Southeast Asia will benefit from the trade war, says ShawKwei founder Kyle Shaw

Southeast Asia will be the net beneficiary of the ongoing trade war between China and the US, according to a top executive of Hong Kong-based private equity (PE) firm ShawKwei & Partners.

“The conflicts between China and the US, Korea and Japan, Germany and Europe, and UK and Brexit … are creating disruptions across multiple economic areas,” Kyle Shaw, founder and managing partner, ShawKwei & Partners, told DealStreetAsia.

Founded over two decades ago, ShawKwei made a final close of its fourth pan-Asia vehicle – the Asia Value Fund 2017 – at $812 million last October. The firm invests in B2B sectors such as precision engineering and manufacturing, automotive, maritime, oil and gas services and solar power.

The latest vehicle made its first investment in Singapore-based oil and gas services firm Gaylin Holdings in a transaction worth $100 million that included debt restructuring. The company had then merged with one of ShawKwei’s portfolio company, AMOS, and was rebranded to Amos Group Limited.

As more global firms are raising Asia-focused funds, competition in the region in terms of PE investments is increasingly intensifying, said Shaw. However, he noted that fundraising is slated to get tougher in the years to come.

“With a softer economy, fundraising will be more difficult and doing deals and managing portfolio companies will also be more difficult. There’s going to be a shakeout in the PE industry in the future.”

In the past year, several mid-market buyout firms in Asia raised funds to invest in the region. While Swedish investment firm EQT Partners closed its Asian mid-market fund EQT Mid Market Asia III at $800 million in May 2018, Singapore-based Southern Capital Group closed its fourth regional fund at $500 million a few months ago.

And, these are not the only ones. Malaysia-based Creador recently raised $565 million for its fourth fund to invest across Southeast Asia and India, exceeding its hard cap of $550 million. It is the largest vehicle raised by the firm so far.

“The easiest thing a private equity firm does is to make a new investment but getting out of it? That’s the hard stuff. I expect soon you will have less new players coming into PE and some people who are not really committed for the long run will exit the Asian PE space,” he said.

There is a slew of PE firms that are currently on the road to raise capital. These include Kuala Lumpur-headquartered Navis Capital that is seeking to raise $1.75 billion for its eight fund – the biggest in Southeast Asia. It reached the first close in April and is expected to hold a final close by the end of this year.

Singapore-based KV Asia Capital is also looking to raise about $300 million for its second fund. We reported the firm is seeking buyers for one of its portfolio companies – Malaysian hypermarket chain TF Value Mart. With a 1 billion ringgit ($240 million) price tag, the retailer is said to have drawn interest from global PE firms KKR & Co. and Warburg Pincus.

Edited excerpts of an interview with ShawKwei & Partners founder and managing partner Kyle Shaw:

How has the year been for you?

We’ve been very busy working with our portfolio companies. We also had an exit earlier this year so that took up some time and resulted in a good outcome for ShawKwei. Basically, we are now preparing our portfolio for a more difficult economic environment that is ahead of us. We also are looking for new deals and opportunities, but we and our investors are patient, and so we do not feel a need to quickly throw money at investments.

How has the journey been in terms of restructuring Gaylin?

It’s been quite involved as we expected. We bought a 73 per cent stake in Gaylin in March 2018 through a new share issuance of $52 million of new capital into Gaylin. We also renegotiated the bank loan facilities and brought in new lenders to replace the old ones for altogether about $100 million of financing for Gaylin. In October 2018, we announced the merger of Gaylin with AMOS International Ltd and rebranded the combined group of companies as Amos Group Limited, which basically doubled the old Gaylin in terms of revenue supplying the marine and offshore industries.

Do you see lot more of such opportunities to go in and help restructure businesses?

Yes, part of the trend is demographics. There are ageing business founders in Southeast Asia, who started their business in 1960s and 1970s. Sometimes they have succession plans, but oftentimes they do not. They may have thought their children were going to eventually take over the business, but over time the children do not necessarily want to come back and help run the business.

The second reason for opportunities is more timely given the current weak economic environment. Basically, there is a drop in end-user demand and when groups see their sales dropping, it becomes necessary for them to confront the issue of what to do with the business. For example, do they stay the course hoping for the good times to come back? Or should they think about restructuring the business and resizing to fit the current demand? Sometimes these restructuring decisions are driven by banks, especially if a company has borrowed a lot of money and is being pressured for a repayment plan.

I would assume many ageing entrepreneurs tend to also run traditional businesses and are not accustomed to the tech space. How does ShawKwei bring in its expertise then? How do you add value to these businesses?

I think just because people are in their 60s it doesn’t mean they have not kept up with the current technology and trends in the industry. In fact, they must have kept up because if you’re still running your business like you did 30 years ago then you couldn’t have survived. And so many of the long-established businesses that we look at today are fairly forward-thinking in their use of technology.

The issue is the owner of such a business, who maybe is in his 60s, isn’t looking to put more money into his business to drive it for the future. He’s not looking to take a 10-year horizon to work even harder on the business when his peers are enjoying life.

The auto parts business is a great example where clearly the opportunity today is electric vehicles instead of traditional internal combustion engines, which are a declining industry. What a business needs for EV production is to make new investments in electronics and start engineering products for future demand with different specifications from the previous product demand.

And that’s where I think ShawKwei can bring in both capital and a long-term vision because we can be patient on refocusing the business and taking it where it needs to be over the next 5-7 years. We also bring in a management team as successors to the management team of the past.

In addition, there are a lot of other areas such as marketing and branding to help a company to set a more global profile to rise above the noise in today’s world and differentiate itself. We also bring advance data and information management technology to improve efficiency. In summary, ShawKwei brings capital, technology, and connectivity to the rest of the world, similar to best practices of leading PE firms around the world.

Do you see the trade war affecting your pace of investment?

Yes. Countries have always competed on economics it’s just that now you’re seeing it a lot more vividly due to media coverage and certain animated politicians. The conflicts between China and the US, Korea and Japan, Germany and Europe, and the UK and Brexit are not just affecting two countries but are creating disruptions across multiple economic areas. I think that Southeast Asia will be a net beneficiary of these disruptions because of its low profile and well-established supply chain and advanced manufacturing capabilities.

Not all of the supply chain in China will relocate out of China because of tariffs, but Europeans and Americans will seek to rebalance their supply chain between Southeast Asia and China. There is also an abundance of skilled and educated workers in Southeast Asia with a 600 million population sitting at a crossroads between India and China with a friendly political footprint around the world. Trade wars in all the locations previously mentioned actually create disruptions which for private equity can be good if you are anticipating it and positioning yourself to take advantage of it.

What are some of the challenges you see in investing in Southeast Asia, especially when the region is so fragmented and diverse?

It’s regulatory governance. Governance has a lot of meanings, and in this case, I mean simply the governance of bureaucracy and political institutions in terms of putting together business-friendly and pro-development rules and regulations. You need to have a fair and level-playing field because if it seems government-sponsored entities are winning everything then you know it’s not going to work in the long-run. You need to have clear rules, pro-government policies, and rules that are followed and fairly enforced. If Southeast Asia can focus on good regulatory governance then I think it will really take off, because Southeast Asia has interconnectivity to the rest of the world and a great value chain from commodities to processing to domestic markets. There is a lot going for the region.

Of course, within Southeast Asia, there is a variety of investment opportunities across countries. Vietnam has been really popular in attracting new manufacturing investments this year but it’s not more advanced in manufacturing than Thailand, Malaysia, Indonesia, and the Philippines. However, Vietnam has a very dominant government focus on economic development. Some of the other Southeast Asian countries are not so singularly focused on economic growth and are slower in marshalling all their country’s resources. China has been focused on economic development in the last 30 years, which allowed them to become what they are today. Southeast Asia needs a little less local political drama and more focus on economic development.

So, would you say you’re particularly bullish about Vietnam? Which other markets are you looking at?

We are looking at Vietnam now. We are also looking at Malaysia and Thailand. The Philippines and Indonesia are further back in our priorities, but we continue to monitor the situation as they both have a very large population of consumers and a large group of well-educated people. Vietnam is very popular in the private equity industry now, but because of our experience in Thailand and Malaysia, we’re actually more keen (to invest) in those two countries because we know them.

Many PE firms and even sovereign wealth funds are entering the Vietnamese market – do you think the surge in investment firms focusing on Vietnam heightens competition?

Yes, Vietnam is a crowded space with PE firms and foreign companies looking to set up business there. When a market is crowded it pushes up building and equipment prices and the cost of talent. It also just makes the market more congested overall. So, we’re actually not spending a lot of time in Vietnam as we see it as a crowded trade right now.

Our money is long-term at ShawKwei, so we prefer places that are less popular and where you find better valuations and your pick of talent. All of these markets are cyclical so we would rather come into a market at the bottom of the cycle rather than the top. Certain parts of southern China also now look attractive for us as well, with Guangdong a particular area of interest for us.

In fact, ShawKwei is more focused on industrial investments across a broad sweep of countries and is not just focused on any particular country. The industries of tomorrow, such as electric vehicles and autonomous vehicles, provide a variety of fast-growing opportunities that makes them very interesting. In addition, we focus on the Internet of Things, Industry 4.0, and areas that allow companies to move up the value chain including logistics, transportation and warehousing. We are interested in companies who have created brands with a critical mass, and not necessarily just consumer brands as B2B industrial brands are also very attractive.

Are brands a huge opportunity for the private equity industry as a whole?

Yes, brand is a significant value creation tool for Asian private equity. The challenge has been some Asian PE firms in the past have invested into branded restaurants or businesses with consumer-facing products and have not done well. Those negative outcomes become discouraging.

Every deal has its unique characteristics, so it’s hard to draw generalisations on deal underperformance. But I would say that branding and marketing must be a very concentrated effort from top management and owners down to the rank and file following a couple of principals. First, you need to get everyone in the company to buy into it so that you have a chance of working. Second, the investment of time and money has to be a continuous, multi-year kind of effort.

The challenge is, in the past, branding had not suited Asian entrepreneurs’ idea of how to spend money and time as they tended to be nimble and focused on quick returns. Generally, their philosophy has been to keep a low profile and so you are going against their experiences and nature when you embrace a marketing and branding campaign. In order to achieve success, you have to have majority ownership and control the board to push marketing and branding through.

So, for the deals that you do, is it important for them to all be controlled deals?

We want to be a control investor in situations where we think there is a necessity to bring change. In situations where it’s more of just growth capital to support the existing team, it is not necessary to have a majority. But, most of the attractively priced deals we see nowadays involve a control-stake for ShawKwei.

Last September, you closed your fourth pan-Asia fund at $812 million but you earlier said you’re in no hurry to make investments. So, how are you placed in the coming months? Will you be looking to cut larger ticket sizes across fewer deals?

We here at ShawKwei like to do deals. We wake up in the morning and look forward to finding good investments and then executing them. So there is a sense of urgency for us to do deals. However, we are not paid to just do deals. Our incentive program is based on building value in portfolio companies and then exiting those deals with significant capital gains. So if we don’t find something that can meet our criteria of what we think will provide us with a good return, then we are not going to do it – that’s a differentiator.

Other PE firms may have different incentive programs, such as paying staff on doing deals. Which is quite different from ShawKwei where we pay people on exiting deals based on the quantum of the return. Our investors prefer us to make good investments and not just put money to work for the sake of closing deals.

This period of 2019 feels a bit like 2007 to me. Stock market valuations in the first half of this year were fairly robust in spite of gathering storm clouds. There’s a lot of concern about a soft economy, so in this environment, we are likely to have a period when valuations drop precipitously and buyer demand dries up.

ShawKwei has done a really good job exiting our past investments and we only have three investments left in our portfolio today. They are performing well in the current environment and so we are satisfied. Our overall fund performance has been at the top end of the industry. We have survived for 21 years because we do good deals, we have good return performance, and we have a very focused strategy on industrial-related types of businesses where we can add value based on our prior experience. Most importantly, we get out of deals that we get into, so we do not have any investments laying around that we cannot exit.

Last but not least, on fundraising, many global firms are raising larger Asia-focused vehicles to enter the region. Do you see the competition getting more intense in the PE space?

I think the Asian PE competition is already intense. With a softer economy, fundraising will be more difficult and doing deals and managing portfolio companies will also be more difficult. There’s going to be a shakeout in the PE industry in the future. The easiest thing a private equity firm does is make a new investment but getting out of it? That’s the hard stuff. I expect soon you will have less new players coming into PE and some people who are not really committed for the long run will exit the Asian PE space.