This article first appeared in Personal Wealth, The Edge Malaysia Weekly on October 29, 2018 - November 4, 2018

Foreign players may have neglected private equity (PE) opportunities in Southeast Asia in the past due to a lack of investible deals. However, positive trends — such as a young demographic, an emerging middle class and rapid urbanisation — have translated into significant opportunities for growth investors such as Warburg Pincus, says its Southeast Asia chief Jeffrey Perlman.

According to him, the people of the region are very young. For example, half the population of Vietnam is under 30. So, the countries in this region are set to benefit from a younger workforce at a time when developed markets such as China and Japan are facing ageing populations.

“We are about to see the middle class reach 400 million people in the next few years alone. In my view, investors have been to this ‘movie’ before in markets like China and India and they are starting to wake up to the substantial opportunity that exists in Southeast Asia. With a large population, rising urbanisation and an emerging middle class, the playbook that has been used by experienced investors such as Warburg Pincus is now ‘actionable’ in key markets in Southeast Asia,” Perlman says in an email interview with Personal Wealth.

According to Bain & Co’s Asia-Pacific Private Equity Report 2018, which was published in March, Japan and Southeast Asia saw the biggest gain in PE activity last year. Southeast Asia experienced phenomenal growth as deal value jumped to US$20 billion — an increase of 182% over the 2012-to-2016 average.

Despite this, it is important to highlight that investments in Southeast Asia are mainly made by growth equity investors, not buyout investors, says Perlman. PE investors traditionally buy large majority stakes or conduct leveraged buyouts on a scale that does not translate at the current maturity of the region, he explains.

“In fact, over 90% of PE deals in Southeast Asia are minority transactions and less than 20% represent an investment larger than US$150 million. The majority of businesses in the region are family-owned while in some countries like Vietnam, many entrepreneurs are running their first businesses. It would be very rare for an owner to be willing to relinquish control of his company,” he says.

Perlman was a speaker at the Employees Provident Fund’s Global Private Equity Summit 2018, where he delivered a presentation on “Growth investing in Southeast Asia”.

Big believer in REITs
Warburg Pincus, which was founded in 1966, is a leading global PE firm with more than US$45 billion under management. The firm has launched 17 PE funds, which have invested more than US$68 billion in more than 825 companies in over 40 countries. Its active portfolio of more than 175 companies is highly diversified by stage, sector and geography.

The New York-headquartered firm has offices in Amsterdam, Beijing, Hong Kong, Houston, London, Luxembourg, Mumbai, Mauritius, San Francisco, Sao Paulo, Shanghai and Singapore.

In Southeast Asia, the firm specifically targets some of the largest sectors that will benefit directly from an emerging middle class. This includes real estate, telecommunications, media and technology (TMT) and financial services.

Perlman says real estate is one of the best ways to play emerging consumption at scale, whether it is selling bigger apartments as people trade up, providing retail outlets for shopping and entertainment and setting up hospitality facilities for leisure travel.

“When we approach real estate investing, we always do it with an entity and platform approach. Consistent with Warburg Pincus’ venture and growth DNA, we have partnered leading entrepreneurs and top-tier management teams in the region to create de novo platforms to develop and acquire such assets with the long-term goal of creating the top player in each sector, as we have done successfully in China,” he adds.

Real estate companies that the firm has co-founded with local partners include Vincom Retail, BW Industrial Development and Lodgis in Vietnam and NWP Retail in Indonesia. It has also invested in ARA Asset Management Ltd, Asia’s largest real estate fund manager.

Warburg Pincus is a key shareholder of Hong Kong-based e-Shang Redwood Group (ESR), a merger between e-Shang Cayman Ltd and Redwood Group Asia Pte Ltd. The group is a pan-Asia logistics real estate developer.

ESR acquired a stake in Sabana Shariah Compliant Industrial REIT (real estate investment trust) in April. On Oct 15, it was reported that its own Singapore-listed ESR-REIT had merged with its rival Viva Industrial Trust to create the fourth-largest industrial REIT in Singapore.

Perlman says Warburg Pincus is a big believer in REITs as a key investment class for both retail and institutional investors. “Real estate tends to be a great hedge against inflation, so it can always be viewed as a defensive asset class. That being said, I think investors in Asia gravitate towards real estate as it is in their DNA,” he adds.

“Given the secular trend of capital flows for institutional real estate, which we think will move from places such as Europe and the US to Asia, I think the REIT sector will be a long-term beneficiary of this dynamic and we expect the asset class to only grow further from here.”

Meanwhile, the proliferation of cheap smartphones and low data prices have transformed connectivity in Asia. This is benefitting the TMT sector, says Perlman. “Internet access has exploded in the past three to four years, doubling to 60% of the entire Southeast Asian population today compared with 30% in 2013.”

These trends have led the firm to focus on vital areas of initial adoption, which it identifies as mobile first e-commerce marketplaces. That is why it invested in Indonesia-based ride-hailing platform Go-Jek, which has become the country’s first tech unicorn.

“When we invested in the company over two years ago, Go-Jek was just starting to scale its ride-sharing business and had a small but fast-growing food delivery business. Fast forward to today, Go-Jek has become ubiquitous in the daily lives of Indonesians,” says Perlman.

“Go-Jek has grown its fleet to more than 1.5 million drivers. It is now the largest food delivery platform in Asia outside China. Additionally, given the high frequency of its services, it has built the largest e-wallet in the country and a best-in-class online and offline merchant network. To use a China parallel, Go-Jek has essentially become Didi, Meituan, ZTO and Ant Financial all rolled into one platform.”

Warburg Pincus has made investments in the region’s financial services sector as it thinks the sector still has a low penetration rate and strong growth potential. Earlier this year, the firm made a substantial investment in Techcombank, the largest private bank in Vietnam. The firm is currently paying attention to opportunities in financial technology (fintech) and digital payments and playing this trend in Indonesia and Vietnam with investments in leading digital e-wallet and payment platforms.

Warburg Pincus, as a leading growth investor in the region, will continue to be impressed by the quality and depth of talented entrepreneurs in Southeast Asia, says Perlman. “We currently have a very strong pipeline. We look to remain disciplined in the key markets we have focused on in Southeast Asia as well as in the sectors that will directly benefit from this large and growing middle class,” he adds.

“Our goal is to continue leveraging our best-in-class franchise in China and India, where we started investing nearly 25 years ago, to bring knowledge, experience and value-add to entrepreneurs in the region who are looking for a strong partnership to capture the exciting market opportunity ahead of us.”

Key challenges in the region
Warburg Pincus made its first investment in Southeast Asia in Vincom Retail, the largest shopping mall operator in Vietnam. With more than 100 malls in operation or under development at the end of last year, Vincom Retail represents more than 60% of the total modern retail space (by floor area) in the country.

According to Perlman, the shopping mall operator is the firm’s first significant partial exit in the region. “We helped to list the company on the Ho Chi Minh Stock Exchange in November. At the time, it was the largest initial public offering in the country,” he says.

“The transaction raised about US$750 million in capital and valued the company at US$3.4 billion. At the IPO, which was 100% a secondary offering, Warburg Pincus sold about two-thirds of its stake in the company, which represented a landmark transaction for PE in Vietnam.”

Vincom Retail was incorporated in 2012 by its controlling shareholder, Vingroup, which transferred three malls to its portfolio in early 2013. That year, a Warburg Pincus-led consortium made a US$200 million investment in the company, providing capital to fund its accelerated expansion plans. Two years later, the consortium invested another US$100 million in the company.

Since its inception, Vincom Retail has grown more than 10 times and has become the only nationwide network of retail malls in Vietnam, catering to the rapidly growing consumer market there, says Perlman. “The IPO also made Vincom Retail one of the top 10 listed companies on the stock exchange and the first Vietnamese shopping mall developer and operator to list its stock,” he adds.

“The Vincom Retail transaction represented a lot of ‘firsts’ for Vietnam. It was the largest PE investment in the country. We achieved the first high-yield bond issuance on behalf of Vingroup. And at the time, we were able to achieve the largest-ever IPO in Vietnam.”

The biggest challenge for Warburg Pincus in the region as a growth investor is making sure that the firm selects the right local partner, says Perlman. “It truly is about who you partner more than anything else. Unlike a buyout deal, where control lies with us as the investor, growth equity deals in Southeast Asia are almost always minority investments. This is where alignment of interest is key. But at the end of the day, it is the partner selection above all else.”

The other key challenge is exiting potential investments. Perlman says the capital markets in the region are still nascent, with relatively low deal volume and value. As a result, IPOs only comprised less than 10% of the PE exits in recent years. The majority of them were driven by trade sales instead.

“While we are seeing more interest from North Asian strategics (across China, South Korea and Japan) in Southeast Asia, as well as an increasing depth in local IPO markets such as Vietnam over the past 12 months, investors would do well to carefully consider the availability of potential exit scenarios before pulling the trigger on new investments. The old adage is certainly true — it is always easier to get in than to get out,” says Perlman.

Despite not being exclusive to Southeast Asia, high valuations remains a key challenge to PE investors, he says. Currently, the amount of dry powder in the region is at a record high, driving up valuations. According to Bain & Co’s report, dry powder in Asia-Pacific at the end of last year had risen to US$225 billion or 2.2 years of future supply at the current pace of investment, from just US$170 billion in 2016.

Perlman says that while it is easy to point to high valuations as a key issue in doing new deals, the firm believes there are ways to get around this. One way is to go back to its venture roots — to avoid paying the premiums of an established platform, the firm could either pursue an earlier-stage platform or create a new platform with a talented entrepreneur. “The other is old-fashioned value-add. We have seen first-hand that entrepreneurs will prioritise the sector domain expertise and value-add over the last dollar of valuation,” he adds.

Despite the rapid growth witnessed in a few large technology and internet companies in Southeast Asia, Perlman believes the firm is still in the early innings of the overall sector. The firm expects activities to pick up considerably over the next two years. During this period, he expects many of the early funded platforms — more than 400 companies are currently in the Series A or pre-Series A stage — start to reach Series B, C and D.

“This is not ‘if it will happen’, but rather ‘when it will happen’. The issue has not really been on the venture side, but rather the lack of capital in the Series B and C rounds, which hopefully will start to change over the next few years, given how many good emerging companies there are that received early-stage funding,” says Perlman.

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