Hong Kong-based alternative investment management group PAG is on track to deploy about $2 billion in private equity deals this year, in line with its investment pace last year, despite difficulties in deal-making amid virus-induced lockdowns around the globe.
“In my experience, there are both headaches and opportunities in every crisis. But our best deals tend to be done during crises,” said Weijian Shan, Group Chairman and CEO of PAG, during a fireside chat at DealStreetAsia’s Asia PE-VC Summit 2020.
“If you find the right business, the crisis is probably a time as good as any other times to make investments because the market is down, especially in the private market – if not in the public market.”
Shan, who primarily leads PAG’s private equity (PE) efforts, said the team expects to register an aggregate of about $2 billion in PE investments this year in light of its current deal pipeline, comparable to the year before.
As one of Asia’s largest alternative investment management firms with $40 billion in assets under management (AUM), PAG started more than two decades ago across three core businesses, namely PE, real estate, and absolute returns, which are helmed by its three founders.
Shan established the PE branch in 2010 after his previous stints leading deals at PE companies TPG and Newbridge Capital. The team has by far raised four vehicles, including three buyout-focused pan-Asia funds: PAG Asia I (closed in 2012 at $2.5 billion), PAG Asia II (closed in 2016 at $3.6 billion), and PAG Asia III (closed in 2018 at $6 billion).
Its first growth-focused PE fund, PAG Growth I, was raised in 2018 with $350 million in capital commitments, according to the firm’s website.
Having navigated through several business cycles, Shan says he has developed a consistent set of investment strategies that allow him to assess deals in the pandemic crisis the same way as in normal times, which is to focus on businesses’ “scalability” and “uniqueness.”
“You need to be disciplined in valuation and look for businesses that have uniqueness or competitive advantages, whether it’s [in] technology, market share, or licence – something that prevents competition from eroding its profitability,” said Shan.
According to Shan, the team is ramping up efforts to expand operations and increase deal-making activities in other parts of Asia for a “more balanced” portfolio. Such efforts cover countries including Japan, South Korea, India, Australia, and Singapore.
As an investor in the private equity industry over the past two decades, you’ve seen a number of crises including the Asian financial crisis, the GFC, amongst others. What have you been able to draw from your earlier years to navigate through this current crisis?
In my experience, there are both headaches and opportunities in every crisis. But our best deals tend to be done during crises, including the 1999 deal I wrote about in my new book, Money Games: The Inside Story of How American Dealmakers Saved Korea’s Most Iconic Bank, a story of a deal that I had led during a financial crisis to acquire what used to be the largest bank in Korea.
Crises present opportunities. In times like this, we should be alert to make sure that our portfolio companies will survive by managing their cash flows, debt levels, and so forth. But at the same time, we should look for new investment opportunities. If you find the right business, the crisis is probably a time as good as [better than] any other times to make investments because the market is so down, especially in the private market – if not in the public market.
What are the opportunities that you’re seeing this year? PAG has been fairly active this year, even as many other investors have largely stayed on the sidelines.
PAG has three businesses: real estate investments; absolute returns, which include credit funds, special situations, and hedge funds; as well as private equity, buyout, and growth funds. I’m the chairman and CEO of the group, where I spend almost all my time on the private equity side, especially on the buyout side. We deployed about $2 billion to private equity investments in 2019. This year, even three months ago, I thought we would invest about $1 billion, because the market was slow and doing deals is difficult with city lockdowns across many countries. However, looking at our pipeline today, it seems we’re going to invest as much this year as we did last year, and that is about $2 billion.
Some sectors are impacted, and probably permanently impaired by virus-induced city lockdowns, including almost everything related to hospitality, such as hotels, airlines, restaurants, retail shops, and entertainment. Investors have to be very careful to pick up the ones that could survive and thrive in the future.
But at the same time, some other businesses are doing extremely well in 2020, like e-commerce. We’re the second-largest shareholder of Tencent Music Entertainment, which posted increases in revenue and profit this year. We are also the largest shareholder of Chinese dairy farming businesses, China Youran Dairy. The firm’s revenue and EBITA have upped substantially, probably because people think milk can help enhance immunity. Some businesses are struggling, but you will find bright spots as those I just mentioned. We look for these opportunities, which probably will have greater potential in the future.
Our strategies are very different across markets. In China, we tend to invest in businesses that cater to private consumption, while staying away from exports. In India, we do the opposite since we tend to look at firms involved in outsourcing and exports. The reason is China’s labour costs and currency have been appreciating sharply in the past 10 years, driving up costs of input, whereas the prices for finished products have remained either flat or even falling. This leads to the profit margin in China’s export industry being squeezed thinner every year, so we stay away from it. RMB has appreciated about 6 per cent this year, while the rupee [in India] has depreciated about 4 per cent.
In a country like India where the interest rate is also high and hedging is difficult, we tend to invest in outsourcing businesses because they receive hard currencies like US dollars or euros as income, whereas their costs are in the rupee. If there’s a devaluation, you will actually benefit from it.
Investors have to understand the macroeconomic conditions in different countries, in order to make the right decision and follow the right strategy.
Is there an opportunity in impacted businesses that you just mentioned for buyout and turnaround deals?
Yes. We just (September 2020) announced a deal in Australia in Rex [in which PAG has agreed to invest up to A$150 million ($107 million) in the country’s airline Regional Express Holding Ltd (Rex) to support the launch of the firm’s jet services between major cities].
While most people would stay away from investments in airlines, the deal is a little different because Rex serves routes that are more or less exclusive to connect cities within Australia – a country that is as big as 95 per cent of the entire continental United States. There is a massive demand for domestic flights. The business will rebound sooner or later. We have signed agreements that are subject to the local regulatory approval to make the transaction.
In India, we have signed two deals so far this year, including an investment in wealth management firm Edelweiss Wealth Management, which caters to affluent consumers; and another investment in Anjan Drug [a Chennai-based manufacturer of active pharmaceutical ingredients (API)]. You’ll see different opportunities in different markets. Even in the crisis, some opportunities will shine through.
Besides China, Australia, and India, have you seen any opportunities in Southeast Asia amid the COVID-19 pandemic?
With an office in Singapore, we have done deals in Southeast Asia and have been active across different markets in the region. After the signing of the Regional Comprehensive Economic Partnership (RCEP), Southeast Asia has become even more attractive for a buyout firm like us. But it’s not so easy to find good buyout opportunities in Southeast Asia, because we invest no less than a few hundred million US dollars per deal, and therefore we need the business to be of significant scale.
Coming back to deal-making in times of crisis, do you think the pandemic and its impacts have triggered the adoption of asset valuation standards that were not in place in a pre-crisis time?
I don’t think the way you look at deals in crises will be different from that in normal times. I think the only difference is that the sell-side is more in need of capital in a crisis, or in some kind of a distress situation. Investors really need to understand the industry and the business with sufficient knowledge and experience to make the call. But you would underwrite deals, I would think, in the same way in crises as in normal times. You need to be disciplined in valuation and look for businesses that have uniqueness or competitive advantages, whether it’s [in] technology, market share, or license – something that prevents competition from eroding its profitability.
From our point of view, especially in the buyout business, another very important consideration is that the business will need to be scalable. It is not good enough to be profit-making. We want to make sure that there is enough room and potential for growth. Businesses will be able to scale in a large market like China and Japan. For example, our portfolio firm Tencent Music Entertainment now has 800 million monthly active users (MAUs). Where else on earth do you find 800 million users for one business? The same business model, if taken to Hong Kong, wouldn’t get anywhere because the population is just too small.
Speaking of these details that give you an edge in challenging times, there is rising competition for talents as family offices, pension funds, and more are all out to hire people for direct deal-making. For PE companies like PAG, how do you build a team for the future?
The private equity business is all about talent. If you have the right people, you will be successful. From our point of view, PAG is somewhat unique in its culture in that everybody feels like the owner. We conduct an annual review on everyone, during which we evaluate professionals on a number of attributes, including the sense of ownership. If you have a sense of ownership, you will do things fairly well.
The question is: How do you foster a sense of ownership? Of course, in private equity, we have an incentive system that ties employees’ performance to their compensation. But an important part of it is to be able to participate in the decision-making process. We are almost unique in that, in our investment committee, everybody has a veto and nobody, including myself, has the right to push through a deal. Every decision is made on a unanimous basis, which means everybody will have to participate and express his or her own views. If anything goes wrong after an investment, we don’t point fingers at each other because all of us are involved in the decision-making process. So, to the extent you participate, you own the deal. The sense of ownership keeps a team together and keeps your talents together.
Do you already have your next generation of the team in place, since you three founders have been at the helm for so long? What does PAG’s next generation of leadership look like?
Absolutely. Our most recent buyout fund PAG Asia III raised $6 billion, compared to PAG Asia II at $3.6 billion and PAG Asia I at $2.5 billion. We have grown over time. For the first two funds, I was the one flying around to raise capital because I was more familiar with our LPs. By the end of 2018, when we raised our current fund of $6 billion, I didn’t travel at all, except for meeting LPs who came to Hong Kong for due diligence. It’s all other partners who travelled and spoke with LPs. We wanted to show LPs that we have a very long runway. We have the next generation of leaders who are a lot better than me.
What are your observations about the developments in US-China relations? What does a Biden administration mean for investment sentiments and outlook in China and the overall Asian market?
We are in the middle of a transition period for US-China relations. We don’t know yet what’s going to happen with a Biden administration. But I think enough analysis has been made to indicate that the new administration is more likely to go back to the consistency of America’s foreign policy. America is said to be more likely to work with international institutions, multilateral agencies, and other countries. To that extent, I think we could expect a more stable world that is good for investments.
I haven’t visited China for a whole year because of the pandemic, and therefore I’m not familiar with the sentiments over there. But I think it was weak in Q1, as the credibility of the government took a severe hit due to virus-induced city lockdowns that led to almost a panic among the populace. China’s GDP dropped 6.8 per cent in Q1, compared with the same period of 2019. But I suppose China’s lockdown and other virus control measures were quite successful, so its Q2 GDP was up 3.2 per cent YoY after the economy started recovering.
Meanwhile, the rest of the world stepped into a tailspin [in Q2], including America, whose GDP dropped by over 9 per cent. In Q3, China’s GDP went up by 4.9 per cent YoY and we expect the economy to continue recovering in Q4, probably to a tune of 6 per cent. China’s economy seems to have recovered to a pre-pandemic level.
I think this year in Asia, maybe worldwide, only two countries will register positive growth: China, and potentially, Vietnam. Almost every country in the rest of the world is in a recession. The US, for example, will probably take a year to recover to the same level as 2019. When we make investments, we take into account all these macroeconomic conditions and always bear in mind the disparity in economic performance across the globe.
In that case, can we expect PAG to make more investments in China?
In fact, we’re making efforts to [increase] investments in other parts of Asia apart from China, just to make our portfolio more balanced. We are strengthening our local teams in Japan, South Korea, India, Australia, and Singapore.
What about some headlines that we’re seeing related to defaults by Chinese state-owned enterprises?
Personally, I don’t pay too much attention to troubles that this company or that bank gets into because that happens from time to time in a market economy. What I focus on is whether there is a systemic risk, a crisis, or a recession. By and large, I think China’s economy and financial system are healthy and resilient. It doesn’t really matter if there are a few defaults here and there, which probably would help impose some discipline to the market. Generally speaking, I think there’s no visible systemic risk in China or in the rest of Asia.
What do you think are the two or three most serious risks for the global economy, if it is not a debt crisis?
I don’t know if there’s a preset list of risks. Obviously, everybody is busy dealing with the pandemic right now. Before the pandemic is brought under control, the economy will not fully recover, especially for markets in America and Europe. It is imperative for countries to deal with this COVID-19 crisis first. The development of coronavirus vaccines, which are now near Phase III clinical trials, has been encouraging. I hope much of the world will be vaccinated by mid-2021 and we can get out of this pandemic.
Apart from China, which has largely eliminated the spread of this virus, we still see major impacts of the pandemic elsewhere in Asia. Governments worldwide have introduced stimulus to help enterprises and individuals, but the question is whether it is enough to pull the economy through the crisis. The ongoing debate between the US Treasury and the Fed about what credit facilities should be used and what else should be withdrawn bears some risks to the market.
Although the global economy has been struggling this year, the stock market has been rising rapidly and unstoppably. That is also worrisome. Because there has to be a limit. There has to be a relation between the public market and the actual economy. If something happens in the stock market, that certainly will not go well for the economic recovery.
As the stock market rallies and valuations continue to go up, we’re seeing an increasing number of large funds being raised with competition getting fiercer. How do you expect the current scene to play out in the PE field? Do you expect more global investors to deploy capital to Asia?
There is no doubt of that. This is a world where there’s a glut of capital, but there’s a dearth of good investment opportunities that can generate very good returns. Asia certainly offers its fair share of good investment opportunities, especially for those who are familiar with the market.
Asia – maybe with the exception of Japan – is a low-trust society in comparison with America and Europe. What that means is that trust and reputation are very important, as people take them as a signal of quality. PE firms with years of experience, good track records, and well-known brands are likely to do much better than newcomers. As capital flows into Asia, my advice to LPs is that you really have to look for those GPs who are time-tested and weather-tested.