In Asian private equity, China and India have traditionally grabbed most of the investor attention and fund allocation. There are signs, however, that Southeast Asia is also emerging as a favoured PE investment destination.
Bain & Co’s Global PE Report for 2012 identified Southeast Asia as a key opportunity and revealed that in 2010 and 2011 combined, Southeast Asia-focused funds had committed funding of almost $4 billion, a more than 40% rise from the amounts raised in the previous two years.
The consequence of such increased allocation, together with the dry powder already in the region, is too much capital chasing too few deals. Listed below are the five key things that savvy investors are doing to stay ahead of the game in the increasingly competitive Southeast Asian PE market.
1. Get in the flow
When asked about the challenges of PE investing in Southeast Asia, the first thing that an investment professional from one of the international PE houses said was “access”. International PE houses in particular face the challenge of building deep local relationships, especially if they rely on regional coverage teams and operate a “fly in, fly out” coverage model.
Indonesia stands out as a market where the indigenous PE houses dominate the scene. A notable exception is CVC who was responsible for the leveraged buy-out of Matahari Department Store, which, at $774 million, is Indonesia’s largest LBO to date.
A deep local network will make the difference between failure and success. This is particularly true in respect of origination. Relationships with the family businesses that are the bedrock of the Indonesian economy give access to deal flow and first pick of the choice deals.
Local knowledge also plays a role in successful execution, particularly in jurisdictions where regulations are opaque and subject to interpretation. Those who are in the know will be able to pick a way through regulatory and other obstacles. To a certain extent, it is possible to buy in some of this knowledge, if you have the right advisers with the right local knowledge.
2. Get the diligence right
PE investors in Southeast Asia are often investing in early stage companies. In such companies, corporate governance and hygiene in commercial contracting can often take a back seat to chasing growth. The investor will need a due diligence team that can see the forest, not the trees, and that can assess the real risk areas. Working in emerging markets also requires a healthy dose of pragmatism — checking off by rote that a target company has all the licences it is theoretically supposed to have, for example, is simply not a meaningful exercise. The lack of a licence may simply be due to the realities on the ground. For example, we have seen at least one instance of a licence not being in place because the government agency that is empowered to issue such a licence has not yet been set up. Local knowledge is key in understanding the difference between theoretical and real risks and knowing how to mitigate such risks.
An increasing area of diligence is in respect of anti-corruption. The UK Bribery Act is only the newest piece of anti-corruption legislation with extra-territorial reach. It has focussed the minds of companies with a UK connection and of investment professionals who are UK citizens.
The good news is that local counterparties are no longer affronted by this line of questioning and now accept it as a standard part of due diligence. Diligence on this aspect should be a combination of documentary and management due diligence, with the legal advisers and the forensic teams of financial due diligence providers working closely together. “Live” diligence sessions are key — no amount of documentary diligence is a substitute for looking the counterparty in the eye. As Nicola Tassel, senior counsel at 3i, commented, the discussion around such issues is a way of “taking the temperature” of management and counterparties. The way they deal with this aspect of the diligence and their willingness to make any changes required by the investor is often a telling indication of how they will approach the relationship more generally.
Diligence on the target is only one part of the investigations that an investor needs to conduct. The counterparty, any joint venture partner and management also need to be thoroughly diligenced. Such diligence can reveal any divergence in the parties’ commercial alignment. Where the investor is a minority shareholder and there is an on-going relationship with the other shareholders, commercial alignment gives the investor the best chance of ensuring (or in reality, encouraging) adherence to the legal agreements.
A good diligence process identifies not just the existing issues of a target but also lays the groundwork for post-closing operational improvements to drive performance. This leads us to the next point...
3. Add value
We have already alluded to the abundance of capital earmarked for Southeast Asia. How does a PE investor differentiate itself in a sea of open chequebooks? Increasingly, we have seen that PE investors do this by demonstrating what they can bring to the party, for example, operational expertise, assisting in regional expansion and an understanding as to how to raise capital, for example by helping the investee company map a route to IPO.
Showing value-add is also a way that the PE investor can increase its de facto influence over the management of the investee company. Growth capital investments are typically minority plays. In some cases, foreign investment restrictions require that the investor holds only a minority stake. As a minority shareholder, the PE investor’s rights will typically be negative control rights. While an investor may have a veto over the business plan, for example, the investment agreement is unlikely to give a minority investor the legal right to direct the management and control of the company. Such influence, therefore, can only be achieved by “soft” means and the most compelling way of influencing management will be to demonstrate the value-add brought by the PE investor.
Getting more deeply involved on the operational side is not just for the benefit of the investee company. It also has clear benefits for the investor. The more time spent in asset management, the better the returns. This is likely to become increasingly important because as markets mature, investors will not be able to rely only on macro-economic factors to drive their returns.
4. Beat the strategics
Particularly with the larger investments, PE investors compete not just with each other but with strategic investors eager to build their footprint in the region. The Suntory investment in Garudafoods is an example of a transaction where a PE investor was pipped at the post by a strategic investor. Cash-rich companies like Cargill are also making acquisitions in the region — for example, its acquisition of Sorini Agro Asia Corporation. Competition with strategic investors is fuelling a value gap between sellers and buyers.
It can be hard for PE investors to compete on price with strategic investors — this may be because there are less likely to be cost synergies that can be reflected in a higher initial price and because a relative lack of knowledge may not enable them to price risks as keenly as a strategic investor.
In addition, the increasing focus that owner-managers have on partnering with investors who can help them move up the value chain may give strategic investors a competitive edge. A strategic investor is more likely to have the ability to communicate on a detailed level with owner-managers about their businesses — often businesses that have been lovingly built up from scratch. There can be a credibility gap between a financial investor and a strategic investor steeped in the industry and sometimes already with operational experience in the relevant jurisdiction.
A PE investor, could, however, capitalise on its fleetness of foot. There have been occasions where the speed and certainty of execution that a PE investor can offer has trumped a larger offer by a strategic investor. Another factor working in the PE investors’ favour is their willingness to invest by means other than straight equity. Quasi-equity instruments with control rights can meet an investor’s objectives while being face-saving for the promoter.
5. Plan for exit
It is a feature of PE investing that the investor has an eye on the exit at the same time as it is making its entry. A savvy investor starts paving the way for exit from the time it starts structuring the investment, for example, by putting tax efficient structures in place or by incorporating holdcos in listing-friendly jurisdictions.
Sales to strategic buyers remain the most likely exit route in Southeast Asia as illustrated by TPG’s sale of its Parkway stake to Fortis. In Singapore, at least, which has a more liquid equity market compared to some of its neighbours, an IPO is also a possible route, the reported IPO plans of CVC-backed Formula One being only the most recent example.
As many of the investments in Southeast Asia are still at a relatively early stage and not yet ripe for exit, it will be interesting to see in time how the successful exits will be achieved.
Conclusion
Most PE investors are keenly aware of what they need to do. The challenge is not “what to do”, but rather “how to do it”. Those investors (and their advisers) who will get it right are those who can tap their local relationships and knowhow, and deliver international-level execution capabilities and world-class operational expertise. In a world where the fast eat the slow, those who can do all of that will always be that little bit faster.
Sophie Mathur is a partner at Linklaters and can be reached at [email protected].
