Private Equity in Asia

Joel Tay NOVEMBER 22ND, 2012 |

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Contents 1.

Executive Summary ......................................................................................................................... 2

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Introduction .................................................................................................................................... 2

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Trends ............................................................................................................................................. 2 3.1 Deal Volume .................................................................................................................................. 2 3.2 Deal Values.................................................................................................................................... 3 3.3 Investor Nationality....................................................................................................................... 3 3.4 Exits ............................................................................................................................................... 3 3.5 Fundraising .................................................................................................................................... 4

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Country Focus ................................................................................................................................. 4 4.1 China ............................................................................................................................................. 5 4.2 India .............................................................................................................................................. 5

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Conclusion: Future opportunities in South-East Asia ..................................................................... 6

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1. Executive Summary The following report is a write-up on my earlier presentation that was given on the 13th of November 2012. The report covers the growth of private equity in Asia (particularly in China and India) after the financial crisis of 2008, key drivers of this growth, the situation of private equity in China and India and finally, further investment opportunities in South-East Asia.

2. Introduction Ever since the 2008 financial crisis, the global environment has changed. With a prolonged debt crisis in Europe, weak unemployment data and a tight credit environment, investors are living in uncertain times with private equity activity in Europe and North America seeing a decline as compared to the heydays of the early 2000s1. While the level of private equity investments in North America and Europe have not recovered to pre-2008 levels, investments in Asia have risen back to 2006 levels, or $65 billion. This growth is attributed to the positive macro environment in China and India and the opening of relatively untapped markets in South-East Asia such as Vietnam, Indonesia and Myanmar. However, it is worthy to note that the private equity industry is still considered to be in its infancy, with its investment values accounting for only 21% of all global private equity investments2.

3. Trends As stated above, total investments by value in Asia have recovered to 2006 levels. The level of investment in Asia is taking share out of North America and Europe. In 2005, investments in Asia only comprised 12% of total investments made in three regions; namely North America, Europe and Asia. This level has since increased to 21% in 2011. In this part of my report, I will analyze 5 trends of this private equity growth that I have identified from McKinsey’s latest report on private equity in Asia. To further supplement the data found in the McKinsey report, I have included various data acquired from other sources. These five trends are: Deal Volume, Deal Value, Investor Nationality, Exits and Fundraising.

3.1 Deal Volume By analyzing the amount of transactions that have been processed within the years 20052011, Asia has seen a high of 1,700 deals done in 2008 and a low of 500 deals done in 2010. As mentioned earlier, this huge drop can be attributed to the effects of the 2008 financial crisis and low investor confidence. However in 2011, Asia has seen its deal volumes shoot up to 1200, amounting to a growth of 134% from 20103. According to analysts and industry players, investors believe that 1

McKinsey Quarterly. Private Equity in Asia: Is the boom back? McKinsey Quarterly. Private Equity in Asia: Is the boom back? 3 McKinsey Quarterly. Private Equity in Asia: Is the boom back? 2

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Asia is recovering from the financial crisis and that private equity will continue to grow in Asia4. Also, while there has been a huge increase in the number of deals made, it has been observed that the main driver of this growth has been smaller deals.

3.2 Deal Values While deal volumes have increased sharply in 2011 from 2011, small deals of value under $100 million continuing to comprise the majority of deals done in Asia. Deals under $100 million constituted 87% of all deals done in 2011. The volume of small deals increased from 345 to 745, or 115%, from 2010 to 2011. Although deal volume has increased by 134% in 2010 to 2011, deal values have only increased from $46 billion to $66 billion, a 20% change. In Asia, growth in terms of value has been seen lagging behind growth of value in deal numbers. This could be due to valuation mismatches between buyers and sellers. While public equities markets remained volatile in Asia, sellers are still reluctant to reduce prices and instead, are holding on to high prices that were commanded during market peaks. 5 Another reason why deal values have remained low in Asia is that the majority of limited partners in Asia prefer smaller fund sizes. Due to smaller fund sizes, private equity firms instead focusing on smaller deals and on smaller companies6.

3.3 Investor Nationality The rise of private equity investments in Asia has also seen the rise of local general partners. While local general partners controlled only 18% of all deals in value, that figure has been increased to 28% in 2011. At the same time, “mixed” deals, or deals that comprise both local and foreign players have risen, mixed deals comprising 31% of all deal values in 2011 compared to 19% in 2010. As such, it can be said that the private equity industry in Asia will continue to see an increase in local players as the macroeconomic environment improves in emerging markets.

3.4 Exits With low confidence in the public equities markets, Asia has seen a decrease in exits. Market volatility across the global has decreased value investor confidence in the stock market, thus causing a decrease in the attractiveness of IPOs in Asia. In 2010, major stock market indices such as the Dow Jones and Shanghai Composite took a dive due to an unfavorable macro environment and high market volatility. Factors that caused stock 4

Ernst & Young. Asia Pacific private equity outlook http://www.forbes.com/sites/baininsights/2012/06/21/private-equity-goes-prospecting-in-emergingmarkets/ 6 PE Asia. Special: Asia Private Equity Report 5

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markets to plummet were the debt crisis in Europe with Greece requesting for a bailout, monetary tightening and efforts to curb asset bubbles in Asia7. As such, private equity firms turned to trade sales, which have grown from 25% to account for 51%, or $35 billion, out of $78 billion of the total value of exits in Asia from 2010 to 20118. Another point of view regarding the lower values of private equity exits in Asia compared to Europe and North America is that a large amount of the investments made are still maturing and are not ripe of sale yet. As private equity investments usually require a longer holding period than buyout investments in developed economies, more time is needed for these investments to grow.9

3.5 Fundraising Although the amount of capital that was raised in Asia increased $6 billion from $18 billion to $24 billion from 2010 to 2011, Asia’s share of the amount of capital raised decreased from 21% to 28%10. On the other hand, North America and Europe saw increases of $18 billion and $27 billion respectively. While it can be said that fundraising in North American and Europe has grown much more than Asia, it is important to note that North America and Europe had seen a greater decline in fundraising levels from 2008 to 2010. In 2007, the amount of funds raised in North America and Europe combined was $210 billion while the amount in Asia was $20 billion. However, in 2010, the total amount raised by American and European funds was only $47 billion compared to Asia’s $18 billion11. As such, it can be said that Asia is more resilient to shocks when it comes to fundraising and will continue to attract investors as they seek safer havens to invest their money in.

4. Country Focus The private equity industry consists of 6 main markets; these consist of China, India, SouthEast Asia, South Korea, Japan and Australia. It is worthy to note that the private equity market in Japan and Australia are considered as mature markets. Private equity investments in China currently make up 43% of all investments in Asia. Japan, Australia and South-East Asia are tied in terms of market share, with each of them taking up 14% of all investments in Asia Pacific. India and South Korea make up 12% and 3% of all investments respectively12. As this section of the paper will focus on growth in private equity in emerging markets,

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http://articles.marketwatch.com/2010-12-31/markets/30810123_1_markets-hang-seng-index-straits-timesindex 8 McKinsey Quarterly. Private Equity in Asia: Is the boom back? 9 Bain and Company. Global Private Equity Report 2012 10 McKinsey Quarterly. Private Equity in Asia: Is the boom back? 11 McKinsey Quarterly. Private Equity in Asia: Is the boom back? 12 Bain and Company. Global Private Equity Report 2012

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I will analyze the state of private equity in both China and India. Private Equity in South-East Asia will be discussed at the end of the report. Also, according to a survey by consulting firm Ernst & Young, 60% of respondents (which consist of 50 general partners, 30 limited partners and 20 investment bankers) believed that private equity activity would be the highest in China. In second place was India and Japan, which gained 14% of the vote13.

4.1 China China is seen as one of the main drivers of private equity growth in the Asia-Pacific region. In 2011, deal volumes tripled from what it was in 2010. However, following the general trend in Asia, deal values continued to lag behind deal volume growth. In terms of exits, IPOs began to slow down due to lower investor confidence in the public equities market. The number of IPO exits constituted 68% out of all exits in 2011, down 18 percentage points from 86% in 201014. However, as regulations in China are not favorable for trade sale exits, especially with foreigners, IPOs are believed to be the main route for private equity exits in China15. Local players in China were seen getting more involved in the private equities market in 2011, with local general partners controlling 25% of all deal values in 2011, up from 20% in 201016. This can be attributed to increasing disposable income and the number of high net worth individuals in China. Fundraising in China has seen a huge growth, with investors favoring RMB funds. RMB fundraising reached levels of $7 billion in 2011, which was a 75% increase from the $4 billion raised in 201017. One reason for this trend is due to the fact that investors view support from government related institutions such as the China Investment Corporation very favorably, as these institutions are able to make sizeable commitment to RMB funds18. As China’s economic and financial policies are tightly controlled by the Chinese government, I believe that private equity firms in China feel that investing in RMB funds are a relatively safe and secure choice.

4.2 India Aside from China, India is seen as the other big driver of growth. Deal volume in India has seen an exponential growth of 181% since pre-financial crisis 2007. Small deals made up a majority

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Ernst & Young. Asia Pacific private equity outlook McKinsey Quarterly. Private Equity in Asia: Is the boom back? 15 Bain and Company. Global Private Equity Report 2012 16 McKinsey Quarterly. Private Equity in Asia: Is the boom back? 17 PE Asia. Special: Asia Private Equity Report 18 PE Asia. Special: Asia Private Equity Report 14

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of the volume however, as deal values remained at $7.6 billion, or half of 2007’s peak level $14.7 billion19. Exits decreased on 2011, with trade sales making up 58% of all exits. IPO exits in India remained extremely subdued in since 2010 due to increased borrowing costs and a volatile stock market20. In fact, as of Q2 2012, there were only 9 IPOs in the Indian market, with only one of them bring PE-backed21. As with China, local general partners continue to play a bigger role, with 16% of all deal values under them, up from 8% in 2010. However, recent changes proposed by the Securities and Exchange Board of India have made investors concerned of whether the new regulations would increase the cost and risk for their investments22. As such, it is likely that the private equity industry in India will see further partnerships between local and foreign partners in order to mitigate concerns regarding the new regulations. While fundraising in 2011 rose 22% from 2010 levels, the amount of funds raised in 2011 was only 66% of 2007’s peak. One of the reasons why capital is hard to raise in India is due to the fact that the internal rates of return have been underperforming. It is estimated that for every $5 billion of investments made in India, the average internal rate of return has been only 18%, 7% less than the benchmark of 25% for most investors23. As such, it can be said that investors in India are adopting a cautious attitude when it comes to committing in India.

5. Conclusion: Future opportunities in South-East Asia While investors are continuing to increase their investments in China and India, fears of a slowdown in growth and overpriced assets in these regions have made some investors seek out newer opportunities in untapped regions in Asia. South-East Asia, with its combined GDP of $2 trillion, is certainly attractive for investments. GDP growth was at 4.7% from 2010 to 2011, and it is believed that it will continue to grow at a pace of 4.5% to 6.7% annually through 201524. The region is home to roughly 600 million consumers, with Vietnam and Indonesia being two of the largest markets. Consumers in the region have seen their disposable income rise, and analysts believe that this would lead to growing consumer segments. In terms of the amount of current investments in South-East Asia, the market is relatively untapped, with the ratio of private equity investments to GDP being half of that of developed Western economies25. As such, the market is unsaturated and there is plenty of room for growth and expansion. While there are a few big foreign private equity firms, such as KKR, that are looking into 19

McKinsey Quarterly. Private Equity in Asia: Is the boom back? Bain and Company. Global Private Equity Report 2012 21 Ernst & Young. Private equity roundup - India 22 http://www.forbes.com/sites/baininsights/2012/06/21/private-equity-goes-prospecting-in-emergingmarkets/ 23 PE Asia. Special: Asia Private Equity Report 24 http://www.bain.com/publications/articles/will-2012-herald-the-arrival-of-southeast-asias-pebreakthrough.aspx 25 McKinsey Quarterly. Private Equity in Asia: Is the boom back? 20

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and making deals in South-East Asia (such as KKR’s $150 million investment in a fish sauce company in Vietnam26), at the same time there are plenty of available domestic equity funds to partner with as well as the “well- capitalized and well-connected” sovereign wealth funds, with examples such as Singapore’s Temasek Holdings and Malaysia’s Kahazanah27. In terms of opportunities, Countries to pay particularly attention to would be Indonesia and Myanmar. Indonesia is considered the most populous country in South-East Asia with plenty of natural resources. Myanmar on the other hand, has been relatively untouched by investors as it was only until recently that sanctions placed on it by the United States has been removed. As per Indonesia, Myanmar is rich in natural resources. As these two countries are still developing, sectors to look towards to for investment purposes would be mining, infrastructure and communications. However, despite of the region’s attractiveness, analysts believe that underlying problems could undermine growth. These include bureaucracy, regulations and inflation. As the region is undergoing change, it is believed that accounting and regulatory standards will continue to evolve, thus changing the business environment for investors28. Also, government corruption as well as big family-run conglomerates, as seen in Indonesia, could prove to be a big hurdle for private investors to overcome29. As such, investors should be cautious before and when entering this unfamiliar market.

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http://www.bloomberg.com/news/2011-04-13/kkr-buys-masan-stake-in-biggest-vietnam-private-equitydeal-1-.html 27 http://www.bain.com/publications/articles/will-2012-herald-the-arrival-of-southeast-asias-pebreakthrough.aspx 28 McKinsey Quarterly. Private Equity in Asia: Is the boom back? 29 http://online.wsj.com/article/SB10001424052970204276304577261803114708294.html