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Is Asian private equity still an attractive play?
PRIVATE equity has enjoyed a prolonged period of growth and success, and is now one of the most important asset classes among institutional and private investors. However, with the intense competition and challenging environment especially in Asia, will private equity's boom fade away sooner than expected?
There has been much talk about the global private equity bubble bursting - from cheap credit fading a decade ago, to too much money chasing after too few deals, deals are expensive, multiples are high, returns are diminishing, economic growth is slowing, trade tension, etc.
Concerns about private equity have never ended. Asia, where there is an increasing number of private equity investments, now represents 26 per cent of the global private equity market. However, the overall investment landscape is seen as becoming more and more challenging and as such, some claimed it is less attractive. Is the situation really that treacherous? Will investors abandon private equity soon?
According to the annual Asia Pacific Private Equity Report by Bain & Company, fundraising had definitely slowed in Asia in 2018, both in terms of aggregate amount raised and the number of funds raising money. This trend has continued in the first quarter of 2019. So, have investors lost interest in private equity in Asia? Probably not. The Asia private equity assets under management is now at an all-time high. The slowing of fundraising could well be explained by a number of factors.
Firstly, the majority of the fundraising activities had already been done between 2015 and 2017. These funds still have dry powder and may not come back to the market any time soon. As a reference, dry powder in Asia increased 14 times from the beginning of this decade to the end of 2018. There's still quite some money to spend.
Secondly, Bain's report showed that the Chinese regulator is becoming more stringent about the wealth management products offered, including RMB private equity funds, which had curbed fundraising in 2018.
Thirdly, more and more large institutions such as the sovereign wealth funds, pension funds and insurance companies invest through separate accounts alongside private equity fund managers instead of directly into the funds. Some of these numbers may therefore not be captured in the fundraising data.
One interesting trend to note is investors' preference for the large/ mega funds with strong track records. For high-net-worth individuals in particular, they are still in favour of brand names. That explains why certain funds are able to close within months with significant oversubscription. This trend will likely continue. Although investors are still keen to invest in Asia, they should be mindful of the price they are paying to acquire a company.
The median M&A entry multiple, measured by EV/EBITDA, was at 14.5x by the end of 2018 according to Bain's report; whereas five years ago, it was only 9x. The average entry multiple was even higher. From observation, not only are the tech companies being priced at a level never seen before (with many anticipating a tech bubble crash in 2019 or 2020), those low-tech companies in the traditional sectors such as Consumer are also bought by private equity firms at an unbelievably high price.
However, given the fact that valuations for private and public companies are narrowing, and the public market is still booming (more or less), valuations of private companies will definitely follow. The days for buy-low-sell-high are gone, investors have to be able to identify private equity managers that can either still locate the hidden gems, or are able to create real value for the underlying companies instead of merely relying on financial engineering.
Asia private equity returns remain attractive, and outperform the public markets in the region over different time horizons.
However, the gap between the top-quartile and bottom-quartile managers is huge, and the difference can be as much as 15 per cent net IRR. As many funds - large or small, regional or country-focused, first-time or new strategy from an existing manager - are trying to raise money to invest in Asia, investors need to be able, or rely on experts, to perform due diligence and distinguish the really skilful managers from the mediocre ones.
Key areas to look at include background of the firm, team experience, dynamics and compensation, local experts on the ground (including relationships with local governments), investment strategy, track record, etc. Investors should be alert if any of the information is not obtainable.
From our point of view, we remain positive on Asia, and intend to increase our global portfolio's exposure from 25 per cent to 30 per cent.
Although we are not a thematic investor, four sectors are particularly appealing to us over the long term: healthcare, education, food and technology. However, as mentioned before, certain tech companies may be too expensive or too big to exit.
Therefore, in comparison, the small-/mid-sized tech companies seem more attractive at the moment.
Last but not least: China. The scale of the mainland economy is huge and is still developing, albeit at a slower pace. In the long run, we believe China has the potential to become the second largest private equity market in the world.
This will help many Chinese enterprises to expand overseas and become international corporations.
- The writer is head of private equity, Asia, Indosuez Wealth Management.