Wall of uncertainty

Though LBOs remain scarce in Asia, they’ve tripled in value over the past year and regional banks have played a role. But worries over tightening lending criteria may slow that surge as market uncertainty continues. By Drew Wilson

The barbarians aren’t at the gates in Asia, where no standard model for a private equity deal exists. Each country varies by regulations, level of financial sophistication, type of deals and cultural distinctions that shape the business mindset. It all ultimately impacts on deal financing.

“In the US you can look at five LBOs and discern main market terms, but that gets very hard to do in Asia,” says Soo-Jin Shim, a partner with Weil, Gotshal & Manges in Hong Kong, who also worked on LBOs in New York. 

A lot of regional deals are for small minority stakes or for obtaining growth capital.

“In which case it’s just a cost/benefit analysis for private equity firms to see if it’s worth leveraging a deal,” Shim says.

Leveraged buyouts – the classic private equity deal in the West – are popular only in the region’s sophisticated markets, which include Japan, Australia and to an extent South Korea and Singapore, sources say. 

China and India have had very little LBO activity by comparison. The dominant deals in Asia’s two most attractive markets for private equity are sub-$100 million minority investments, with no debt financing and general terms that are investor friendly. 

The number of targets in Asia worth multi-billions and truly worth a global syndicate are still very far and few between

That said, LBO value more than tripled in the region last year. LBOs in Asia rose to $26 billion in 2011 compared to $7.2 billion the previous year, according to data from Thomson Reuters. But the total is still small compared to $107 billion in the US and $71 billion in Europe.

“The number of targets in Asia worth multi-billions and truly worth a global syndicate are still very far and few between,” says an investment executive at a global investment bank.

Those “far and few between” deals tend to be take-private transactions, a relatively recent trend involving undervalued Chinese companies that are publicly-listed in the US or Europe. 

For example, TPG-backed Grohe, a German bathroom fixtures maker, last year took private Frankfurt-listed Chinese rival Joyou in a €324 million deal advised by Weil, Gotshal & Manges. Bain Capital did a similar deal last May, de-listing China Fire & Security Group for $266 million. In a proposed deal, Hong Kong’s Abax Global Capital in December offered a revised $353 million to take NASDAQ-listed copper products maker Fushi Copperweld private. Sources expect to see more such deals this year. 

“The value of China take-private deals [companies listed overseas] has been more than the amount of capital raised by Chinese IPOs in the West,” says Heath Zarin, HSBC’s head of principal investments, Asia Pacific global banking. “That’s an anomaly but it’s likely to continue.”

Regional lenders step up

Influential private equity lenders in Asia include HSBC and Standard Chartered, as well as JPMorgan and Goldman Sachs, National Bank of Australia, Westpac, Nomura and Sumitomo. But sources say Asia simply hasn’t had enough large deals to label any one of them a heavyweight in regional LBO financing. 

“In the US, for similarly sized deals, you could name the lead banks in the LBO market that you would typically see,” says Weil’s Shim. “But in Asia you won’t always see the same players in each LBO transaction.”

International players are complemented by the regional banks, some of which are extending their financing activities outside their home countries. Notably, China Development Bank has been actively looking at financing a number of LBO-type transactions, often involving take private deals of China businesses. 

“We’ve seen CDB across the table from us,” says Peter Feist, a partner with Weil, Gotshal & Manges in Hong Kong.

Additionally, two Taiwan banks, Cathay United Bank and China Development Industrial Bank, last year engaged in their first LBO. The banks led the financing for the $527 million acquisition of Hong Kong movie company Shaw Brothers by financial consortium Young Lion Acquisition Co, in which Providence Equity Partners is an investor.

The overall trend is more regional banks participating in LBOs.

“We see a lot of cross investment among Asian countries,” says Feist. “Local banks that may be in an undeveloped market grow their own business by providing regional financing.”

This is particularly true in markets such as Taiwan and Korea, which have a lot of liquidity but not enough local deals to use their cash, he added.

The year of uncertainty

Obtaining financing is expected to become more difficult this year globally. Lenders and equity investors both are more mindful of the tremendous macroeconomic uncertainty and more circumspect in funding allocation decisions.

“That manifests itself through tighter leverage multiples (being willing to lend a lower amount against a certain amount of cash flow), higher pricing, and, to the greatest extent, deals not getting done,” says HSBC’s Zarin.

European banks are cutting staff worldwide and scaling back lending activity due to difficulties at home. Some are selling assets – the debt they hold – in order to shore up balance sheets and meet new regulatory requirements, one source says. Meanwhile, US banks are also cutting staff. Bank of America Merrill Lynch recently revealed it was laying off one-fifth of its Asia-based managing directors. 

US and European banks are expected to remain active in Asia, but become far more cautious in terms of risk profiles. The lending climate could temper the surge in LBO value Asia had last year.

Uncertainty is influencing deal financing. Generally, all banks are more focused on diligence than they have been historically. Deals take longer to complete than one-two years ago. Leverage is down and pricing is up. 

Refinancing deals is more difficult in this climate. MediaWorks, a New Zealand broadcast company owned by private equity firm Ironbridge and US-based GST Autoleather, owned by Advantage Partners, are both struggling to re-finance debt, Reuters reported.

“Banks have become much more selective in the deals they want to back,” says Michael Nicklin, a partner with Ropes & Gray in Hong Kong.

Private equity firms looking at maturing loans from an acquisition done a few years ago may find that the lenders are not prepared to extend the maturity. 

Nicklin says many lenders have tightened their lending criteria. In some cases, businesses may have deteriorated and credit doesn’t look appealing. Covenants may have been flexible when the deal was initially made. Covenants may not have been breached, but refinancing still won’t be easy. 

“Rather than refinance, banks may say `we just want our money back’”, Nicklin says. 

However, not everyone agrees that macroeconomic uncertainty will tighten deal financing in Asia.

“Sponsors are awash with equity capital and debt financing has not really been an issue to date,” says Iain Drayton, head of the financial sponsors group in Asia at Goldman Sachs. “The biggest challenge is the origination of attractive deals of sufficient size in Asia.”

Nonethless, investors are preparing for the worst. Private equity firms in Asia are reviewing their portfolio companies – the financial and capital structure, the mix of debt-to-equity, the liabilities and assets. HSBC, for example, went through that exercise late last year in order to feel comfortable with its existing investments, Zarin says.

“We made sure sufficient cash is on hand with committed bank lines in case it’s needed,” Zarin says. “It’s best to look at whether each company’s capital structure is sufficiently robust to endure a major dislocation in the financial markets – a post-Lehman shock.” ?

Deal watch 

1. Bigger stakes in China 

Last June, Unitas Capital and Affinity Equity Partners sold Beijing Leader & Harvest Power Technologies Holdings, a China-based manufacturer of medium voltage drives, to Schneider Electric for $650 million.

Noteworthy: An LBO involving a controlling stake in a Chinese company. In China both LBOs and foreign controlling stakes are rare.

“There may be one or two other analogous deals this year in China where sponsors will be able to buy control of investments,” says Iain Drayton, head of the financial sponsors group in Asia at Goldman Sachs.


2.Asia growth, HQ elsewhere

3i’s €525 million sale of Hyva, a Netherlands-based maker of transport equipment components to Unitas Capital, a deal completed in early 2011. 

Noteworthy: The first high yield bond financing for an LBO in Asia, suggesting the bond market may be a financing option in Asia. Also notable because it was a unique Asia deal – a European company with nearly all its growth in Asia.

“It’s a quintessential LBO, an Asia deal that happened to be headquartered in Europe,” says Peter Feist, a partner at Weil, Gotshal & Manges in Hong Kong. “There will likely be more of those sorts of global deals with major Asia components because people are willing, and wanting, to write these bigger cheques. There are only so many growth capital deals one can do.”

3. Rise of regional banks

Cathay United Bank and China Development Industrial Bank in March 2011 led the LBO financing for the $527 million acquisition of film company Shaw Brothers in Hong Kong by Young Lion Acquisition Co. 

Noteworthy: The deal was the first LBO for the two Taiwan banks, highlighting the trend toward more Asian banks finding financing opportunities outside their home markets.

4. Good deals get done

In October 2011, Bain Capital’s $2.1 billion buyout of Japanese restaurant chain Skylark was the country’s biggest buyout in two years. Banks involved included Mizuho, Mitsubishi UFJ, Bank of Tokyo-Mitsubishi, Sumitomo, Nomura and Shinsei.

Noteworthy: The Skylark deal shows that “with the right sponsor and with the right credit, commercial banks are willing to step up,” says Goldman’s Drayton.

5. LBO flow in India? 

Carlyle Group and Blackstone Group are currently in separate talks to buy a major stake in the tower unit of Indian telecom operator Reliance Communications, which is valued near $3.5 billion, according to local reports.

Noteworthy: “This is potentially the largest ever LBO in India,” said one banking industry source, who did not want to be named because the deal is under negotiation. “If it happens, it will be a huge milestone for leveraged transactions in India.”

India’s largest deal to date has been a $1 billion investment in Bharti Infratel in 2007 by several investors including Temasek Holdings and Goldman Sachs.