Challenges ahead

In Asia, the credit crunch has had limited impact on debt markets so far. Buyout pros and leveraged finance specialists in Hong Kong and Singapore are nevertheless bracing for tricky times. By Patricia Lee.

Asia's leveraged buyout markets look fraught with challenges for banks and private equity houses alike. After a reasonably successful 2007, the backwash of the global credit crisis means LBO practitioners on either side of the fence are preparing for a bumpy ride.

Last year, financial sponsor-led LBOs and privatisations in Asia excluding Japan produced record activity: according to Dealogic, a total of 340 sponsor-led transactions amounting to $25.5 billion were completed, a 42 percent increase on the $18 billion of deals done in 2006. But whether 2008 will be yet another record-breaking year remains to be seen.

The global sub-prime mortgage and securitised credit meltdown, although still primarily a Western phenomenon, has put things in perspective for banks in Asia, too. Bankers are at best cautiously optimistic and expecting to take a more conservative approach to supporting leveraged finance transactions going forward. According to practitioners, the Asian debt market will be more constrained, the availability of credit will be limited and debt pricing will be higher. In addition, deal sizes, pricing and structures will be more heavily scrutinised than before.

Boey Yin Chong, managing director of syndicated finance, corporate and investment banking at Singapore-based DBS, says deals will still garner support if they are well structured and supported by strong sponsors with a sound understanding of the underlying business. As a rule, however, smaller deals will fare more easily than larger ones he believes: “Deals of less than $500 million will find enough liquidity from the bank market, but transactions from $500 million upwards would have to find banks with strong balance sheets. Whilst there is still liquidity in the mezzanine market and from hedge funds, these are not enough to close the funding gaps.”

“Spreads are widening and covenants are tighter. If you want to get deals done, you have to accept that cheap easy money is no longer there.”

In the aftermath of the sub-prime saga, both local and international banks will also require deals to be structured with robust covenants, says Karunia Tjuradi, managing director of debt capital markets at UOB Asia in Singapore. Covenant-lite transactions of the sort that rose to prominence last year in North America and to a lesser extent in Europe will not be feasible, he says.

Reflecting a sentiment shared by many, Boey says: “Some of the recent deals have seen very high valuations and if they are not well structured, these deals will start to break down. We have to look at what is fundable and sustainable in the terms being offered.”

Bankers highlight the $1.25 billion leveraged loan arranged by TPG and Affinity Equity Partners to fund the S$2.2 billion ($1.46 billion) buyout of Singapore's microchip testing company United Test & Assembly Center (UTAC), Asia's first, and quite possibly last, covenant-lite deal. The facility was designed to attract US institutional investors but floundered when the subprime mortgage crisis hit. Leveraged finance specialists say the aggressive structure would be a tough sell to the bank market today.

Bankers also note that some of the loans launched after the crisis had begun either had to have their structures enhanced or the deal downsized to ensure sufficient take-up in the syndication market. Pricing has started to pick up as well.

As a result, debt-to-earnings ratios are coming down, with banks likely to look at senior debt-to-EBITDA ratios of no more than four or five times, according to Tjuradi. This is a far cry from just six months ago when buyout deals featuring debt-to-EBITDA ratios of seven or even eight times were deemed perfectly acceptable.

In addition to weakening sentiment, regulation is also expected to have an impact on debt market dynamics: Basel II, which requires banks to increase their risk capital provisions to guard against credit, operational and market risks, will take effect this year and will inevitably affect lenders' credit decision process. “Loan pricing will have to be more reflective of the credit risk as banks would need to ensure a minimum return to justify lending to a deal,” says Aaron Chow, executive director global leveraged finance and head of syndicated finance, Asia, at UBS.

To be sure: in light of recent market events, banks “tightening their grip” on their lending policies shouldn't surprise anyone. Joseph Ferrigno, managing partner at Asia Mezzanine Capital Group (AACG) in Hong Kong, says a correction has in fact been overdue: “The global credit market has been diseased by an oversupply of capital created by central banks and the dramatic growth lending by traditional and alternative banks such as hedge funds. This is a period when lending and investing practices will become more prudent. Private equity fund mangers now have more realistic expectations with respect to the availability and terms of credit.”

“We are consistently looking out for good deals. We will bring our balance sheet to bear to anchor a deal if we have to.”

The equity houses are acutely aware of how the market has changed. Says Bill Kerins, a managing director at Oaktree Capital in Hong Kong: “Spreads are widening and covenants are tighter. If you want to get deals done, you have to accept that cheap easy money is no longer there.”

BUMPER YEARAsia Pacific targeted financial sponsor M&A Buyout1 volume by country.

2007 2006
Rank Target nation Deal value ($m) No. Deal value ($m) No.
1 Japan 11,268 119 9,436 116
2 India 7,766 143 3,786 113
3 China 5,664 108 7,791 102
4 Australia 5,334 74 9,007 91
5 Singapore 3,381 16 616 14
6 Taiwan 3,202 11 3,950 8
7 South Korea 2,303 22 1,501 19
8 New Zealand 2,205 16 3,408 22
9 Hong Kong 1,890 13 45 3
10 Malaysia 968 13 0 1
Total Asia (ex Japan) 25,479 340 18,020 275
Total Asia Pacific 44,286 549 39,871 504

In light of the ongoing recalibration of the debt market, the LBO deal pipeline for 2008 is not easy to predict. However, bankers expect a clearer picture to emerge during the first quarter.

“Because the Asia LBO market is so fragmented, it is hard to say which country will see more deals this year. Singapore, for instance, turned out to be the country with the biggest transaction in the region last year with a decent pipeline. Nonetheless, we expect a few interesting, sizeable transactions to come up this year,” says Chow of UBS. “There is a huge amount of private equity money out there and banks are still open for business. But whether we will see a big jump in volume from last year, that's something we can't say for sure at this juncture.”

Oaktree's Kerins offers this country-by-country outlook: “The Japan market is highly liquid and many of the deals done there were highly leveraged and overvalued. In Korea, there is a lot of liquidity but not a lot of international activity as the market is dominated primarily by domestic funds. Taiwan also has enormous amount of liquidity in the banking system and spreads are still attractive although they have risen since last year. But you don't see highly leveraged transactions done there. China is still a big question as to how the buyout market is going to take shape.”

But even though a sudden explosion of buyout activity in Asia's key economies is unlikely, interest in the region from international groups remains strong, not least because LBO prospects in Europe and North America appear even more uncertain. Leading global private equity firms Kohlberg Kravis Roberts, Blackstone, TPG and Permira are widely expected to step up their pursuit of investment strategies for the region.

However, asks Heine at ICG, will there be enough large buyout opportunities? Pointing to the recent emergence of Asia-dedicated buyout funds with up to $5 billion in commitments, he says: “Fund sizes are getting larger, and the size of the transaction that sponsors look at has also increased. We have yet to see whether the funds can deploy their capital in a large number of big buyouts. In fact in 2007 there were less $1 billion buyouts consummated in Asia than in 2006.”

Kerins expects to see a lot of activity in the middle market. “We target our fundraising toward the area of greatest activity. In Asia, most private equity activity takes place in the middle market and we expect this to continue.”


The 10 largest financial sponsor buyouts in Asia (ex Japan) 2007.
Deal Status Target Target nationality Acquiror Deal value $ (m) Financial sponsor
Completed United Test & Assembly Singapore Affinity Equity 1,682 Affinity Equity Partners;
Center (UTAC) Partners; TPG Capita l TPG Capital
Completed Shanghai Shimao (59.1%) China Shimao Property 1,092 Standard Chartered
Holdings Private Equity
Completed Bharti Infratel (8%) India Temasek Holdings; 1,000 AIF Capital
Investment Corp of
Dubai; India Equity
Goldman Sachs Group;
Macquarie Bank;
AIF Capital;
Completed Fu Sheng Industrial (86.2%) Taiwan Oaktree Capital 846 Oaktree Capital
Management Management
Completed Galaxy Entertainment Group Hong Kong Permira 842 Permira
Completed Housing Development India Citigroup; 767 Carlyle Group
Finance Corp. (6.6%) Carlyle Group
Pending Siltron (49%) South Korea KTB Network; 759 KTB Network Corp;
Vogo Fund Vogo Fund
Completed ICICI Bank (2.8%) India Dubai International Capital 741 Dubai International Capital
Completed EnTie Commercial Bank (51%) Taiwan Longreach 695 Longreach Group
Management (Hong Kong)
Completed MMI Holdings Singapore Kohlberg Kravis 663 Kohlberg Kravis Roberts
Roberts & Co & Co