Despite global uncertainty, Asia-Pacific’s private equity (PE) investment value experienced its second best year in 2016, and deal making in Southeast Asia (Singapore, Indonesia, Malaysia, Thailand, Vietnam, the Philippines, Laos, Cambodia, Brunei, and Myanmar) reflected the positive momentum.
According to Bain & Company’s annual Southeast Asia Private Equity Report, released today, the ASEAN region continued to deliver high returns overall but sources of value in the region are shifting and squeezing profits.
Competition is also heating up, keeping prices high as new players flood the market. PE funds poised to win in this environment are those with a differentiated angle and a creative value creation strategy, the Bain & Co report said.
After a subdued 2015, PE deal value in Southeast Asia bounced back to $6.8 billion last year from just $4.8 billion, which is 14 per cent higher than the 2011-15 historical average. A rebound in Malaysia from a record low in 2015 helped spur the rally. The region’s deal market was driven by Singapore, Indonesia and Malaysia. Together, the markets comprised over 80 per cent of the region’s deal value from 2012-2016.
Interest in the Internet sector remained strong, accounting for a quarter of Southeast Asia’s total deal value in 2016. Buoyed by the region’s rising middle class, while other emerging sectors of interest included agriculture, consumer products, retail, healthcare and education. Momentum in early stage deals under $10 million continued to be strong, with 102 deals closed in 2016 – approximately 20 per cent higher than the 2011-15 historical average.
Limited partners (LPs) were highly active in Southeast Asia contributing 40 per cent to PE deal value in the region from 2012-16 versus 29 per cent in APAC. Sovereign Wealth Funds (SWFs) were especially active in the region, participating in 35 percent of Southeast Asia PE deal value from 2012-16.
Exit value overcame flat volumes and zero IPO activity, increasing 26 percent from 2015 as a result of a strong corporate M&A market and 5 large exits exceeding $1 billion (compared with just two in 2015).
Sebastien Lamy, who leads Bain’s Private Equity Practice in Southeast Asia, said, “PE markets in Southeast Asia are steadily improving, due to a larger pool of targets and more robust general partner netwzorks. This healthier momentum has boosted limited partners’ expectations for the region, putting PE firms in a tough spot as they look for new ways to rally against the effects of high prices and heavy competition, coupled with local macro challenges.”
Changed Value Source
While Southeast Asia continues to offer ample opportunity to earn high returns, delivering outsized profits has become more difficult as sources of value shift. With the days of ‘buy low, sell high’ coming to an end, wringing greater value from PE investments has become much more of a priority than it has been in the past. It is also more complicated. In response, PE firms looking for new sources of value and relying far less on traditional levers.
Bain surveyed about 120 general partners (GPs) and direct investors from across the Asia-Pacific region, including Southeast Asia, and found that about a fifth (22 percent) said that they considered cost and capital gains to be the most important source of returns for deals exited five years ago, while 6 per cent cited M&A.
Looking ahead five years, these factors are expected to increase dramatically, with 37 percent of GPs pointing to margin efficiency and more than 20 percent to M&A. On the other hand, most respondents anticipated multiple expansion and leverage to both go down in importance.
Revenue growth, while still the most significant factor, is expected to plateau in the next five years.
“Funds poised to succeed are those that understand they must exercise an entirely different set of muscles to win the best deals and unlock new sources of value,” said Suvir Varma, who leads Bain’s Private Equity Practice in Asia-Pacific.
“Many firms say they have plans for creative value creation, but we know from our research that nearly all need to improve their execution. Last year, less than a quarter of GPs said they successfully implemented plans that yielded the intended results,” he added.
Strategies that will permit PE funds to thrive in the evolving Southeast Asian market are those that can successfully create a differentiated angle across the value chain, the report said.
According to Bain, this includes tactics such as smarter sourcing and clearly defining a sweet spot, as well as and build and external network to identify all relevant opportunities and thesis-based diligence to develop proprietary insights during diligence by leveraging advanced analytics; this integrates costs and growth to get a holistic perspective of a target’s full potential
Finally, the use of creative methods of value creation that involve the development of a repeatable model for creating value and build out teams and capabilities to exercise new muscles will also aid in driving fund performance.
Complex & changing PE scenario
The PE environment is increasingly getting complex and fluid, with differing macro scenarios across Southeast Asia. The dis-aggregated markets of ASEAN which are at differing stages of economic development and the addition of corporates, LPs (who may participate in co-investments) and SWFs competing for deals.
Increasingly, PE firms will need to overcome intensifying competition as new types of players enters the market. Singapore delivered solid deal and exit activity last year amid declining deal size, while strong activity in Malaysia helped the region rebound after a quiet 2015. However, its future PE outlook hinges on how macro challenges will evolve and the ability to find scale opportunities.
Indonesia, the region’s largest economy, had few exits in 2016 but delivered strong deal value, despite persistent low valuations and slowing economic growth. Looking ahead, mismatched valuation expectations and the talent gap are top-of-mind issues for GPs. Meanwhile, deal activity in the Philippines bounced back to its historical average, with strong macro growth a lure for investors, but the country needs a sustainable return story to continue to attract capital.
Usman Akhtar, a partner in Bain’s Indonesia Private Equity Practice, explains: “Dynamics in many Southeast Asian markets, notably Indonesia, have shown some improvement over the last year. While there are still choppy waters ahead and turbulence will ebb and flow, those looking to invest in the region have good reason to be optimistic for the foreseeable future.”
A traditionally small PE market, Vietnam had a strong surge in 2016 that was helped by its improving economy. Looking ahead, the country’s anticipated growth could be hampered by a lack of scale opportunities and regulatory challenges. Thailand, a traditionally tiny PE market but with solid historical M&A activity driven by cash-rich corporates, is threatened by an uncertain political context.