Operational Value Add: The Next Stage in Asian Private Equity “A gem cannot be created without polishing and carving.” - Chinese Proverb
Ancient Chinese wisdom teaches us that value is not merely found, but instead created with effort. This idea is reflected in important changes that we observe in a number of Asian private equity markets today. As growth across Asia moderates, and particularly in China, many private equity General Partners (GPs) are recognizing that they cannot rely on market growth to drive their investments. GPs are recognizing that if they want to create investment gems, they need to expend effort in polishing. To this end, GPs are building specialist teams with operational capabilities to help their investee companies design and achieve business objectives. StepStone terms this effort Operational Value Add (“OVA”). By leveraging specialized experts in various functional areas such as Operations, Finance, Human Resources or Information Technology, or industry niches such as organic food or electric cars, private equity managers are increasingly able to target these high potential companies and help them achieve their business objectives. StepStone considers this topic to be important, particularly in light of the Pan-Asia versus country specific, and foreign versus local debate that we addressed in our last research paper on Asia (“Crossing the River by Feeling the Stones,” 2013). We believe that OVA is an enduring theme and that it will become an important differentiator between GPs in Asia, particularly as control opportunities increase in historically growth-oriented markets. While it is easy to look at more developed private equity markets for a roadmap on how OVA could develop, we believe that the development in Asia will be more nuanced with local characteristics.
November 2015
What is OVA in Asia? As a diverse market with many investment strategies implemented across multiple geographies at varying degrees of development, Asia’s GPs have adopted a number of different approaches towards OVA, which can be thought of across a spectrum of engagement, as shown in Figure 1.
To facilitate this, they often focus on implementing a new financial system, and pay particular attention to appointing a new CFO, to allow for regular and relevant flow of financial information. This can be enhanced by benchmarking studies to understand how a company is performing relative to peers on specific metrics. Such groups often hire external consultants for assistance in specific operational issues.
No OVA
Specialized OVA
At one extreme, some Asian GPs do not provide any OVA. This is often evident in GPs that follow a minority growth strategy. Often they have heavily-diversified portfolios with 20 or more holdings.
On the more involved end of the spectrum is Specialized OVA, where the GP has certain competencies specific to a particular industry or function within their team that is leveraged for its portfolio companies. Sometimes this develops organically. For example, a Principal who gains industry experience in manufacturing businesses over time becomes the resident guru on Operations within Manufacturing plants. In other cases, a Principal could have developed expertise in a particular function, such as marketing, in a prior career. The GP ensures that, when one of their investee companies has issues around Manufacturing Operations or Marketing and Branding, the relevant Principal is assigned. However, the Principal continues to have other deal responsibilities.
Limited OVA One step up is value-add through a monitoring focus, or Limited OVA. GPs that follow Limited OVA believe that they can hire the most capable management teams. Once they have utilized their network to assist in hiring and filling out the C-Suite, the GPs rely on this management team for all operational initiatives and conduct oversight of business at the board level.
FIGURE 1 | Spectrum of Operational Value Add No OVA
Limited OVA
» Typical of minority growth investments » GPs with heavilydiversified portfolios
» Utilize network to hire C-level executives, particularly CFO » Upgrade of financial systems » Board-level oversight
Specialized OVA
Intensive OVA
» Focus on core competencies in certain functions or sectors
» Dedicated team of Operating Partners covering many competencies
» Learn from previous experience to deliver results
» Potential secondments into portfolio companies
Increasing Intensity of Operational Value Add
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Catalysts Driving OVA in Asian Private Equity Markets
A third scenario is that some Principals enjoy working with companies post-investment in a broader multi-functional role, and develop more generalist operational expertise. Over time, these generalists may solely focus on portfolio company management capabilities and may become Operating Partners.
We have noted that three thematic factors need to appear before we see the development of OVA in earnest. Market Maturation
Intensive OVA
GDP growth is expected to remain strong in Asia relative to developed markets; however, these growth rates are expected to be lower than in the past, as shown in Figure 2. Of the ten Asia Pacific countries in which StepStone actively tracks GPs, seven are expected to see lower GDP CAGRs and five are expected to see lower GDP per capita CAGRs in the next five years compared to the previous five years. Those countries include the emerging economies of China, Indonesia and Malaysia, where minority growth capital has historically been the key driver of private equity markets.
Finally, the most involved version is Intensive OVA. In this case, the GP forms a dedicated, in-house Operations team with a number of operational competencies, including Operations, Finance, Marketing, Strategy and Human Resources, among others. This team may comprise generalist Operating Partners as well as functional experts. Typically, the Operations team follows the investment team through a deal, and is responsible for the management of the deal post-acquisition. Operating Partners may be seconded into the business to run a project or for an extended period as part of the C-suite.
In the past, high GDP growth tended to mask operational weaknesses in businesses, as high growth could be realized by
Figure 2 | GDP Growth in the asia pacific Real GDP
Real GDP per Capita
Country
2009-2014 CAGR (%)
2015E-2020E CAGR (%)
2009-2014 CAGR (%)
2015E-2020E CAGR (%)
China
8.6%
6.6%
8.0%
6.1%
India
7.2%
8.1%
5.9%
7.0%
Vietnam
5.9%
6.4%
4.8%
5.6%
Indonesia
5.8%
5.2%
4.5%
4.1%
Malaysia
5.8%
5.1%
4.0%
3.6%
Taiwan
4.5%
3.6%
3.1%
3.4%
Thailand
3.8%
3.7%
3.5%
3.6%
South Korea
3.7%
3.4%
3.2%
3.0%
Australia
2.7%
2.8%
1.2%
1.6%
Japan
1.5%
1.1%
1.5%
1.3%
United States
2.2%
2.7%
1.5%
1.8%
Source: Global Insight, July 2015.
StepStone | Operational Value Add: The Next Stage in Asian Private Equity
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As economies in the region mature, private equity is becoming more entrenched. Control buyouts and turnaround strategies – which are more OVA reliant – are becoming more prevalent, as evident in Figure 3. After 2011, Asia saw a rapid increase in the share of buyout fundraising, which grew from 7% of aggregate fundraising in 2011 to 22% in 2012 and 28% in 2013, as shown in Figure 4. This increase was driven by a rise in buyout fundraising by Chinese and Pan-Asian GPs. The increase in buyout fundraising reflects a trend where entrepreneurs and family groups have become more willing to sell control. This trend is occurring for a number of reasons. First, as growth slows, entrepreneurs and companies are beginning to realize that they need more than strategic guidance and capital markets expertise to address operational issues. Second, as entrepreneurs age and their priorities shift towards retirement, succession issues are emerging in both the mature economies of Japan and Korea and the growth-oriented markets of China and India. Third, slower growth also creates distressed and turnaround situations that require control strategies, which is evident in markets such as Japan, Australia and South Korea. The availability of debt is also important in financing a control buyout. Debt financing is more readily available in mature economies such as Japan, Korea and Australia, which have robust financial services industries. While this is often lacking in the emerging economies in Asia, recent developments, such as securing offshore lending for an onshore asset, have opened a channel to access debt capital.
Mature markets are characterized by lower growth and greater use of control strategies, both of which benefit from OVA. FIGURE 3 | Private Equity Investment Strategies in Asia $100 $80 (US$ billions)
simply being in the market. As Asia’s economies mature and world-leading growth rates begin to moderate, deficiencies in business strategy, execution and management capabilities are likely to become more apparent. At the same time, GPs may be required to hold on to these portfolio companies for longer, until growth targets have been met. Therefore, operational excellence and cost efficiencies become increasingly important in a slow-growth environment.
$60 $40 $20 $0 2006 2007 2008 2009 2010 2011 2012 2013 2014 Buyouts Turnaround Venture Capital
PIPE
Growth Equity
Source: AVCJ, July 2015.
$100
FIGURE 4 | Buyout Fundraising as % of Total $80
28%
30% $60 25% $40
25%
22%
20% $20 15% 10%
$0
'06 8%
'07
'08
'09
'10
'11
'12
'13 14%
'14
'15
2014
1H2015
7%
5% 0% 2010
2011
Source: AVCJ, July 2015.
4
Mezzanine
1H 2015
2012
2013
Focus Media: The Deal That Paved The Way The case of the take-private of Focus Media is illustrative of how the availability of debt paved the way for one of the largest Chinese leveraged buyouts. Although the structure would have required a prohibitively large amount of equity, FountainVest, a lead consortium member, overcame a major hurdle when they secured the participation of Bank of America Merrill Lynch, Citi and Credit Suisse as lead underwriters to provide debt financing. Despite the asset-light structure, FountainVest was able to use an offshore holding company structure and achieved a successful syndication. This was a landmark case for the leveraged finance market in China, and laid the foundation for additional control buyouts, such as Baring Asia’s investment in Giant Interactive approximately two years later.
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Exit Volatility In addition to the increasing maturation of Asia’s economies and the private equity market, exit channels in Asia have become more volatile in recent years, as shown in Figure 5. The number of Asian IPOs fell by nearly 60% between 2010 and 2013, from 322 to 137 IPOs, and increased by over 70% to 238 the following year as the Chinese IPO window re-opened in 2014. Since the IPO window is strongly impacted by regulatory oversight, it is very difficult for GPs to predict when it will be open, even if the GP has government access. There is similar volatility in the trade sale, or M&A, markets in Asia, with the number of trade sales reaching a peak of 565 in 2013 and subsequently falling by nearly 60% to 231 in 2014.
Uncertainty around exit timing can lengthen holding periods, but OVA can drive incremental returns.
As the steady stream of IPOs that drove growth equity across Asia began to falter, IPOs became a less reliable exit option for private equity. This has meant that GPs cannot rely as much on valuation arbitrage between private and public markets as they once did. Although trade sale exits have increased in prevalence during the same time, they have not been able to fully absorb the IPO backlog, leaving many portfolio companies without an optimal exit route.
Asia IPO Trend
Despite this, the recent return to IPOs, although short-lived, suggests that this mindset still has room to develop. This is evidenced by the hot IPO market in 2014, which continued to entice GPs with an easy path to returns, even if they have increased their focus on creating operational value over the past few years.
(US$ billions)
$100
600
$80
500 400
$60
300
$40
200
$20
100
$0
0 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 IPO Fundraising
# of IPOs
Source: AVCJ, July 2015.
Asia Trade Sale Trend
600
$100 (US$ billions)
In the same way that the maturing market has forced GPs to hold on to portfolio companies for longer, the volatility in exit routes has clouded GPs’ visibility into the length of holding periods. This means that, in the interim, GPs need to add value to the business by growing earnings, professionalizing systems, or turning the company around – all in order to ensure that they can maximize their potential for exiting when the opportunity presents itself.
FIGURE 5 | ASIA ExIT activity
$80 $60 $40 $20
'06
'07
'08
'09
'10
'11
'12
'13
'14
'15
500 600 400 500 300 400 200 300 100 200 0 100
$0 $100 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Trade Sale Value
$80
# of Trade Sales
$60 Source: AVCJ, July 2015. $40
600 500
$20 $0
0
400 '06
'07
'08
'09
'10
'11
'12
'13
'14
'15
300 200 100
'06 $100
6
$80 $60
'07
'08
'09
'10
'11
'12
'13
'14
'15
0
Increasing Sophistication of Market Players In the past few years, StepStone has observed a significant building-out of Operations teams within private equity firms. Whereas there were only a handful of Pan-Asia GPs (and even fewer country GPs) that had Operations teams as late as 2012, almost one-third of the GPs that StepStone tracks now have dedicated Operations teams or Operations professionals. In particular, Asian GPs have learned from their western counterparts to incorporate management executives or industry experts into their broader investment platform. Asian GPs are beginning to understand that operational capabilities can be beneficial to their investment process. There are now fewer obvious IPO candidates, given that large state-owned companies or local champions already went public during the high-growth era. The typical company in this new generation is less institutionalized, has weaker management, is focused on niches rather than large segments of the market, is smaller in scale, and requires planning around growth strategies. In order to ensure successful investments, having a keener eye around operational risks and opportunities during diligence and understanding how these levers drive returns are becoming increasingly important. OVA is also a differentiator in a maturing market that is becoming more diversified in strategy (growth, buyout, structured credit, etc.) and in structure (take-privates, convertibles, PIPEs, etc.).
StepStone estimates that almost a third of the major GPs in Asia are using OVA as a tool to manage risks and identify opportunities.
StepStone | Operational Value Add: The Next Stage in Asian Private Equity
The new generation of local industry experts is increasingly willing to work alongside GPs as private equity has become more entrenched in the region. GPs may possess or develop over time certain competitive advantages, such as knowledge of sub-segments, baby products for example, or areas of functional expertise, such as supply chain management, that can be leveraged to differentiate themselves from the competition. At the same time, more and more professionals with industry backgrounds are willing to work with private equity firms. The previous generation of local professionals was more conservative and preferred to build a comfortable management career at a local branch of a multinational corporation or a local champion, such as Samsung or Tata. The new generation, particularly in China and India, has more entrepreneurial spirit and a willingness to prove themselves in a new context. As companies develop into larger and larger businesses, they must also consider strategies around growth. As a result, these companies need more tailored and sophisticated advice, which operating teams can provide by leveraging their industry backgrounds. This has resulted in a number of cases of industry professionals working in partnership with private equity firms (discussed later in this paper); this acceptance of private equity is expected to increase further as the track record of the asset class continues to lengthen and successful case studies emerge.
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OVA in China China’s private equity market is an example of how private equity in Asia has evolved through a fast-paced transformation. As China’s GDP increased by over 170% between 2000 and 2010, most industries and companies grew as well. OVA was much less of a concern, given that the key driver of value was growth, usually in the form of operational scale. Efficiencies were de-prioritized until they became issues later. Another important factor fueling the private equity market in China was the availability of exits via IPOs. Given the lack of acquisitive domestic strategics and foreign ownership restrictions, exits were mostly achieved via public offerings, both domestically and internationally. Relative to the number of Chinese IPOs in 2006, the number of Chinese IPOs had doubled by 2014. However, various factors have catalyzed the development of operational capabilities in China-focused GPs. When the overall industry growth slowed and continuous top-line expansion became more difficult, portfolio companies had to begin focusing on costs. For example, in the manufacturing sector, China’s Purchasing Managers’ Index (“PMI”) showed contraction for 11 consecutive months for the first time between 2011 and 2012. In the face of declining sentiment, executives who had no experience in managing a company through a slowdown started to seek help from within their shareholder base. Further, the domestic IPO market was suspended starting in 2012, which effectively cut off the exit channel for those GPs – particularly RMB-denominated GPs – that were reliant on a multiple arbitrage strategy. This caused GPs to hold on to companies longer, and as the hold period became longer, issues around company strategy and management capabilities emerged, and the need for additional Operations professionals to help manage portfolio companies rose.
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OVA in China (continued) In order to deal with existing portfolio companies and to better evaluate and future-proof new investments, GPs such as CDH Investments, Boyu Capital and FountainVest Partners chose to enhance their investment teams with professionals with operational experience. Others have placed operating expertise at the center of their investment strategy, giving rise to a new group of control buyout-focused GPs, such as CITIC Capital and PAG Asia. The makeup of Operations professionals has followed a similar development path to the GP landscape. Initially, China’s private equity market was dominated by brand-name foreign entrants, whose investment teams consisted of foreign investment professionals and some local talent. As the local investment talent pool matured, locally-bred GPs began to emerge. Similarly, GPs previously turned to Hong Kong or Taiwanese multinational corporation executives with some experience in mainland China to build their Operations teams. However, as the group of local managerial talent matured within the Chinese branches of multinational corporations (such as Procter & Gamble and Unilever) and at local champions (such as Alibaba and Wanda), Operations teams have become much more localized.
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Foreign Versus Local Interpretations StepStone generally prefers local teams in Asia: local applications of OVA that appreciate local business cultures and management team dynamics are better suited to the diverse economies in the region. However, given their experience in mature markets outside of Asia, it is not surprising that most of the foreign groups in Asia have more readily adopted OVA. Foreign OVA Often, global private equity firms have an existing Operations team that they import into Asia, together with western processes and methods. The approach tends to involve hiring locals to supplement the core expatriate team. Initially the team may be located in Hong Kong or Singapore, operating on a fly-in, fly-out model. The dominant background for members of these groups is from the multinational consulting firms such as McKinsey or Bain, or from the Big Four accounting firms. The largest Operations team in Asia is KKR’s Capstone; other GPs with large Operations teams include TPG Asia, Bain Capital Asia and CVC Capital Asia. These foreign GPs have developed successful OVA case studies in Asia despite their non-local teams and approaches. For example, at the time of KKR’s investment in Oriental Brewery (“OB”), OB had a market share of approximately 40% of the Korean beer market. Following the transaction, KKR Capstone set about assisting the company in revamping its sales and marketing efforts particularly in regard to how sales representatives engaged wholesalers and resetting sales representatives’ and wholesalers’ incentives to focus on growth and not current volumes. KKR Capstone also helped the company create new product assortment guidelines for the merchandisers servicing the highly-fragmented traditional channel (large, mid-sized and “mom-and-pop” grocery stores) to optimize OB’s shelf space at the retail stores. This has led to OB taking over from Cass as the largest beer company in Korea. Local OVA The biggest change in OVA over the last five years is that local groups, such as CDH Investments, Hony Capital (“Hony”) and CITIC Capital in China, have grown their own Operations teams rapidly. The largest of these local teams is now 25 strong, although the majority of them still have fewer than 10 professionals. Local groups have historically been slower to adopt OVA relative to foreign peers, but are now 10
picking up with increasing pace given their understanding of local sensitivities. One of the key distinctions between OVA in the US and Europe is the emphasis in Asia on personal relationships with founders and other key personnel. There is sensitivity around aiding, but not necessarily replacing, management. It is a delicate balancing act for the GP, working to achieve change but not sidelining the management team, which requires a high EQ and understanding of local business culture. For example, during Hony’s due diligence process prior to completing their investment in Dihon Pharmaceutical (“Dihon”), Hony’s consulting team prepared a general consulting report for Dihon, analyzing its areas for improvement. Dihon’s family business nature had limited the company’s development. The management team was impressed by the consulting report and asked the team to continue to help them for another six months, to build out the internal control system and the decision making process and separate the responsibilities of the Accounting, Human Resources, and Public Relations departments. Foreign-Local Partnerships for OVA A slight twist on OVA is local GPs forming partnerships with international GPs to leverage know-how of operational best practices. This allows the Asian GP to call on the relationships to bring in global-standard expertise but continue to present a local face. For example, in Northstar and TPG’s investment in Delta Dunia, TPG had initially sent in their foreign Operations team, who had prior industry expertise, to assist the CEO. However, as performance started to deteriorate, it became apparent that a more local presence was required. Northstar, which had modeled its Operations team after TPG’s, decided to second Operations Director, Ronald Sutardja, a former global business manager at Infineum with a management consulting background, to continue TPG’s work. Mr. Sutardja expended significant effort to train and motivate the next tier of senior managers, while meeting weekly with customers to position Delta Dunia/BUMA as the preferred contractor – both of which required a local operator to take discussions to the next level. Further, Mr. Sutardja began a rationalization program that reduced the workforce by 2,500 people in the space of 12 months, which was enabled by his understanding of local unions.
These two initiatives significantly improved cash flows and profitability and within six months the company had returned to a growth trajectory. Advanced OVA Some country GPs have taken this idea of OVA further and are placing their specialist Operations professionals at the center of their investment strategies, above and beyond the standard risk management, financial monitoring and value creation process. In fact, in the more mature North Asia markets of Japan and Korea, country specialist groups that focus on turnarounds have emerged. As this strategy requires material OVA, these Operations teams need to be leveraged and need to be well-coordinated with the investment teams, which increases the complexity in management. However, we think that this can be a strong source of value add if they are able to attract individuals with suitable skills and backgrounds. In the case of Integral, a Japanese small-buyout GP, the Operations professionals implemented a series of operational and strategic initiatives following Integral’s investment in the troubled high-end apparel company Yohji Yamamoto. In filing for civil rehabilitation, Integral dispatched an initial Corporate Planning and Legal team to assist in liquidating overseas subsidiaries. In addition, Integral leveraged their network to bring in a CFO with cost reduction and turnaround experience to complement the existing management team. One of Integral’s VPs was also seconded into Yohji Yamamoto until exit, where she spearheaded the company’s expansion strategy and negotiated overseas partnerships. A Korean mid-market buyout GP, Hahn & Company, also heavily leveraged their Operations team for Cowell, one of their earliest portfolio companies. Operations professional DC Lee was key in helping Cowell expand its R&D capacity by bringing in the Samsung Electronics’ R&D team, increasing the research team’s size from 26 researchers to 162. This team was further supported by a new camera engineering team, which developed a new high-end camera module that secured Cowell an exclusive project with Apple. The expanded workforce, coupled with an improved emphasis in R&D, has allowed Cowell to become the sixth-largest camera-module Manufacturer in the world. Besides improving Cowell’s R&D capabilities, Mr. Lee also led an initiative to move Cowell’s manufacturing facilities to Dongguan, in China’s Guangdong province, to reduce costs. StepStone | Operational Value Add: The Next Stage in Asian Private Equity
GP Profiles Kohlberg Kravis Roberts Asia Investing Since: 2005 Latest Fund: Fund II (2012) Fund Size: US$6 billion Strategy: Pan-Asia Growth/Buyout Operations Professionals: 19 Hony Capital Investing Since: 2003 Latest Fund: Fund VIII (in market) Fund Size: US$2 billion Strategy: China Growth/Buyout Operations Professionals: 14 Northstar Equity Partners Investing Since: 2006 Latest Fund: Fund IV (2014) Fund Size: US$950 million Strategy: Indonesia and Southeast Asia Growth/Buyout Operations Professionals: 12 Integral Corporation Investing Since: 2008 Latest Fund: Fund II (2013) Fund Size: US$475 million Strategy: Japan Small Buyout Operations Professionals: 2 Hahn & Company Investing Since: 2011 Latest Fund: Fund II (2014) Fund Size: US$1.2 billion Strategy: South Korea Mid-Large Buyout Operations Professionals: 9 11
Who Foots the OVA Bill? In certain cases, OVA is packaged together with a private equity firm’s investment into portfolio companies. The rationale is that a GP should already be sufficiently incentivized by the possibility of achieving their investment goals that they will actively create value for their portfolio company. The resources required to support an Operations team are paid for through the management fees collected by the GP. In effect, the Operations teams are groups of extra professionals on standby, hired by private equity firms to support their investment activities whenever required. No economics are collected from portfolio companies, although this model makes greater use of third-party resources, which are billed to the company. In other cases, GPs run their Operations teams as a revenue-generating division distinct from their investing business. A portfolio company is charged on a project-by-project basis for whichever OVA services they elect to use, with extra fees paid for each further project. Sometimes, different projects will have different pricing structures – for example, supply chain optimization may cost less than a full restructuring project. Unlike the above, the GP’s Operations professionals are partially or fully supported by the fees generated by each project. The most well-known of these models is KKR’s Capstone, while another is Hony’s consulting team. A further twist on the above idea is where a portfolio company pays a retainer to the GP in exchange for its OVA services. Rather than paying a fee for each individual project, the portfolio company is given the option to pay a set price, perhaps once every year or half-year, and then is able to call on the GP’s OVA resources whenever and wherever required. This model is particularly effective in cases where a wide spectrum of OVA services is deployed at a portfolio company over a sustained period of time, such as in a turnaround situation. It is difficult to say which model is the most appropriate, as there is no one-size-fits-all model in Asian private equity. Even in the more mature markets of North America and Europe, multiple models can still be observed. However, StepStone believes that OVA fees in general should reduce in quanta as OVA becomes more integrated into GPs’ investment strategies. It makes less sense to charge incremental fees to reward OVA, especially if it was part of the thesis that the GP originally invested behind. 12
Opportunity for OVA in Different Asian Markets StepStone believes that the rising prevalence of OVA is a welcome trend and should help to ensure more consistent returns from the asset class in the region over the longer term. However, just like private equity investments in Asia, OVA applied uniformly across all Asian markets may not result in similar results in all cases. Developed Asian Markets Broadly speaking, the more control-oriented markets in Asia are more receptive to OVA. In the more developed Asia Pacific markets, such as Australia and Korea, where GPs can focus on buyout transactions due to favorable regulation, availability of financing, and high entrepreneur acceptance, the opportunity for OVA is correspondingly high. As a control investor, GPs are able to 1) implement all the strategic and operational changes they need to make without the constraint of managing the legacy team’s expectations, and 2) focus their attention on OVA without concerns about a free-rider problem where they would create value for other shareholders more than for themselves. In this market, StepStone believes that proponents of Intensive OVA would be more successful and would be a key differentiator between GPs. India Following a similar logic, OVA development in India has been hampered by the difficulty in gaining control. Despite India’s large market and longer history within private equity relative to other Asian countries, promoters are still wary of selling control stakes. Although that is now changing, with more family groups or conglomerates willing to sell non-core assets, the lack of an LBO financing market has prevented further development of a buyout market and the corresponding room for OVA within private equity. While StepStone welcomes Indian GPs who are focused on adding operational value, StepStone believes that the market is too immature at this stage for OVA to be a critical differentiation factor.
China Although China remains growth oriented, entrepreneurs have historically not been willing to sell a majority stake, and thus control opportunities are still in the minority. Regulations have previously prevented the development of an active LBO financing market. However, these historical roadblocks are now changing. There is an increasing prevalence of succession issues and a growing acceptance by Chinese entrepreneurs and state-owned enterprises of strategic and operational advice from GPs, who in particular could help with cost management in a slower-growth environment and international expansion to further drive top line growth. There are increasing case studies of banks willing to lend to offshore-structured companies, which has facilitated control buyouts such as Focus Media (as discussed previously). We think that this presents an increasingly interesting opportunity for Specialized OVA, with a small but increasing opportunity set for GPs who are willing to try Intensive OVA. As economic growth is expected to remain slower over the next few years, StepStone believes that GPs who implement a No OVA or Limited OVA model will face challenges, as there is limited room in both cases to mitigate downside business risks. Southeast Asia As the youngest private equity market in Asia, Southeast Asia remains high-growth and control buyouts remain underdeveloped, which would seemingly imply a similar investment thesis to that of India. However, looking more granularly at the region, StepStone believes that there is an interesting opportunity for GPs with Limited OVA in markets such as Malaysia and Indonesia, given the growth prospects of these nations and their proximity to Singapore, a country with a highly developed talent pool. StepStone also sees opportunities for GPs with Intensive OVA in markets such as Vietnam, given the lack of professional management talent in this market. StepStone believes that GPs at either end of the spectrum, i.e., able to back the remaining high-growth companies with strong talent or help build management capabilities from the ground up, will be best-positioned to generate returns from this region.
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Japan Despite Japan’s slow economy and many GPs’ ability to secure control in Japan, enacting change often comes up against deep-seated cultural roadblocks, such as an influential mid-level managerial class who are highly protective of their existing modi operandi. Japan also has relatively rigid labor regulations that prevent GPs from cutting costs through labor force restructuring, which is a large component in a developed and highly-skilled economy and a key part of a cost-restructuring investment thesis. However, within Japan’s private equity market, most deals can be characterized as either carve-outs of non-core assets from large conglomerates or investments in smaller, highly advanced niche companies, often with a specialized technological advantage. StepStone believes that proponents of Intensive OVA will be best suited for carve-outs, while proponents of Specialized OVA should be able to maximize their value in scaling the smaller niche players up through global expansion and marketing and branding initiatives among others.
Conclusion StepStone believes that OVA is not lip service, and is increasingly a central lever for GPs to generate value in their portfolio companies. StepStone is focused on investing with GPs that have OVA capabilities, as we believe that the GPs who are able to take advantage of the appropriate OVA opportunities within each market will generate the best returns and will be the most credible investors in the long run.
For now, the advantage is on the side of Pan-Asian groups with higher AUM to support such resources. However, as country funds develop, StepStone expects them to compete with the likes of KKR and TPG for Operations personnel. The playing field is becoming very competitive with regard to OVA offerings from global funds versus domestic players, and StepStone has been impressed with the quality of some of the teams assembling under certain country-specific GPs. As this competition intensifies, however, evaluating the operational capabilities of GPs within Asia becomes a critical component of due diligence and requires extensive local knowledge. For groups with an Operations team, diligence requires spending time with the relevant team members to understand their backgrounds, skillsets, business model, turnover and remuneration. For groups that have adopted a No OVA or Limited OVA strategy, further diligence is required to understand why this is a viable strategy and why they will remain competitive. StepStone believes that the potential rewards of understanding nuances of Asian OVA and the opportunities it presents far outweigh the resources required. At the very least, LPs can count on an extra stone on which to cross the rivers of Asian private equity. If GPs continue to polish their OVA offerings, this presents the next important stage of development in Asian private equity. This, in turn, should contribute to economic growth and benefitting LPs through sustainable long-run returns.
This document is for information purposes only and has been compiled with publicly available information. StepStone makes no guarantees of the accuracy of the information provided. This information is for the use of StepStone’s clients and contacts only. This report is only provided for informational purposes. This report may include information that is based, in part or in full, on assumptions, models and/or other analysis (not all of which may be described herein). StepStone makes no representation or warranty as to the reasonableness of such assumptions, models or analysis or the conclusions drawn. Any opinions expressed herein are current opinions as of the date hereof and are subject to change at any time. StepStone is not intending to provide investment, tax or other advice to you or any other party, and no information in this document is to be relied upon for the purpose of making or communicating investments or other decisions. Neither the information nor any opinion expressed in this report constitutes a solicitation, an offer or a recommendation to buy, sell or dispose of any investment, to engage in any other transaction or to provide any investment advice or service. Past performance is not a guarantee of future results. Actual results may vary. Each of StepStone Group LP, StepStone Group Real Assets LP and StepStone Group Real Estate LP is an investment adviser registered with the Securities and Exchange Commission. StepStone Group Europe LLP is authorized and regulated by the Financial Conduct Authority, firm reference number 551580. Manager references herein are for illustrative purposes only and do not constitute investment recommendations.
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StepStone is a global private markets firm overseeing US$70 billion of private capital allocations, including approximately US$12 billion of assets under management. The Firm creates customized portfolios for the world’s most sophisticated investors using a highly disciplined research-focused approach that prudently integrates primaries, secondaries, and co-investments.
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