Private Equity: Southeast Asian PE market growing but still a laggard globally

This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on December 30, 2019 - January 05, 2020.
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Private equity (PE) has broadly stood out as an asset class over the last decade (2009 to 2019), with much of the outperformance coming from North America in particular. Having said that, Southeast Asia has enjoyed significant inflows in recent years, as investors chase potential gains from the region’s 600-million strong consumer base.

According to Brahmal Vasudevan, founder and CEO of regional PE firm Creador, North America’s outperformance can be attributed to the region’s comparatively strong economic growth over the past decade, which was a boon to the business community.

Furthermore, historically low interest rates have allowed North American PE firms to use significant amounts of debt to fund acquisitions, thereby keeping their own investments relatively small while maximising ownership stakes.

Stock markets in the region have also enjoyed historic highs over the last decade, meaning portfolio companies have been able to achieve successful exits, thereby providing PE investors with significant gains.

Malaysian Venture Capital and Private Equity Association chairman Victor Chua said in an email interview that in 4Q2018 alone, North America raised US$240 billion in PE funds. This accounted for more than half of the total global fundraising (US$426 billion) during the period, he tells Personal Wealth.

More broadly, record amounts of capital — US$2.6 trillion between 2009 and 2018 — flowed into PE funds globally, according to financial services data firm PitchBook. In fact, the asset class attracted more funds than exchange-traded funds (US$2.2 trillion during the period).

Technology companies have been a major driver of PE gains over the last decade, says Chua. “The broad technology category consists of many subsectors, including IT services, software development and financial technology (fintech). It was perhaps unsurprising that with the wealth of investment options, 2018 saw the most PE technology exits ever at 411, worth a total of US$152 billion, according to PitchBook.”

 

The region’s PE play

While Southeast Asia has historically struggled in terms of PE performance, it has attracted significant fund flows in the last few years. According to a Bain & Co report, Investing in Southeast Asia: What’s Behind the Boom, PE deal values rose 75% to US$15 billion in 2017 alone, bucking a previous decade-long trend of flat growth. Key contributing factors include the region’s average economic growth of 7%, a burgeoning middle class and a rapidly growing pool of digital natives.

By all accounts, 2017 has been a watershed year for Southeast Asian PE fund flows, the report notes. The number of active investors completing PE transactions with deal values of US$10 million or higher rose to 124 in 2017, up 45% from the previous five-year average.

That year also saw exit deal values rise to US$16 billion, up a whopping 86% from the previous five-year average. According to the report, these figures are helping PE fund managers to feel more confident about raising new funds and putting capital to work.

Taken in the context of global PE flows however, the region still lags behind its global peers. While there are no Southeast Asia-

specific figures, indicative numbers provided by PitchBook show that the broader Asia-focused PE funds accounted for just US$80 billion of the US$2.6 trillion that flowed into PE funds globally between 2009 and 2018.

In fact, according to the Bain report, Southeast Asian PE investments had hovered for years between US$6 billion and US$9 billion, leaving many PE funds with regional offices wondering when the investments would take off.

According to Creador’s Brahmal, Southeast Asia’s PE scene saw a lot of excitement between 2005 and 2010. “But generally speaking, returns had been poor and there were few strong success stories in this part of the world. I think this is reflected in the fact that we have seen comparatively fewer deals thus far and that very few firms operate in this region,” he says.

Admittedly, one key factor has been the strong outperformance of US securities over the last decade or so, says Brahmal. “I was in the US conducting fundraising activities and investors there questioned the need to go to Southeast Asia at a time when the S&P 500 had been returning roughly 16% a year over the last nine years. As for Southeast Asian investors, they are generally not big PE investors. Their typical allocations tend to be between 1% and 3%, as opposed to between 10% and 15% for Western investors.”

Chua notes that more local investors have moved into the private markets in recent years, mainly due to the sluggish stock market. “I have been hearing of more investors tapping into the local and regional private markets for additional alpha. This has been the case for both PE and venture capital, although PE is perceived to be less risky. That is because PE porfolio companies tend to be a lot more mature.”  

Southeast Asia has lagged for a number of other reasons. While the region as a whole is an attractive consumer market, it is nonetheless very fragmented, says Brahmal. “There are roughly 600 million consumers in the region, but the countries are pretty distinct from one another. Indonesia is very different from the Philippines while Malaysia is very different from Thailand.

“Additionally, while we must of course acknowledge some major successes, there remains an all-round lack of high-quality entrepreneurs in the region. For example, if a fund had invested exclusively in Vietnam or perhaps Indonesia, it would have really struggled.”

In this regard, Malaysia is no exception, he says. “We just do not have enough high-quality local entrepreneurs who want to build big, regional businesses. We need to find a way to empower entrepreneurs and get them to build much bigger businesses. One of our portfolio companies, Mr. DIY, started in Malaysia but has since expanded into Thailand, Indonesia, the Philippines and India.”

In Malaysia, Ekuiti Nasional Bhd (Ekuinas) announced that its maiden fund — the Ekuinas Direct (Tranche I) Fund — that was launched in 2010 had delivered an annualised gross internal rate of return (IRR) of 10.1% and a net IRR of 6.5% until the fund’s closure at end-2017. “This is a country-specific fund that only delivered 6.5%. So, country-specific funds are tough as each market is often too small on its own. Therefore, the only way to be successful is to have a regional footprint right from the start,” says Brahmal.

Over the last decade, country-specific PE funds have gradually given way to funds with broader, region-wide mandates, he adds. That said, two other Ekuinas funds — Tranche II and Tranche III — saw net IRRs of 10.2% and 10.7% respectively (as at May). According to Bloomberg, the FBM KLCI recorded an average annualised return of 5.48% between end-2009 and November 2019.

Malaysian investors have allocted a comparatively small amount to PE as an asset class. Compounding the problem is the fact that few entities in the country tend to allocate any funds to PE at all.

Chua says that to date, most funding in Malaysia are still derived from government-linked companies. “GLCs and Malaysian investors broadly allocate just 3% to 4% of their AUM to PE. This is well below the allocations we have seen in developed markets. For example, for 2020, Yale University is targeting an allocation of 16.5% of its multibillion-dollar endowment to leveraged buyout activities alone.”

As at June, the university boasted a US$30.3 billion endowment, up slightly from the previous year.

Going forward, Chua advises investors (such as family offices and larger corporations) to work closely with PE firms and invest as limited partners, rather than going all in to the public markets or attempting to make PE investments themselves. “During the 2007 to 2009 recession, PE firms and their portfolio companies learnt a valuable lesson on holding up during the downturn. PE firms have also embraced data-driven technologies in their investment-making decisions over the last 10 years,” he says.

“There are various new data science platforms to help PE firms make more accurate analysis of past performance, in addition to making better decisions about key business drivers. Examples of these data companies include Preqin and PitchBook.

“More broadly, they are embracing diversification to reduce the impact of volatility, in addition to being heavily focused on value creation [in their portfolio companies]. Hence, firms have been able to report spectacular returns, to the extent that they outperform the public markets.”

 

Better days ahead

North America may have dominated over the last decade, but the next 10 years will see plenty of opportunities for Southeast Asian private equity (PE) funds to finally take centre stage, according to a recent report by Singapore-based PE firm Asia Partners. It projects that by 2029, Southeast Asia is expected to give rise to more than 20 new technology companies with a market value of more than US$1 billion each. According to its 2019 internet report, Southeast Asia’s Golden Age, at least half of these companies are expected to pursue listings over the next decade. 

Co-founders Nicholas Nash and Oliver Rippel believe the region is entering what they refer to as “the golden age of disposable income”. And coinciding with this golden age is the region’s rapidly growing unicorns.

Malaysian Venture Capital and Private Equity Association chairman Victor Chua cites massive amounts of capital ready and waiting to be deployed globally over the next few years. Preqin estimates some US$2.4 trillion in dry powder available for investments over the next few years. Chua believes that technology will remain a top target for PE firms over the next few years, with a particular bias toward financial technology (fintech), healthcare technology and e-commerce.

He says Southeast Asia’s potential as a destination for major PE investments was first noticed in 2016, when PE giant KKR led a US$550 million investment round for Indonesian ride-sharing company Gojek. “The investment boosted the start-up’s credibility and in the years since, it has acquired even more investments from major companies such as Alphabet Inc’s Google and Singapore’s Temasek Holdings. The investments led by KKR signalled that it was now less of a challenge for companies in the region to attract significant PE investments, he adds.

Since then, other Southeast Asian unicorns, including Malaysia-founded and Singapore-headquartered giant Grab, have successfully closed massive investment rounds. The ride-hailing giant, which recently outcompeted and forced Uber out of Southeast Asia, raised more than US$4.5 billion in a private investment round in March. Japanese investor SoftBank led the round, putting in US$1.5 billion from its Vision Fund.

Taking a local view, Chua believes that the Malaysian PE scene will be more diverse going forward. “Over the next few years, I see more family offices and larger corporations becoming involved in this asset class, primarily as limited partners. As the investing community continue to gain awareness, they will realise that PE is a good long-term asset class that can provide returns that are not quite as cyclical as the public markets.”

Southeast Asia will continue to converge over the next few years, with more cross-border investment opportunities. To this end, he sees Malaysian PE firms gradually investing more overseas — something he believes will provide significant value to companies operating in markets that are not yet as mature as Malaysia.

Creador founder and CEO Brahmal Vasudevan is also looking at technology-heavy themes going forward. His firm is looking to invest in manufacturing businesses that possess significant intellectual property assets. “We do not want to invest in contract manufacturers. We are not interested in a manufacturer that simply builds for other brands. We are looking at high-end manufacturers that own their IPs, have their own brands and, ideally, are export-oriented,” he says.