On the middle ground

Sandwiched between China and India, Southeast Asia is fragmented, risky and often bypassed in favour of the more developed private equity markets of its enormous neighbours. But for investors with the right appetite, and managers with the right skill-set, the region presents a uniquely compelling investment case.

Buttressed by Asian economic behemoths China and India to the north and west respectively, Southeast Asia is often overlooked in discussions on private equity in the Asia Pacific.

This could perhaps be due to the fact the region has not seen the same spike in activity as other Asian markets such as China, India or even Australia, in the past four to five years, but – as Nick Bloy, co-managing partner of Kuala Lumpur-headquartered Navis Capital Partners, points out – the number of deals getting done in Southeast Asia is ultimately a “function of how much capital investors are willing to allocate to the region”.

With the tremendous growth story taking place next door in India and China, many investors’ focus has been on getting, or building, exposure to these two economies. And while Southeast Asia as a whole has a sizeable economy, the fact remains that while it is one region, it is not one market: it is instead an amalgamation of different economies, at varying stages of development.

Much of the capital invested in Asian private equity comes from Europe, North America or the Middle East, and many LPs simply do not have the specialist knowledge to target Southeast Asia. Instead, they tend to follow the law of large numbers and make their first foray into Asia with commitments to funds investing in India and China, because these are simpler – and more accessible – markets to invest in.

Bruno Raschle, managing director of Switzerland-based fund of funds manager Adveq, which is currently raising its second Asia-focused fund of funds, says that there are “a few excellent” fund managers in Southeast Asia, but adds that as an investor, one has to decide how to make money. “In Southeast Asia, the markets are smaller and I think for the crowd of investors, it is just more convenient to concentrate on India and China,” he says.

It is only in the next phase of their investment in Asia that western LPs might look to Southeast Asia, says Bloy, by which time they might have developed a more granular understanding of the region.

In his words, Southeast Asia does not “lend itself to easy categorisation”. It is a fair point: looking around the region, China and India stand out as a growth capital markets, and the more mature economies of Japan and Australia as buyout markets. Southeast Asia, however, which you might expect to fall into the growth capital bracket, is a territory of mixed approaches, dominated mostly by control investments (see boxout).  

Alun Branigan, Singapore-based partner at Actis, sums it up, saying the region’s disparity poses challenges. “It is one of the reasons why private equity has not yet truly taken off in Southeast Asia. Southeast Asia is much more complex and nuanced – it is far more difficult to understand than other single markets.”

That said, he and other managers point out that the difficulties of the markets benefit those firms already investing in the region, as the lack of fund managers targeting the area makes it easier to get proprietary access to deals.

No zero-sum game

Although the fragmented markets of Southeast Asia remain overshadowed by those of India and China, living in the shadow of such relentless growth engines does not necessarily detract from Southeast Asia’s growth prospects; in fact, it may enhance them.

Pote Videt, a Bangkok-based managing director at Lombard Investments, a Southeast Asia-focused firm which manages assets of about $750 million across three funds, says that while people seem to think Southeast Asia loses out to India and China, the reality is it is far from “a zero-sum game”.

In his view, one of the theses behind investments in this region is that its growth patterns are linked to China and its domestic demand growth. “Many Southeast Asian countries have a sizeable trade surplus with China,” he says. This is through the export not just of raw materials and basics like food, but also intermediate and end-products.

And while most Southeast Asian economies do not have the same rates of growth as China, as long as China’s growth continues apace, their companies stand to benefit.

Branigan agrees that the region’s location can be an advantage. “It sits right in between China and India and while trade flows between those two economies are strong, trade and investment flows are actually stronger between Southeast Asia and India and China respectively, than they are between India and China,” he says.

No exit

However, while its neighbours might actually prove a boost Southeast Asia, there are other factors besides the area’s heterogeneity and complexity which play a significant role in limiting private equity activity there.

“A major factor curtailing private equity activity in Southeast Asia has been the lack of exit opportunities,” says Lachmi-Niwas Sadani, a Singapore-based director at fund of funds manager AXA Private Equity. He adds though that the Singapore Exchange is now getting more liquid and, in some cases, it may be possible for companies to list in Hong Kong.

Bloy has a different view. “We don't feel that the stock exchanges provide a suitable exit mechanism. Trying to sell a 100 percent interest in companies on the stock market is difficult, especially in the small- to mid-cap sector as the liquidity is not just there,” he says, adding that stock markets are “unreliable in the best of times and impossible at a time like now”.

Despite this, he doesn’t believe exits are a problem in the region. Navis, which is focused on making control investments in Southeast Asia and the Indian sub-continent, has made 15 exits, of which 12 have been achieved through trade sales and two through sales to financial sponsors.

Looking ahead, a number of practitioners say that exiting businesses could become easier in the region, as many Chinese and Indian multinational corporations are emerging as prospective buyers as they look to expand in the region through the acquisition of assets. It is a trend that will continue, most say.

Leaving exits aside, another hurdle facing the would-be private equity investors in Southeast Asia is that the levels of transparency and corporate governance found in more developed Asian markets cannot be found. Neither is its banking system as developed either, says AXA’s Sadani. Though all this is improving, it will take between five and 10 years for the region to reach the same level as, say, Australia, he adds.

Don Lam, chief executive officer and co-founder of Vietnam-based alternative investment firm VinaCapital, agrees. “Besides Singapore, the legal infrastructure in most other countries in the region is new,” he says, adding that in many markets in Southeast Asia, an emphasis on corporate governance is a new thing. One other clear deterrent for many investors, whether GPs or LPs, says Lam, is the continuing political instability in large regional economies such as Thailand and Indonesia.

With such intricacies to factor in, breaking into this market has proven difficult for larger private equity firms because many of them do not have offices on the ground. “It is not an easy proposition to do deals in Southeast Asia on a fly-in and fly-out basis. There is a need for permanent staff on the ground,” states Navis’ Bloy.

Fund managers also say that a lot of the bigger firms are not as active in Southeast Asia as in other markets because the sizes of deals tend to be smaller in this region, often not large enough to draw the interest of larger private equity firms.

They add that the importance of local understanding and sensitivity cannot be emphasised enough. “A lot of the best practices and ideas we learned on Wall Street or the City of London can be applied here, but you have to be a part of the business fabric of these local communities,” Videt says.

Often, this is a very time-consuming process. In Videt’s view, one of the biggest challenges to investing in Southeast Asia is the time taken to complete deals. On average, it takes Lombard two years from initially talking to a company to closing a deal, even with its extensive local network, he says.

As wealth grows, opportunity grows

For those GPs already established in Southeast Asia, and those now eying the region, the complexities standing in their way are easily outweighed by the opportunities they see for private equity. Besides opportunities emanating out of increasing trade flow with China and India, Southeast Asia has plenty going for it on its own. The region has great supporting demographics and macroeconomic dynamics – stripped to very basic terms, a huge population of about 580 million with rising incomes. “That makes this region a great consumer story,” Branigan says. He adds that anything that plays to the theme of rising wealth in the region – be it consumer goods, healthcare services, or even financial services – has the potential to do well.

Raschle agrees, adding that sectors that have to do with servicing infrastructure, distribution systems, communications, healthcare, logistics and consumer-related, make for attractive investment options.

“We have focused a lot on the domestic demand sector,” says Videt.  However, he adds that in Southeast Asia, it is very hard to find good consumer companies, so the firm has had to find proxies such as retailing, food service and middle-income housing. There are other factors affecting domestic demand that are not highlighted often, he adds. For instance, “one of the hidden drivers in the Philippines is remittances from abroad, which didn’t really slow down much during the crisis”, he adds.

In Vietnam too, rapid urbanisation and a growing middle class are creating a new culture of consumerism, says Lam. His firm is focused on investments in services and products that address this new market – financial and business services, education, healthcare and particularly residential real estate developments.

Furthermore, in a market like Vietnam, many companies need capital for expansion, Lam says. He adds that there is a lot of deal flow in the country originating from the privatisation of state-owned enterprises. The firm had made seven investments and three exits across private equity, real estate and infrastructure by July this year.

The only problem with the consumer-related sector is that it is more likely to be negatively affected in a downturn than other sectors. However, managers agree that if a five- to eight-year time horizon is considered, the consumer story remains attractive.

The abundance of natural resources in the region also presents interesting opportunities. Firms can either invest directly in natural resources or in companies that lie in supporting sectors. Branigan says many companies that support the natural resources sector in the region are looking to expand into other areas such as West Africa and Brazil. These are ambitious regional companies, but they need help from private equity firms to go global.

Managers also talk about attractive valuations in the region. Videt, for instance, says that the difference between Southeast Asia and other Asian markets is “you can get similar growth at lower valuations – which is where you can achieve superior returns”.

Bloy agrees, saying that while it is always hard to pin down pricing, he has heard “anecdotally” that companies with steady, maintainable earnings are being transacted in the 4 to 5 times EBITDA range, numbers which are reminiscent of the pricing range seen during the Asian economic crisis in the late 1990s. “You don't see such attractive valuations in India,” he says.

Good prospects for private equity

With the worst of the downturn seemingly behind us, fund managers investing in Southeast Asia expect increased activity in the months to come. In recent months, there has been a drop in deal activity, fund managers say. Now there is less capital in the market and entrepreneurs cannot get credit easily to fund their businesses. Branigan expects private equity to become an important source of capital for companies in the region.

The IPO markets are not in great shape yet, so that is good for private equity buyers in general, Bloy says, adding that the public markets can have a crowding out effect on private equity.

More importantly, perhaps, the region is still growing and maturing.  As corporate governance and the banking system in Southeast Asia improve further, the likelihood of investments increasing is greater as well.

Governments such as Malaysia’s are also taking initiatives that reflect the increasing acceptance of the asset class in the region, Bloy says. In July, the Malaysian government announced the formation of Ekuiti Nasional Berhad (Ekuinas), a private equity firm that will manage RM10 billion ($2.9 billion; €2 billion) for investment in domestic companies. It has also liberalised foreign ownership rules in the country, which in Bloy’s opinion, is a step in the right direction for foreign investment in general.

In Sadani’s view, private equity firms between them can comfortably deploy between $500 million and $1 billion annually in Southeast Asia. He expects to see a fairly vibrant private equity market blossom in the region, and says he would be surprised if assets under management in Southeast Asia did not rise above $20 billion in the next five years.

Stuck in the middle of two growth giants Southeast Asia may be, but that doesn’t mean it doesn’t have its own giant growth ambitions.

From local to regional: the growth of private equity in Southeast Asia

Private equity is not new to Southeast Asia, as Lachmi-Niwas Sadani, a Singapore-based director at fund of funds manager AXA Private Equity, explains: “Private equity activity in Asia began in this region. Indonesia, Thailand and Singapore were the first countries to see private equity deals in the mid-1990s.”

However, activity in the region quickly stalled, primarily due to the Asian financial crisis of 1997, which began with the collapse of the Thai Baht. Other Southeast Asian economies proved not to be immune to events that transpired in Thailand and were soon engulfed in the crisis. “The currencies went haywire and people lost a lot of money,” says Sadani.

With the near-collapse of regional economies came the realisation that the balance sheets of both countries’ and companies’ were not as strong as had been imagined.

Governments in the region cleaned up their balance sheets and government debt to GDP began declining. They allowed currencies to depreciate, assisting the region’s exporters, and foreign reserves began increasing again. Simultaneously, Sadani says, “there was political change in a few countries, leading to [greater] political stability in the region.”

Since then, Southeast Asia has been competing for capital with other single economies in the region. Now, most managers feel, more capital will start to flow into the region as investors gather more experience of investing in Asia. Lower valuations in the region provide an incentive as well, they say.

In recent years, the region has seen the growth of a few country-specific managers, the likes of Quvat Management, Saratoga Capital and Northstar Pacific Partners in Indonesia, Leopard Capital, which currently invests in Cambodia, and Mekong Capital in Vietnam. The fact that there are more local managers than regional ones only goes to highlight the differences that exist between the various markets here.

Don Lam, chief executive officer and co-founder of Vietnam-focused alternative investment firm VinaCapital, says that country-focused funds are better positioned to invest in local markets as they have local teams. He says that many pan-Asian firms want to work with local firms to benefit from their experience in local markets.

However, as country-focused private equity groups look to expand investment remits, they will start to look at Southeast Asia as a regional block, predicts Nick Bloy, co-managing partner of Kuala Lumpur-headquartered Navis Capital Partners. “It is all part of the maturation process and I think that’s underway,” he adds.

He also underlines the importance of firms knowing how to develop companies in adjacent economies, a need emanating from the ASEAN* Free Trade Agreement. “The need to add value to domestic companies will take local firms to different markets in the region,” Bloy says. As barriers between various regional economies recede further and the economies become more integrated, the expansion of local firms’ operations is to be expected.

* ASEAN (The Association of Southeast Asian Nations) is comprised of Brunei Darussalam, Cambodia, Indonesia, Laos, Malaysia, Myanmar, the Philippines, Singapore, Thailand and Vietnam.

Control or minority investments?

One of the distinguishing characteristics of the Southeast Asian private equity market is that it evades categorisation: most investors will look at growth and buyout transactions, and there are passionate advocates of both.

Buyouts are actually the more dominant deal type, accounting for 60 percent to 70 percent of deals in the region, says Alun Branigan, Singapore-based partner at Actis.

“You can buy control here, and at reasonable valuations as well,” Branigan says. Actis has made five investments from the $130 million Actis ASEAN Fund, four of which have been buyouts.

According to many professionals, it is easier to make buyout investments in Southeast Asia. Nick Bloy, co-managing partner of Kuala Lumpur-headquartered Navis Capital Partners, which makes control investments, says: “The propensity for a vendor to accept change of control is certainly higher here than in India or in China.”

He adds that owners in Southeast Asia do not have issues with ceding control. “There is a real acceptance that if someone's willing to pay a good price, then why not sell a business?”

Furthermore, he says, there is very little government intervention and they generally do not discourage control transactions.

Lachmi-Niwas Sadani, a Singapore-based director at fund of funds manager AXA Private Equity, suggests growth investments are not as common as buyouts in the region primarily because many investors are not comfortable taking minority stakes, particularly in countries seen as being more risky, such as Indonesia. A buyout investment is more reassuring to an investor.

However, not everyone agrees the region predominately lends itself to being a buyout market. Pote Videt, a Bangkok-based managing director at Lombard Investments, has a different view entirely. “Southeast Asia is definitely a growth equity market,” he says. While Lombard has done a few buyouts, most of its transactions have been minority investments. In contrast to Bloy, he says wresting control from the families that still control most businesses in Southeast Asia is not an easy task at all.

Videt acknowledges the challenges of making minority investments, saying deals have to be structured to protect the investor’s interests as a large minority investor. But in the last eight to nine years, he says Lombard has seen more openness to value-added influence by active minority investors.

While much has been made of the difficulty of having a say in companies in which investors have only minority stakes, in Videt’s view, the primary challenge to overcome is the obtaining of the vendor’s trust. Once that is obtained, structuring a deal and the negotiation of terms and conditions is less difficult.

Making growth investments “allows you to get into leading industry franchises – in other words, market leaders that are fundamentally well run but may have some other problems”, Videt says. It allows an investor to get significant exposure to “industry leaders with above-average growth in Southeast Asia”.