While several encouraging signs have emerged from the Asia-Pacific private equity (APAC PE) industry in 2014, Bain & Co notes that there are indication that PE in the region was transitioning from a market fueled by hopes to one that promises strong and sustainable performance.
Last year’s activities showed that Limited partners (LPs) were cash positive in the Asia-Pacific region for the first time ever and that strong exits should help GPs distribute more capital. Returns are also on the rise, especially for top-tier funds.
This year, GPs should look towards healthier portfolios.
“One of the major issues GPs have faced in the wake of the pre-2008 boom period is that they bought too many companies at peak valuations with minority stakes, making it difficult to improve investment outcomes when performance soured (as economic growth slowed in the years following),” Bain & Co said in its Asia-Pacific Private Equity Report 2015.
As a result of the exit overhang, unrealized value in Asia-Pacific portfolios grew 30 per cent annually from 2009 to 2013, ultimately reaching $242 billion.
As exit activity picked up in 2014, growth in unrealized value slowed to 1 per cent when many GPs were able to pare away at their exposure to the oldest transactions.
Looking at buyout deals alone, investments bought from 2005 to 2008 made up 23 per cent of the total value from unrealized and partly realized investments in mid-2014, down from 33 per cent the year before and far below the 44 per cent global figure.
Additionally, the median holding period of Asia-Pacific investments declined to 4.7 years, the first such decrease since 2007, the report noted.
A push for more control
Although minority-stake deals are still most prevalent in the Asia-Pacific region (up to 90 per cent of deal count in some markets), Bain & Co’s survey found that about 60 per cent of the Asia-Pacific GPs and almost 70 per cent of the funds focusing on Southeast Asia, South Korea and Greater China said they are seeking path-to-control mechanisms in these transactions so they can participate more fully in value-creation strategies and decision making.
“The most popular provisions include, board seats and veto authority over key decisions involving people, capital spending and M&A activity. GPs estimate that over the past two to three years, a healthy 30 per cent of the minority deals they have entered had paths to control,” the report noted.
The GPs also believe that the opportunity exists to boost that number closer to 40 per cent over the next few years.
Fewer, but stronger, GPs
As the shakeout in the Asia-Pacific PE market has been under way for several years, fewer under-performing funds are on the market, either seeking new capital or competing for a finite pool of deals, the report stated.
Where in 2011, money-losing funds made up almost half of the total fund value on the market, in 2014, that number dropped to 15 per cent.
“And as the stronger funds get even stronger, they attract the most new capital, perpetuating a virtuous cycle that is creating a more healthy, dynamic pool of funds overall,” the consultancy said, noting however, that it is also increasingly difficult to remain among the top performers.
“Historically in the PE industry, past performance has been a reasonably reliable indicator of future returns for LPs figuring out where to put their money. But as we observe in our Global Private Equity Report 2015, (that it) is becoming harder for GPs to produce market-beating returns year after year.
Despite many years of strong activity, PE is still significantly under-penetrated in the Asia-Pacific region, relative to the rest of the world, the report noted.
Private companies that could benefit from PE investment are plentiful and in recent years, owners throughout the region have become more and more comfortable with taking on PE firms as trusted partners, opening more opportunities for GPs to gain access to proprietary deals or negotiate greater control over decision making.
“As the industry matures, the number of PE-backed assets is also increasing, which creates more opportunities for already popular secondary deals—those where PE firms are both the buyer and the seller.”
Strong investor commitment
The region’s growth profile is a magnet for investors looking for emerging market diversification, and PE offers a lucrative way to capitalize. Even as returns slumped in the Asia-Pacific region following the global economic crisis, the PE asset class still outperformed many other investment options.
Buyout investments have returned more than public markets in the Asia-Pacific region over both short- and long-term horizons. Globally, LPs have become under-allocated in the PE asset class (based on their stated targets), and in the 2015 Preqin Global Private Equity and Venture Capital Report, 84 per cent said they plan to increase or maintain their investment.
More also plan to devote a larger share of their PE allocation to emerging markets. In 2014, 35 per cent of the LPs surveyed by the Emerging Markets Private Equity Association (EMPEA) said emerging market funds made up 16 per cent or more of their total PE allocation. Only 47 per cent said they wanted to push above 16 per cent by 2016.
Bullishness on the ground
The GPs in the survey for this report unanimously said they expect at least a slight increase in deal activity in 2015, with a full 83 per cent of GPs said that making new investments would be the firm’s first or second priority.
“That means that even if competition and rising asset prices provide headwinds, GPs will be pushing harder than ever to find ways to make more deals happen.”