funds manager AXA Private

Equity. He adds though that the Singapore Exchange is now getting

more liquid and, in some cases, it may be possible for companies to list

in Hong Kong.

Bloy has a different view. “We don’t feel that the stock exchanges

provide a suitable exit mechanism. Trying to sell a 100 percent interest

in companies on the stock market is difficult, especially in the small- to

mid-cap sector as the liquidity is not just there,” he says, adding that

stock markets are “unreliable in the best of times and impossible at a

time like now”.

Despite this, he doesn’t believe exits are a problem in the region.

Navis, which is focused on making control investments in Southeast

Asia and the Indian sub-continent, has made 15 exits, of which 12 have

been achieved through trade sales and two through sales to financial

sponsors.

Looking ahead, a number of practitioners say that exiting

businesses could become easier in the region. Many Chinese and

Indian multinational corporations are emerging as prospective buyers

as they look to expand in the region through the acquisition of assets.

It is a trend that will continue, most say.

Leaving exits aside, another hurdle facing the would-be private

equity investors in Southeast Asia is that the levels of transparency and

corporate governance found in more developed Asian markets cannot

be found. Neither is its banking system as developed either, says

AXA’s Sadani. Though all this is improving, it will take between five

and 10 years for the region to reach the same level as, say, Australia,

he adds.

Don Lam, chief executive officer and co-founder of Vietnam-based

alternative investment firm VinaCapital, agrees. “Besides Singapore, the

legal infrastructure in most other countries in the region is new,” he

says, adding that in many markets in Southeast Asia, an emphasis on


Videt: Southeast Asia’s companies benetfrom China’s growth





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Southeast Asia has plenty going for it on its own. The region has

great supporting demographics and macroeconomic dynamics

– stripped to very basic terms, a huge population of about 580

million with rising incomes. “That makes this region

a great consumer

story,” Branigan

says. He adds that

anything

that plays to the

theme of rising

wealth in the region

– be it consumer

goods, healthcare

services, or even

financial services –

has the potential to

do well.

Raschle agrees,

adding that sectors

that have to do

with servicing

infrastructure, distribution systems, communications, healthcare,

logistics and consumer-related, make

for attractive investment options.

“We have focused a lot on the domestic demand sector,”

says Videt. However, he adds that in Southeast Asia, it is very

hard to find good consumer companies, so the firm has had to

find proxies such as retailing, food service and middle-income

housing. There are other factors affecting domestic demand that

are not highlighted often, he adds. For instance, “one of the hidden

drivers in the Philippines is remittances from abroad, which didn’t

really slow down much during the crisis”, he adds.

In Vietnam too, rapid urbanisation and a growing middle class

are creating a new culture of consumerism, says Lam. His firm is

focused on investments in services and products that address this

new market – financial and business services, education, healthcare

and particularly residential real estate developments.

Furthermore, in a market like Vietnam, many companies need

capital for expansion, Lam says. He adds that there is a lot of deal

flow in the country originating from the privatisation of state-

owned enterprises. The firm had made seven investments and

three exits across private equity, real estate and infrastructure

by July this year.

The only problem with the consumer-related sector is that

it is more likely to be negatively affected in a downturn than other

sectors. However, managers agree that if a five- to eight-year time

horizon is considered, the consumer story remains attractive.

The abundance of natural resources in the region also presents

interesting opportunities. Firms can either invest directly in natural

resources or in companies that lie in supporting sectors. Branigan

says many companies that support the natural resources sector in

the region are looking to expand into other areas such as West

Africa and Brazil. These are ambitious regional companies, but

they need help from private equity firms to go global.

Managers also talk about attractive valuations in the region.

Videt, for instance, says that the difference between Southeast Asia

and other Asian markets is “you can get similar growth at lower

valuations – which is where you can achieve superior returns”.

Bloy agrees, saying that while it is always hard to pin down

pricing, he has heard “anecdotally” that companies with steady,

maintainable earnings are being transacted in the 4 to 5 times

EBITDA range, numbers which are reminiscent of the pricing

range seen during the Asian economic crisis in the late 1990s.

“You don’t see such attractive valuations in India,” he says.

Good prospects for private equity

With the worst of the downturn seemingly behind us, fund

managers investing in Southeast Asia expect increased activity

in the months to come. In recent months, there has been a drop

in deal activity, fund managers say. Now there is less capital in

the market and entrepreneurs cannot get credit easily to fund

their businesses. Branigan expects private equity to become an

important source of capital for companies in the region.

The IPO markets are not in great shape yet, so that is good

for private equity buyers in general, Bloy says, adding that the

public markets can have a crowding out effect on private equity.

More importantly, perhaps, the region is still growing and

maturing. As corporate governance and the banking system in

Southeast Asia improve further, the likelihood of investments

increasing is greater as well.

Governments such as Malaysia’s are also taking initiatives that

reflect the increasing acceptance of the asset class in the region,

Bloy says. In July, the Malaysian government announced

the formation of Ekuiti Nasional Berhad (Ekuinas), a private

equity firm that will manage RM10 billion ($2.9 billion; €2 billion)

“Investment ows are actuallystronger between SoutheastAsia and India and China

respectively, than they arebetween India and China.”


Branigan: demographics make Southeast

Asia a great consumer story



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for investment in domestic companies. It has also liberalised

foreign ownership rules in the country, which in Bloy’s opinion,

is a step in the right direction for foreign investment in general.

In Sadani’s view, private equity firms between them can

comfortably deploy between $500 million and $1 billion annually

in Southeast Asia. He expects to see a fairly vibrant private equity

market blossom in the region, and says he would be surprised

if assets under management in Southeast Asia did not rise above

$20 billion in the next five years.

Stuck in the middle of two growth giants Southeast Asia

may be, but that doesn’t mean it doesn’t have its own giant

growth ambitions. l


From local to regional: the growth of private equity

Private equity is not new to Southeast Asia, as Lachmi-Niwas

Sadani, a Singapore-based director at fund of funds manager AXA

Private Equity,

explains: “Private

equity activity in

Asia began in this

region. Indonesia,

Thailand and

Singapore were

the first countries

to see private

equity deals in the

mid-1990s.”

However,

activity in the

region quickly

stalled, primarily

due to the Asian

financial crisis of

1997, which began

with the collapse

of the Thai Baht.

Other Southeast Asian economies proved not to be immune

to events that transpired in Thailand and were soon engulfed in

the crisis. “The currencies went haywire and people lost a lot of

money,” says Sadani.

With the near-collapse of regional economies came the

realisation that the balance sheets of both countries’ and

companies’ were not as strong as had been imagined.

Governments in the region cleaned up their balance sheets and

government debt to GDP began declining. They allowed currencies

to depreciate, assisting the region’s exporters, and foreign reserves

began increasing again. Simultaneously there was political change in

a few countries, leading to greater political stability in the region.

Since then, Southeast Asia has been competing for capital with

other single economies in the region. Now, most managers feel,

more capital will start to flow into the region as investors gather

more experience of investing in Asia. Lower valuations in the

region provide an incentive as well, they say.

In recent years, the region has seen the growth of a few

country-specific managers, the likes of Quvat Management,

Saratoga Capital and Northstar Pacific Partners in Indonesia,

Leopard Capital, which currently invests in Cambodia, and Mekong

Capital in Vietnam. The fact that there are more local managers

than regional ones only goes to highlight the differences that exist

between the various markets here.

Don Lam, chief executive officer and co-founder of Vietnam-

focused alternative investment firm VinaCapital, says that country-

focused funds are better positioned to invest in local markets as

they have local teams. He says that many pan-Asian firms want

to work with local firms to benefit from their experience in local

markets.

However, as country-focused private equity groups look to

expand investment remits, they will start to look at Southeast Asia

as a regional block, predicts Nick Bloy, co-managing partner of

Kuala Lumpur-headquartered Navis Capital Partners. “It is all part

of the maturation process and I think that’s underway,” he adds.

He also underlines the importance of firms knowing how to

develop companies in adjacent economies, a need emanating from

the ASEAN* Free Trade Agreement. “The need to add value to

domestic companies will take local firms to different markets in the

region,” Bloy says. As barriers between various regional economies

recede further and the economies become more integrated, the

expansion of local firms’ operations is to be expected.

*ASEAN (The Association of Southeast Asian Nations) is comprised of

Brunei Darussalam, Cambodia, Indonesia, Laos, Malaysia, Myanmar,

the Philippines, Singapore, Thailand and Vietnam.

Bloy: country-specic funds will start to lookat Southeast Asia as a regional block

“For the crowd ofinvestors, it is justmore convenient to

concentrate on Indiaand China.”

Documents

Private Equity in Southeast Asia: On the Middle Ground (PEI Asia, Oct 2009)