Asia’s gravitational pull on global capital markets is now affecting private equity. According to banking sources, perhaps as much as $20 billion has already been raised by global private equity funds specifically for investment in Asia. That is a staggering number in its own right. But add to that the leveraged capital that such funds employ to boost equity returns and the firepower likely to be trained on Asian targets in the next few years could be as high as $100 billion.
Investment bankers might salivate at the fees bonanza that this sum implies but a dose of sobriety is due. Asian markets are a far cry from the homogeneous US or European markets, where commonality of currency and regulatory environment provide one deep pool in which to fish. Although it is true that Asia’s private equity pioneers have made some spectacular gains, competition for assets early in the investment cycle was light to non-existent and success often comes at a high political price: witness events in Korea and Japan.
Despite the obvious challenges, private equity firms are queuing up to open Asian offices, especially as valuation expectations among buyout vendors have soared in the US or Europe.
New entrants to Asia will find the going little easier than back home. Asset prices in Asia have also soared in the last year or so, despite recent corrections. In the more open buyout markets, many of the larger deals have been completed, particularly in Korea, while in non-distressed Asian assets the founders’ obsession with control still prevails. There is evidence that that mentality is changing but progress is slow indeed.
For evidence of likely trends look no further than the deals closed by private equity funds early to Asia. Classic leveraged buyouts have been few and far between and most have learnt to adjust their investment strategies to take large minority stakes in businesses sufficient to exert meaningful influence over management. Newbridge Capital and Warburg Pincus were the first funds to realize the need to approach private equity investing differently in Asia. Their early funds have benefited handsomely as a result.
The problem now is with all of the newcomers to Asia’s party: the kind of capital seeking a profitable home might well exceed the stock of attractive assets. Some say this is nonsense, pointing to the admittedly vast untapped markets of China and India. But as some prescient funds have recently discovered, Japan still offers a deeper and more accessible pool of assets than China and India, where political, legal and financial impediments are likely to frustrate many funds seeking a home for their money.
Many of the private equity deals closed to date, especially in China, are flattered by gravity-defying stock markets. Investing significant sums into state-owned banks and other assets for minority interests pitched optimistically as strategic capital several months ahead of a planned flotation is little more than a one-quarter’s bet on equities. When markets rise strongly, there is always a greater fool around when you need one. The smart funds will be those that prove they can invest successfully across the investment cycle, not just bagging pops from pre-IPO investments.
Even if the better funds do find attractive assets in Asia in sufficient quantity, the herd of elephant hunters following close behind in search of the same large kills, will inevitably increase competition for prized assets and, with it, the price. That in turn will affect returns, tempting firms to squeeze the pips dry with leverage: a risky game given high equity valuations and a rising interest rate environment.
It all points to significantly reduced returns for limited partners at best and, at worst, some ill-judged deals and probably spectacular failures. One thing is certain: as the latest economic cycle draws to a close, the easy money in Asian private equity has been made. Firms will be working much harder for their fees in future.
