Private equity outperforming public markets has led to pension funds, insurance companies, mutual funds, sovereign wealth funds and other yield-hungry investors wanting to join the party, resulting in the sector boasting of over $2 trillion of “dry powder”, or unspent money for deals.
Despite larger vehicles being raised, with many of these funds targeting Asia, Cyrus Driver, Managing Director & Head of Private Equity in Asia, Partners Group, says that firms are becoming more cautious, even as he admitted to ‘nervousness in the PE community today about the global economic cycle’.
“Around the world, and definitely in Asia, we are starting to see failed exit processes. Buyers have started becoming a touch more cautious in their bids, but seller expectations have not adjusted yet,” Driver said in an interaction.
“The change in sentiment is also manifesting itself in a sharper differential of buyer interest between businesses that have strong organic growth and those that don’t. A year ago, even businesses with low organic growth were getting almost as much buyer interest as businesses with stronger growth,” he added.
Investment manager Partners Group Holding AG, that is currently on the road to raise $6 billion for its fourth buyout fund, closed its largest deal in Asia last year, when it teamed up with Kedaara Capital to buy Indian retail outlet Vishal Mega Mart Pvt. Ltd (then owned by TPG Capital and Shriram Group) for an undisclosed sum.
Yet, the Swiss private equity fund manager maintained caution on India.
“It’s hard to say what the next few years will bring – it could well be that Indian PE enters again a period of subdued returns. Our own view on India is cautiously optimistic, and we have put our money where our mouth is – in late 2018 we made our largest ever Asian investment in India,” Driver said.
Even as industry observers have been warning about a PE bubble on account of the record dry powder, Driver had a measured take, and said the issue needed to be seen in the context of increasing investment opportunities.
“Up until now, the available investment opportunity set has also grown quite strongly in Asia and hence the investment pace has been increasing. Dry power in absolute terms has increased substantially both in Asia and globally. But in terms of the number of years of current investment pace, it has not gone up so much – earlier it was about 1.5-2 years and now, it is 2-2.5 years,” he said.
Big picture – what are the major PE trends that you’ve seen emerge and what should we be looking out for in 2019 and beyond?
The past 4-5 years have been a period of strong fundraising for the private equity industry and there is a fair amount of dry powder around today. PE has consistently outperformed public markets – now, there is a long-term data set available to prove it. Therefore, the allocation for PE by pension funds and insurance funds in their portfolio has been increasing and there are a lot of tailwinds for the industry to get bigger. That’s the macro trend.
Within that macro trend of industry growth, there is some nervousness in the PE community today about the global economic cycle. The last quarter of 2018 saw a stock market correction and a lot of caution in the air. The mood seems to have turned relatively more bullish this quarter, but there is still a mood of caution. Around the world, and definitely in Asia, we are starting to see failed exit processes. Buyers have started becoming a touch more cautious in their bids, but seller expectations have not adjusted yet.
The change in sentiment is also manifesting itself in a sharper differential of buyer interest between businesses that have strong organic growth and those that don’t. A year ago, even businesses with low organic growth were getting almost as much buyer interest as businesses with stronger growth.
Valuations apart, the private equity ecosystem keeps maturing in Asia – in terms of the number and quality of management teams able to run an institutionally owned asset and the ability of PE firms and management teams to integrate acquisitions and scale businesses. The number of quality scaled assets that are available to buy is continuously going up.
Over the last couple of years, we’ve seen global GPs raise massive Asia-focused vehicles – how has that changed the PE scene in this continent?
Asia is no longer a frontier market for any global pool of capital; it is an essential part of everyone’s global portfolio. Pan-Asian GPs and Asian teams of global GPs have raised some very large Asia-focused funds. This is, in my view, a reflection of global fund raising trends and not an Asia-specific phenomenon. Thus far, most of these large funds have been deploying at pace. Deployment has been aided by the funds having a much more flexible investing strategy in Asia than the rest of the world – with investments spread across not just classic leveraged buyouts but also minority investments, listed investments and structured return transactions.
How have these large Asia-focused funds impacted the mid-market funds in the region? Has it made it very tough for mid-market GPs to raise follow-on vehicles?
A lot of the established GPs with a longer track record have raised larger funds and have moved up in deal size, which has led to a thinning out in the mid-cap space. Many LPs as well today want to write bigger cheque sizes and consolidate their GP relationships, which is adding to this trend.
Many reports say that dry powder has hit record levels – what do you make of the increasing dry powder? Is that pushing up valuations?
You have to view dry powder in the context of investment pace. Up until now, the available investment opportunity set has also grown quite strongly in Asia and hence the investment pace has been increasing. Dry power in absolute terms has increased substantially both in Asia and globally. But in terms of the number of years of current investment pace, it has not gone up so much – earlier it was about 1.5-2 years and now, it is 2-2.5 years.
Dry powder will become a bigger problem if there is a global downturn and the pace of transactions slows down. Then suddenly dry powder may go up from 2-2.5 years of investment capacity to, for instance, 3.5 years and people may feel greater pressure to deploy.
When you say that country-specific funds have not delivered, what about India? PE appears to have made a comeback during the last couple of years – where is the country headed?
Country-specific funds have not really delivered on average. This is a broad brush statement and there are exceptions, such as China-focused funds from the early 2000’s. But overall, the Asia returns for geographically diversified funds – be they pan-Asian funds or the Asian arms of global funds – have outperformed single country funds. Individual country markets in Asia can heat up and get expensive. The ability to pick and choose where you want to be more active has proven to be quite valuable.
Indian private equity has gone through phases. In 2003-04, Indian PE kind of got discovered, and a lot of capital rushed in. Funds that focused on exits around 2006-2007 made really strong returns, but those that were investing in that vintage saw a subsequent drop in returns. By 2010-11, India was out of favour and the consensus view was that it was a tough market for PE. After that valuations cooled down a bit and investments made in 2012-2014 have delivered strong returns and a lot of exits. It’s hard to say what the next few years will bring – it could well be that Indian PE enters again a period of subdued returns. Our own view on India is cautiously optimistic, and we have put our money where our mouth is – in late 2018 we made our largest ever Asian investment in India.
At the same time, don’t you think PE has wisened up when it comes to India in the last couple of years? They now look for control deals, or path to control, take board seats and are no longer just silent minority investors.
I completely agree. From a buyouts perspective, India is definitely one of the more interesting markets in Asia. The number of buyout deals has gone up substantially. The pool of experienced, high-quality management teams has also gone up. India today is a structurally better market for PE buyouts than it was a few years earlier
Big picture, in Asia, if you had a pool of capital, where would you deploy it – which country and sectors?
We don’t believe in hard allocations to regions or countries. Individual investment opportunities need to stack up so our historical investment pace in different parts of Asia should not be interpreted as a top-down allocation decision.
The top down themes we like vary by country – financial services and financial inclusion in India is a priority for us, while consumer and retail are our most active sectors in China.
Historically, Asia has accounted for between 10% and 15% of our global deployment.
You have not done much in SEA?
Not yet. We’ve come very close a few times in doing deals here across multiple assets. I am sure you will see us step up the pace of investments in SEA. It is the nature of the business – suddenly, you will see us do 3-4 deals/year, and then you won’t see us do one for the next couple of years.
Southeast Asia is an important market for us – even now, we are actively looking at 3-4 assets, and we hope to close at least 1-2 by the end of this year.
For PE in SEA, the big deals have been real estate or tech. You have steered away from tech. Why has consumer internet not interested you?
We have been cautious with early stage technology and and consumer internet investments, both in Asia and globally. That is not our strength and we tend to stick to the sectors and approaches we know well. We tend to be the best owner for a business that is already profitable, is a category leader either in its core category or core geography, and whose next leg of growth requires international expansion, strategic acquisitions and the adoption of global best practice.
How do you see China? What about Japan and Korea?
We’ve made two investments in China in recent times, and both have performed well. One portfolio company has IPOed and our investment is held at about 3.5x, while the second is still private but growing strongly. We haven’t realized either investment yet, except for dividends. We are not active in Japan and Korea yet because we don’t have deal teams on the ground there. But in the long-term, we will definitely be present there as these are important buyout markets. For now, we are focusing on markets where we have already built our presence.
Apart from PE, we have dedicated teams for real estate, infrastructure and debt investments. Each team’s investment pace has increased substantially over the past three years.
If there is a downturn, does it open up more opportunities for firms like you since a downturn could lead to corrections in valuation?
Yes, definitely. The ideal scenario for any investment firm would be that you have a lot of dry powder left unutilised at the point the market corrects. While corrections create good buying opportunities, transaction volumes do reduce as well – sellers hold off from selling for a while. You have to be patient to catch the right opportunities.
The exchanges in SEA are not doing too great – there is very little liquidity and trading traction. Does that offer an opportunity for PE to take some of the listed companies in this region private? Also, many of the earlier entrepreneurs are reaching retirement status and in some cases, their sons and daughters don’t want to run the business.
Absolutely. Often, the founder’s next generation prefers to invest the proceeds from selling the business rather than to run it hands on. This is becoming acceptable to family owners in many markets within Asia. There are two countries where there is a genuine generational opportunity – China and Vietnam. There, family businesses had been wiped out or lost to communism, and everyone that runs a business is a first-generation entrepreneur. Now many of these business owners are retiring.
We are also seeing PE firms looking at entering deals early, what could be almost considered VC territory.
We don’t do venture investing directly, and I don’t see us doing it for a while. Our DNA is we buy mid-sized businesses that are already category leader in core business, and then we work to build those businesses out much further. It’s a different skill set than picking winners in venture deals. We have stuck to our strengths.