Analysis

ROUNDTABLE

SPONSORS DEBEVOISE & PLIMPTON • CAMPBELL LUTYENS • INTERMEDIATE CAPITAL GROUP • EQT • ADAMS STREET PARTNERS

The calm before the storm

Headline risks and recession fears in the Asia-Pacific markets have put a greater onus on managers to pursue growth levers, Alex Lynn writes

torm clouds weigh heavy over are going downstream to professionals on the Hong Kong offices of De- the ground. It’ll take some time for that to bevoise & Plimpton as five leave the system, and it has a very real pos- private equity professionals sibility of slowing down one’s deployment, gather on a Friday morning to allocations or investment pace.” discuss the Asian markets. Certain sectors are already feeling the SThe ominous skies are fitting given re- heat. “What we hear from our portfolio cent events. At the time of writing, Hong companies is that some sectors, like auto in Kong had entered its 13th consecutive week China, seem to be heavily impacted,” says of protests, the most recent of which saw Wooseok Jun, head of Asia-Pacific and fund barricades torched in the streets, passengers manager for Asia subordinated and equity tear gassed at close quarters on the MTR funds at Intermediate Capital Group. system and Chinese military vehicles enter The impact on private equity could be the special administrative region as part of a mitigated by a movement away from those “routine” rotation. industries most at risk, with manufacturing Dramatic headlines have become a main- and exporting businesses having played a stay of Asian private equity over the past 18 less significant role in recent years. months. Before Hong Kong’s extradition “On the industrial side we’ve not really crisis, it was the ongoing Sino-US trade war touched anything that’s based on cost ex- that dominated much of the discourse. porting since 2010 because the direct work- “In an average CIO’s office or invest- force has been shrinking in China for years,” ment committee, headline risks take time Martin Mok, head of mid-market Asia at to come to the table as something to discuss EQT, notes. “If you listen to most indus- and then linger before they’re swept away,” trialists nowadays, you don’t make cheap says George Maltezos, co-head of Asia at things in China – that game’s long gone.” advisory firm Campbell Lutyens. The focus in Asia has instead shifted to “We’ve been talking about trade wars the tech-related sectors, financial services for quite a long time and now the CIOs and those linked to domestic consumption, are acutely aware of it; they can’t avoid the such as healthcare, according to Bain & headlines so they’re asking questions that Co’s Asia-Pacific Private Equity Report 2019.

52 Private Equity International • October 2019 Analysis

PHOTOGRAPHY: GARRIDGE HO

George Maltezos Wooseok Jun Gavin Anderson Martin Mok Sunil Mishra

Partner, Head of Asia-Pacific, Partner, Partner, Partner, Campbell Lutyens Intermediate Capital Debevoise & Plimpton EQT Adams Street Partners Group Based in Hong Kong, Based in Hong Kong, Mok is an 18-year Based in Singapore, Maltezos heads Based in Hong Kong, Anderson serves veteran of EQT who Mishra is responsible Campbell Lutyens’ Jun serves as head as a member of the serves as partner for the sourcing and Asia-Pacific activities of Asia-Pacific and firm’s investment and head of EQT execution of Asian and looks after fund manager for funds and investment mid-market Asia. He investments ex-China, institutional investors Asia subordinated management group is a member of the specifically in India, in Australia and New and equity funds. advising sponsors and mid-market partners Australia, Japan, Zealand. He joined the firm in investors on a variety investment committee South-East Asia and 2013 as head of Korea of issues, including and the Greater Korea. He joined following an 18-year fund formation, China II investment the firm in 2007 stint leading financings co-investment, fund committee. following spells at Tata and acquisitions of restructurings and Group and Standard companies across the Chartered. Asia-Pacific region. arrangements.

October 2019 • Private Equity International 53 Analysis

Private equity firms deployed $87 billion across 580 transactions in Greater China in H1, compared with $130 billion in 1,069 deals in H2 2018, according to PwC. “We’ve been late cycle for the last two to three years now, so there’s broad consensus that there is a recession coming,” Mishra says. “We’re starting to see GPs being very cautious about what they’re buying and what they are paying, in terms of asset qual- ity, sectors they’re in and valuations. Most people think that during the life of this fund they’ll see the recession and want to deploy the capital gradually so they still have part of the fund to invest during the recession.” China is not immune to recession fears – its GDP growth plummeted to 6.2 percent in Q2 2019, a 27-year low – but the room remains bullish. “The Chinese government did say it won’t go below 6 percent and, without a more escalated trade war or the Hong Kong The internet and technology sectors, which protests blowing up into a national issue, it make up China’s new economy, have ac- “In an average CIO’s doesn’t look like it will,” Mok says. counted for almost 85 percent of the growth “Everybody’s holding the horse a bit in Greater China private equity since 2010. office or investment and recession fears may cause a temporary “When we first started 20 years ago, a falling off the cliff in speed of deployment lot of the capital demand across Asia was for committee, headline and exits, but 6 percent growth is still very building capacity,” Sunil Mishra, a Singa- respectable compared to where other coun- pore-based partner at global risks take time to tries were at this stage of development.” Adams Street Partners, adds. Recession talk may be at least partly to “We quickly moved to a domestic con- come to the table as blame for a moderate slowdown in Asia-Pa- sumption economy and innovation invest- cific fundraising this year. Private equity ment themes, which has been driving our something to discuss firms had raised $33.6 billion for the region portfolio growth in recent years. Consump- across 67 funds as of early September, com- tion is a big part of our investment thesis and then linger before pared with $63 billion across 149 vehicles today across Asia – especially in India, Aus- throughout 2018, according to PEI data. tralia and increasingly China, where they’ve they’re swept away” Last year saw Hillhouse Capital Group gradually shifted the economy over a period raise $10.6 billion for Fund IV, the largest of time.” ever private equity fund dedicated to the GEORGE MALTEZOS region, followed by The Carlyle Group, Holding the horse Campbell Lutyens which raised $6.55 billion for Asia Partners Asian dealmaking slumped in the first half of V, and Hong Kong-headquartered PAG, 2019. Asia-Pacific M&A activity, excluding which collected $6.1 billion for its Asia III. Japan, fell 22 percent year-on-year in H1 to “You have a longer-term trend of the $341.3 billion across 4,095 deals, the lowest big getting bigger, with capital flowing to level since H1 2013, according to Dealog- a handful of brand-name firms,” Gavin An- ic. The decline was driven in no small part derson, partner at Debevoise & Plimpton, by China and India, where deal values fell notes. 31 percent and 52 percent year-on-year to “We’ve seen smaller fund managers can $175.6 billion and $31.2 billion, respectively. find it harder and it can take longer to raise

54 Private Equity International • October 2019 Analysis

China M&A fell by 18% in the first six months of 2019, the largest single-period decline over the last decade “We’re starting to Value ($bn) Volume 140 1,400 see GPs being very 120 1,200 100 1,000 cautious about what 80 800 they’re buying and 60 600

40 400 what they are paying, 20 200 in terms of asset 0 0 H1 2016 H2 2016 H1 2017 H2 2017 H1 2018 H2 2018 H1 2019 quality, sectors they’re Source: PwC in and valuations” funds, particularly if they don’t have much son recalls a time when fund private place- of a track record behind them. There’s also a ment memoranda were primarily focused on creative destruction process, so if the small- Asia’s growth story, rather than operational SUNIL MISHRA er fund fails to raise capital, it probably still improvement. Adams Street Partners has good people and assets that can look for “The focus on operational partners and a home elsewhere.” sector expertise has really evolved and you But this two-speed fundraising environ- have new tools in terms of analytics to help ment could – in time – present opportuni- portfolio companies to look at markets, op- ties for those hunting lower down the food tions and strategies,” he says. “There’s enor- chain. mous opportunity to add value there.” “The trend of money flowing into the Market conditions are likely to favour larger funds has been happening for the those with a strong focus on value creation. last couple of years, but recently a lot of op- “The long tail of managers that are not portunities are brought to us by the second generation of funds,” Jun says. “From what we see in the mid-market space, there are tonnes of deals, whereas in the large mul- ti-billion space in South Korea and Australia the brand names don’t have enough deals.” Firms have completed just 20 private eq- uity deals in Australia in 2019, well below the 107 signed last year, according to a re- port by the Australian Investment Council and EY. Spending could end broadly simi- larly though, with $10.1 billion deployed so far, compared with $17.5 billion last year.

Levers of growth The possibility of an impending recession has changed the way some firms pursue growth. “A lot of managers are actually expect- ing some multiple contraction related to recession and that means the better firms are focusing on higher-growth EBITDA companies to offset that,” Jun says. “If we see a meaningful terminal value risk then we’d try to structure the transaction with a larger debt portion so we’re less exposed to the multiple.” As the market matures, so too has the way firms consider value creation. -Ander

October 2019 • Private Equity International 55 Analysis

“The focus on operational partners and sector expertise has really evolved and quite as experienced or don’t have the teams ers in China, Mok notes. It pursues 40 per- you have new tools and the skill set to focus on operational cent to 50 percent ownership stakes but improvements are going to really suffer,” retains the ability to replace the chief execu- in terms of analytics Maltezos says. “A significant portion of the tive and trigger an exit. market needs to catch up, which is not easy.” “If you do a in China, some LPs to help portfolio In China, only 44 percent of private will say you’re doing people a favour by equity investments completed in H1 2019 picking up the lemons from their private companies to look at were , according to investment advi- owners, so this is a more refined version we sory BDA. Limited ownership means firms use,” he adds. “It’s an improved version of markets, options and don’t always have the ability to implement having many growth assets in your portfolio drivers of growth. that you cannot manage.” strategies” “A lot in the market today are saying they EQT’s buyout team has also started col- can do buyouts in China – a statement most laborating with its and dig- LPs love to hear – but we all understand on itisation teams to assess the disruption risk GAVIN ANDERSON Debevoise & Plimpton the ground that taking full control, having of investment targets before it writes a deal. the right personnel and enacting the right “Things are moving faster here and the strategy from an operational perspective is ‘venturisation’ of everything is disrupting difficult to execute in China,” Maltezos says. all businesses,” Mok says. “After EQT has EQT navigates this issue by opting for invested, we then focus on improving con- co-control deals alongside company found- sumer engagement, operating efficiency and expanding into adjacent products or services.”

The land of opportunity On the subject of growth, talk turns to Ja- pan, which is becoming the destination of choice for global private equity firms. Apollo Global Management, Pantheon and Tikehau Capital have all opened Tokyo of- fices in the past 18 months, while EQT is planning an outpost in the city. A global presence could benefit those at- tempting to crack the market, Jun says. “A lot of Japanese companies are looking for an international brand and want to break out of the local market, so they’re asking how many offices you have around the world.” With around 10 Japanese firms raising funds this year – according to Maltezos – establishing a local team will likely prove integral to their success. “It’s now the market to watch for due to the development of local talent at mid-mar- ket firms run by domestic professionals and also the international firms building very strong local teams who can unlock transac- tions and do value creation without stepping on toes,” Mishra says. “In our mind, the key ingredient is experienced local professionals who have been in private equity for a while

56 Private Equity International • October 2019 Analysis

“On the industrial side we’ve not really touched anything that’s based on cost exporting since 2010 because the direct workforce has been shrinking in China for years”

MARTIN MOK EQT and know what it takes to drive successful torically stuck or perhaps unhappy, but now outcomes.” we’re seeing a lot more solutions available Part of Japan’s appeal lies in its favour- in terms of being able to offer liquidity able lending environment and ageing de- through some sort of tender process or re- mographics, Jun adds. More than half (53 structuring,” Anderson says. percent) of companies with a CEO in their “People can now set up continuation 60s do not have a successor lined up and the funds and keep managing them; there’s a lot same can be said for 34 percent of those with more in the toolbox.” a CEO in their 80s, according to BDA. The region has seen some prominent But implementing the necessary changes secondaries deals over the past 18 months. is not without its challenges, Maltezos says. In February, TPG closed its seventh Asia “Culturally, they’re not all ready for flagship fund on $4.6 billion with the help what many of us from outside of Japan may see as obvious low-hanging fruit in terms of Asia-Pacific fundraising has slowed in 2019 after a peak last year improving operations, rationalising teams Capital raised ($bn) No of funds and digitising some of the businesses. They 60 180 could handle a fraction of what we might dream up as a game plan, so the ability to 50 150 pull the levers that private equity profes- 40 120 sionals have in their toolkit feels limited.” 30 90

Expanded toolbox 20 60 Although the toolkit in Japan might be lim- ited, Asia-Pacific managers have a greater 10 30 number of solutions available when it comes 0 0 to liquidity. 2014 2015 2016 2017 2018 2019 YTD* “If you’ve got an old fund that many Source: PEI people want to get out of, people were his- *data as of 13 September

October 2019 • Private Equity International 57 Analysis

“A lot of managers The LPA Anatomised are actually expecting some multiple Second Edition contraction related to recession and that A practical guide to negotiating means the better firms private fund terms and creating are focusing on higher- GP/LP alignment growth EBITDA Edited by Nigel van Zyl and Edward Lee of Proskuaer, this fully updated edition features the insight and views companies to offset of leading lawyers and industry experts on how GP/LP that” alignment is created, how the long-term relationship between them is fostered though the LPA, and how recent regulation and litigation are influencing LPA WOOSEOK JUN Intermediate Capital Group terms. Content highlights:

• Time for a more flexible model for GP/LP alignment? • A to Z of LPA terms and how to negotiate them effectively. • The role of litigation and regulation in the evolution of private fund partnership agreements • Case study: How to handle a challenging LPA of a stapled secondaries transaction involv- onboard with that idea too and proactively negotiation. ing Lexington Partners, Adams Street and thinking about it as the asset class matures.” • A comparison of LPAs in the US, Europe and Asia. Partners Group. Performance concerns have been a key • How to structure and negotiate separately managed Last August, Government of Singapore driver in Asia’s adoption of secondaries. Investment Corporation and NewQuest “If there is one frustration people have accounts. Capital Partners backed a transaction that about investing in Asia it’s that IRRs look • Issues GPs must consider when approaching LPs to involved restructuring a portfolio of assets great and DPIs look weak,” Maltezos Available now discuss revising fund terms. held in a yuan-denominated vehicle man- notes. aged by Loyal Valley Capital. Meanwhile, “At the end of the day we’re dealing with Order this essential title today Japan’s Norinchukin Bank sold a $5 billion emerging markets where liquidity is availa- portfolio to Ardian earlier this year – the ble during various windows, things may take largest transaction to date. longer and exits are not as buoyant as we “There is increasing awareness globally have seen in the US. We have tools that can www.privateequityinternational.com/the-lpa-anatomised-second-edition for secondaries as a tool for liquidity man- help a set of stakeholders around an existing agement,” Mishra says. portfolio generate some liquidity, short of a “With some of the franchise names forced fire sale or taking on financial lever- globally embracing the secondaries mar- age, and we’ve seen a lot of this in Asia over ket, some of the Asian firms are coming the past three years.” n Special offer to subscribers: Order your copy today quoting SUBBK15 and receive a 15% discount 58 Private Equity International • October 2019