This article first appeared in Forum, The Edge Malaysia Weekly on January 14, 2019 - January 20, 2019

Venture capital and private equity investment in Southeast Asia has soared to record levels as scores of new investors pour into the region. In 2017, the number of recorded venture capital deals rose to 524, four times the level of 2012, and private equity deal value rose 75% to US$15 billion, breaking out of a decade-long phase of flat growth.

Suddenly, all signs are pointing up. Technology companies attracted the bulk of new capital, rising to 40% of deal count in 2017 from 20% in 2014. Southeast Asia-dedicated funds’ dry powder — committed but unspent capital — has more than doubled since 2012. The region also has produced its first set of unicorns — new companies that rapidly achieve market valuations of US$1 billion or more. Since 2012, ten unicorns, including Grab, Go-Jek and Traveloka, have created a combined market value of US$34 billion, ranking Southeast Asia No 3 in Asia-Pacific, behind only China and India.

Can Southeast Asia sustain the new momentum? We see the conditions in place for a long-term investment boom. The region’s venture and private equity ecosystems have developed critical mass and are entering a new phase of growth. Our research shows private equity deal value over the next five years is likely to total US$70 billion — double the level of the previous five years. By 2024, we expect the region to produce at least 10 new unicorns.

But surging investment in Southeast Asia means increased competition and higher valuations. To prosper in a changing market, venture capital and private equity investors will need to redouble their focus on value creation and organic growth.

Stoking the boom

Several important shifts argue for a step change in investment activity in Southeast Asia. One is the steady influx of new venture capital and private equity participants. The number of active investors completing private equity transactions with deal values of US$10 million or higher rose to 124 in 2017, a 45% increase from the previous five-year average. The pool of institutional investors, in particular, has expanded significantly. New investors are attracted by the region’s strong macroeconomic fundamentals, the chance to invest in emerging regional champions and a deepening secondary market for deals of all sizes. The mix includes a combination of local venture capital funds and private equity funds, sovereign wealth funds and global funds. Navis Capital, for example, recently launched a US$1.75 billion fund focused on Southeast Asia and Australia.

The region’s maturing bench of start-ups is another powerful investment catalyst. More than 1,300 companies in Southeast Asia received a first round of seed, or Series A, financing since 2011, including 261 in 2017 — five times the level of 2011. Overall, the region’s increasing demand for capital has dovetailed with rising supply — a signal that company owners across the region are growing more receptive to venture capital and private equity investment.

Strong exit momentum and healthy returns are also increasing the pace of investment by recycling capital faster. In 2017, the exit deal value rose to US$16 billion, up 86% from the previous five-year average. That virtuous investment cycle helps private equity fund managers feel more confident about raising new funds and putting capital to work. And as private equity funds expand their portfolios, they broaden the potential market for secondary transactions.

Deeper integration of the Asean market encourages companies to expand across borders, accelerating their growth. Even businesses that traditionally focused on local markets are attracting capital to expand regionally. Fullerton Health, for example, now operates more than 500 clinics in eight Asia-Pacific countries, after being founded in 2011 with the acquisition of two corporate healthcare providers in Singapore. BookDoc, a three-year-old Malaysian start-up with venture funding, connects patients with healthcare providers and has built an online platform spanning five countries.

Government initiatives have helped spur venture capital investments and start-up centres. Singapore’s Startup SG Founder programme, for example, provides US$3 in matching funds, up to US$30,000, for every dollar that new entrepreneurs raise. Companies seeking to raise a second round of US$2 million to US$4 million receive one dollar in matching funds for every dollar they raise. These moves and others have helped boost the percentage of Singapore-based start-ups that receive follow-on funding to the same level as start-ups in Europe. Governments throughout Southeast Asia are pursuing similar policies. In 2016, the government of Vietnam announced it would offer legal and financial support to 2,600 start-ups over the next

10 years through its accelerator, Vietnam Silicon Valley.

Though Singapore remains Southeast Asia’s investment hub, vibrant start-up ecosystems are emerging across the region, creating a broader base for future investment. The number of companies in Indonesia raising a first round of funding in 2017 rose more than 300% from 2012. Together, Indonesia and Vietnam generated 20% of the region’s private equity deal value over the past five years, and that percentage is likely to grow. A recent Bain & Company survey showed nearly 90% of investors said the hottest Southeast Asian markets outside of Singapore in 2018/19 will be Indonesia and Vietnam.

Strong investor interest in the region’s developing technology sector and other consumption-based industries is likely to help sustain higher levels of investment. A 2017 study co-authored by Temasek Holdings and Google forecasts that Southeast Asia’s US$50 billion internet economy will quadruple by 2025. We expect the technology sector to contribute 20% to 40% of deal value over the next five years.

The financial technology sector, in particular, is expanding rapidly. Based on the valuations of leading fintech companies and strong investor interest in the sector, we expect two or three fintech unicorns to emerge by 2024. Information and communication technology firms are also growing rapidly and attracting larger pools of venture and private equity investment.

More than 60% of top private equity and venture capital professionals in Southeast Asia predicted that technology will be the leading investment sector for 2018/19, our research shows. In addition, we see a redoubling of investor interest in healthcare and education — sectors with significant long-term growth potential, but traditionally fragmented.

Navigating new terrain

Southeast Asia’s maturing venture capital and private equity ecosystems create powerful momentum for ongoing investment. But competition is increasing and valuations are rising — the average multiple of enterprise value-to-earnings before interest, taxes, depreciation and amortisation for private equity transactions is 17, the highest level in a decade. At the same time, uncertainty about global economic growth is rising and new technologies are accelerating disruption across many industries.

To create value in this changing market and help sustain the investment boom, venture and private equity investors will need to help portfolio companies achieve stronger growth and performance. In the coming year, some sectors in Southeast Asia will face greater pressure than others. Investors targeting healthcare and medical technology, for example, already face intense competition. In our experience, investors who succeed in adding significant value to their companies share a common approach based on four investment guidelines.

The most successful investors will take an Asean perspective when evaluating deals and incorporate cross-border expansion in their value-creation plans. Companies that diversify across Southeast Asia grow faster and reduce the risk of reliance on a single economy. The region’s new unicorns highlight the potential for spectacular value creation.

They will also get the right talent in place from the start. Bain research shows portfolio companies’ leadership is the greatest source of success or failure for value creation in Asia-Pacific investing — and talent is particularly scarce in the region. But many investors take an overly positive view of management teams early on and delay making changes.

Winning investors also will build commercial excellence to fuel organic growth. Accelerating top-line growth lifts profitability and magnifies exit multiples, but it is hard to get right. Only 24% of general partners say they have met their top-line expectations in most of their portfolio companies over the last few years, according to Bain & Co’s 2018 private equity survey. Leading private equity firms build strength in commercial excellence by increasing customer segmentation, upgrading sales-force effectiveness and revisiting pricing or product portfolio strategy.

Finally, they will use digital tools to improve strategic position and performance. Top global investors are helping management teams understand how new technologies are shifting their profit pools. Digital tools can help them take practical steps to improve their strategic position, commercial performance and cash flow. Portfolio companies that embrace digital strategies are better positioned to manage disruption and keep pace with rapidly changing markets.

Investing in Southeast Asia is taking off but new challenges will require investors to navigate adroitly. Those who build regional businesses, secure top talent, improve commercial excellence and harness digital technologies will be best positioned to produce the solid returns they have long been anticipating.

Suvir Varma is a senior adviser with Bain & Co’s Global Private Equity practice, based in Singapore. Alex Boulton is a principal in the firm’s Singapore office. Francesco Cigala is a partner and head of the firm’s Kuala Lumpur office.

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