This article first appeared in Personal Wealth, The Edge Malaysia Weekly on September 23, 2019 - September 29, 2019

Private equity (PE) is clearly enjoying its time in the spotlight as billions of dollars make their way to this once unknown alternative asset class on the fringes of the economy. According to reports, the net asset value of this global asset class has grown more than sevenfold since 2002 and twice as fast as public equities.

Although fundraising fell last year, PE deal values reached US$1.4 trillion globally, surpassing the last peak recorded in 2007. Deal multiples rose to 11.1 times from 10.4 times in 2017. This was largely attributed to record levels of capital, known as dry powder in the industry, of US$2 trillion at end-2018.

“Globally, more capital is allocated to PE because of its ability to generate higher returns than traditional asset classes such as equities. Institutional investors such as pension funds and government funds have been increasing their allocations to PE because of its enhanced returns and for portfolio diversification. Furthermore, because interest rates in developed markets are extremely low, PE firms can easily leverage their investments,” says Creador Sdn Bhd founder and CEO Brahmal Vasudevan.

According to Forbes, the global PE industry could reach US$15 trillion in assets under management (AUM) in the next decade, up from US$2.8 trillion recorded last year. Southeast Asia’s contribution to the AUM of global PE and venture capital (PEVC) is modest but growing quickly.

Preqin — the leading provider of financial data and information on the alternative assets market — found that Southeast Asia made up less than 1% of the US$3.6 trillion in global AUM at the end of last year. Between 2017 and 2018, Asean’s PEVC AUM rose 8.6% to US$28 billion.

Kelvin Yap, managing director of HarbourVest Partners LLC, finds that global institutional investors have been increasing their allocations to PE in this part of the world. “Previously, only about 10% of their PE allocation was deployed to Asia. This has increased to 15%. Of the amount allocated to Asia, less than 10% goes to Southeast Asia and this really depends on the opportunities that are found,” he says.

Positive spillovers

Like in other countries in the region, interest in Malaysia’s PE opportunities has been growing, although not at a rapid pace. Industry observers say such interest should be encouraged and the growth of the local PE industry should be supported as it results in the creation of market-leading companies, stimulates industries and generates positive spillovers for society.

These benefits result from the PE firms’ active management, which is needed to build capabilities in their investee companies and their employees. The core business model of a PE firm is to acquire a company, create value by growing the business (as well as its talent) and/or reducing costs before exiting. Done well, this process has been found to positively impact the investee company’s employment, profitability and productivity.

“Essentially, PE-owned companies raise competitive standards and cause the entire industry to be more productive. On average, a one standard deviation increase in the amount of PE investment in an industry leads to a 0.9% increase in employment growth, a 1.2% increase in labour productivity growth and a 2.6% increase in profit growth. In the long run, these gains are shared widely by investors, workers and society as a whole as labour productivity and GDP per capita increases,” says a research report by the University of North Carolina, titled Private Equity in the Global Economy: Evidence on Industry Spillovers.

Brahmal notes another invaluable intangible outcome of PE involvement in the country — the development of entrepreneurs who are keen to build and manage billion-ringgit companies. “Finding good quality deals is always a challenge for PE firms. We need to find fast-growing companies with great potential. Equally important is the person who helms the company. This entrepreneur must have big ambitions and must be open and willing to build a billion-dollar company.

“This is a challenge in Malaysia. Here, it is hard to find entrepreneurs with large ambitions. But this can be addressed through talent development and a supporting ecosystem. We must plant the seed of possibilities within our entrepreneurs and guide them along the way.”

The rise of the new digital industrial technology, known as the fourth industrial revolution or Industry 4.0, is another area in which PE can benefit a company as well as the wider economy.

Industry 4.0 changes the competitiveness of companies and, on a larger scale, countries and regions. It is especially relevant to the manufacturing sector as it enables the production of higher-quality goods at a reduced cost. The use of smart technologies in Industry 4.0 is expected to increase productivity, foster industrial growth and modify the workforce.

While many countries are still trying to understand how to ride this wave of technological advancement, China has already taken steps to implement the systems, networks, skills and infrastructure to emerge as the next technology superpower in the digital age. This expedites the urgency for countries, industries and companies — especially those in the manufacturing sector — to think about how they can leverage technology in the coming decade.

“China did not have much of a bricks-and-mortar economy to begin with. So, the new economy grew extremely quickly and there are a lot of creativity, innovation and business solutions here. Disruption has created and continues to create many business opportunities,” says Wang Piau-Voon, chief operating officer at Legend Capital Co Ltd.

“As PE investors, we focus solely on technology. This includes pure tech, or entirely digital companies, and other companies in the technology industry such as software manufacturers.”

In addition to building a new market and/or a competitive advantage for a company, large tech-related investments that follow the involvement of a PE partner also improve the employability of its workers. A report by The Review of Financial Studies, titled Private Equity and Workers’ Career Paths: The Role of Technological Change, suggests that (at least some) employees at PE-backed companies get more valuable skills versus their counterparts at non-PE-backed companies. “This highlights the role that PE firms can play in mitigating some of the workforce obsolescence issues that are an increasing concern in an era of rapid technological change,” the report adds.

Better PE skills expected

Southeast Asia’s economic vibrancy is underpinned by its demographic trends and a shift in production by US manufacturers to countries outside China as trade tensions between the world’s two largest economies stretch into a second year. This is a conducive environment for businesses to grow and, consequently, for PE deals to take place.

“Demographic trends, repositioning of the supply chain from China to other countries and many opportunities to improve the standard of living across Asean support this outlook. I believe its prospects are bright,” says Yap.

Wang and Brahmal share this outlook and find that a growing number of PE firms are looking for investment opportunities in this region. “It is possible for PE firms to be successful in Malaysia. Creador has been able to find deals worth RM1.7 billion in the last seven or eight years,” says Brahmal.

“The country’s deep and large capital markets also mean that it is possible to exit from your deals. And that is a very important aspect for a PE firm before it commits to an investment.”

As foreign PE firms enter the region and the competition for deals heats up, Wang points to the need for local PE firms to respond by honing in on their differentiating factors and leveraging their strengths. “It important for PE firms such as ourselves to focus on what we do best and to be mindful of what we can do for the companies we want to invest it. As we ask whether these companies have the potential to succeed, we must also check to see if we have the resources to help them address their weaknesses,” he says.

The trends in and issues of the PE industry in Malaysia and the rest of Southeast Asia will be discussed at the Malaysian Private Equity Forum on Oct 1 at Mandarin Oriental, Kuala Lumpur.

Save by subscribing to us for your print and/or digital copy.

P/S: The Edge is also available on Apple's AppStore and Androids' Google Play.