Asia's battle for dry powder

Asian private equity is going through another record year of fund formation. Sharon Lim explains why, and asks for how much longer the boom can continue.

18 February ushered in the Year of the Fire Pig in the Chinese calendar, and participants in global markets had better be aware of it. At the outset, feng shui gurus such as Hong Kong-based destiny consultant Raymond Lo predicted that the year ahead would be volatile, and cautioned investors “to be cautious towards autumn and winter as there will be a substantial setback as the fire element will disappear in 2008”. With turmoil raging in the world's credit markets, this now seems sound advice indeed.

In Asian private equity, however, volatility isn't the dominant theme of the moment yet. Far from it: the market is still highly active, and fund formation activity is particularly buoyant – so buoyant in fact that “pigs can fly”, as one general partner sums up his take on the current state of the fundraising environment in the region.

Most professionals canvassed for this article made similar comments, describing the market as frothy and warning that more capital was being raised than managers will likely be able to invest profitably. So far there is no sign of a slowdown: as far as the disruption in the credit markets is concerned, it is too early to detect any knock-on effects on the fundraising trail in Asia.

Already 2007 looks poised to deliver a new fundraising record for Asia, Australasia and the Middle East. According to statistics recently published by the Emerging Markets Private Equity Association (EMPEA) in Washington, funds investing in “emerging Asia”, excluding Japan, Australia and New Zealand, raised $11.5 billion in the first half of the year, more than half the $19.3 billion garnered in the whole of 2006. Likewise firms based in the Middle East raised $1.8 billion in the first six months of 2007, against a total of $2.9 billion raised in 2006.

“At some point over the next three years, the market is going to change. When it does, it will be good to have dry powder.”

Unsurprisingly, those currently marketing new funds are optimistic: “We remain positive about the appetite for a couple of funds we are launching,” says a source close to a private equity firm with more than one Asia-dedicated investment vehicle currently looking for commitments.

Much of the focus remains on the large LBO funds currently being organised, which if closed successfully will mark the beginning of a new era for the asset class in the region. Earlier this year, Affinity Equity Partners raised $2.8 billion for a pan-Asian fund, and Kohlberg Kravis Roberts closed on $4 billion. These funds will soon be joined by pending offerings from CVC Asia Pacific, which is tipped to set a new record with a $5 billion fund, its third for the region; TPG, which is expected to close a new Asia fund near its $4.25 billion hard cap; and CCMP Asia in Hong Kong, which is said to be on its way to raising $3 billion for its second fund. In the Middle East, Dubai-based regional ring leader Abraaj Capital is seeking commitments for a $2 billion vehicle.

Country-focused buyout funds have also received their fair share of attention, with Sydney-based Pacific Equity Partners seeking A$4 billion ($3.5 billion), CDH China advancing on a $1.6 billion closing, and India's ChrysCapital having completed a new fund on $1.25 billion in the summer. Throw in the marketing work being carried out by numerous Asia-focused funds of funds, venture groups, private equity real estate specialists and infrastructure investors, and you are looking at a virtual guarantee that 2007 will deliver a new high watermark for Asian private equity.

The rising tide isn't floating all boats equally, however. “Despite all this capital inflow, there is still a distinct differentiation between the haves and have-nots. Some vehicles, be they first-time funds or run by seasoned players, can be oversubscribed many times over, and yet other players will have issues reaching their first close,” says Vincent Ng, a Hong Kong-based director at Atlantic Pacific Capital, a placement agent. Whichever camp they find themselves in, sponsors have to convince investors they can “walk the talk” in order to succeed, as a Hong Kong-based limited partner puts it.

One of the most seasoned fund investors in the business is HarbourVest Partners, the Boston-based global fund of funds group that opened its Hong Kong office in 1996 and is currently investing in Asia from its fifth international fund raised in 2006.

Describing the firm's fund selection methodology, Sebastiaan van den Berg, a vice-president based at the firm's Hong Kong office, says stable teams and a manager's track record over multiple fund cycles are key criteria.

Most other LPs place a similar premium on longevity and relevant experience, and so it is not surprising to find less stable teams or first-time managers often struggling to reach their targets. The exceptions are mostly firms founded by individuals with strong personal track records, or teams that have worked with heavyweight private equity brands or influential sovereign funds in the past. Recent examples include North Asian specialist MBK Partners, and fund of funds start-ups Axiom Asia in Singapore and Asia Alternatives in Hong Kong.

For the foreseeable future, barring any nasty surprises in what has been a fast-growing and robust-looking economic region, Asia is likely to remain popular with private equity fund investors the world over. In fact, even before the US sub-prime woes brought the global credit market to a near-standstill, Asian private equity was already right in the middle of many institutional radar screens. Now, relative to Western markets, it may look even more appealing.

Innes Meek, portfolio director responsible for China at CDC, a UK government private equity fund of funds, says: “Despite, and probably because of the volatility in the rest of the world, Asia and a few other emerging markets are coming out looking well. The emerging markets have escaped the credit crunch because leverage is not an issue. And investors continue to be interested in Asia's growth prospects.”

CDC is looking at five China-focused funds, and an equal number of India-focused funds, according to Meek.

Equally enthusiastic is Ralph Günther, who oversees the fund of funds business at BMP, a German private equity advisory and fund of funds manager based in Berlin.

BMP has made four commitments to Asia to date, backing two funds of funds and two direct pools. Günther says his firm has doubled its allocation to Asia in the past 24 months, just like many other limited partners in Europe and the US have stepped up their commitments to the region as well.

However, as Ng at Atlantic-Pacific points out, there is a risk of limited partners becoming more circumspect because of the credit crisis. As a result, some may consider taking a more cautious approach to private equity as a whole, at least until the dust settles – which could have ramifications for Asian funds as well.

The future will in part be shaped by the managers' ability to invest the capital they raise. Singapore-based Christophe Florin, managing director of AXA Private Equity Asia, feels there is ample room for private equity funds to be put to work across Asia, where markets like Japan have yet to be fully tapped. If anything, he fears, managers are at risk to invest too quickly: like the lead-up to the 1999-2000 venture bubble bust, today's buoyant market could result in general partners losing their discipline.

He says: “There might be some bad investments and some disappointments. Over the last two to three years, some funds have been very quick to deploy capital over short periods of time. This will not last forever. Private equity is a long term commitment ultimately.”

If deal-making does slow, Asian private equity faces the risk of a mounting wall of uninvested capital. Already there has been a string of broken deals or, as one investor notes, a reality plagued by “more failures than successful transactions, which GPs aiming to raise larger funds are now expected to address in their pitch”.

The phenomenon of proposed deals failing to close has become a talking point in Australia in particular, where a string of multi-billion dollar bids for listed companies produced a number of retreats because of shareholder resistance, credit market jitters or a combination thereof. In markets like China and Taiwan, regulatory hurdles also proved insurmountable on a number of occasions.

Yet another issue facing private equity buyers across the region is the fact that stock market valuations are still high. This makes IPOs a potentially lucrative exit mechanism, but it also means valuations of investment targets are often inflated.

IN DEMANDAccording to new research published by the Emerging Markets Private Equity Association in Washington, 2007 is on course to set a new record for private equity fund formation in the emerging markets. “Emerging Asia” is the most popular destination for investor dollars, “Mid-East & North Africa” is another key region.

Emerging CEE/ LatAM & Sub-Saharan MidEast & Africa & Emerging
Asia Russia Caribbean Africa N.Africa MidEast Asia TOTAL
2003 2,200 406 417 350 116 3,489
2004 2,800 1,777 1,714 545 618 6,454
2005 15,446 2,711 1,272 791 1,915 3,630 25,765
2006 19,386 3,272 2,656 2,353 2,946 2,580 33,193
1h 2007 11,549 3,611 1,354 592 1,816 2,127 21,049