Afraid of missing out, PE, wealth funds flock for a slice of financial services pie in APAC

(left) Stephen Bates, a Singapore-based Partner at KPMG and (right) KPMG's Swiss Partner and Global Financial Services Deal Advisory Lead Stuart Robertson.

As private equity (PE) firms and sovereign wealth funds consistently increase exposure to the financial services sector — banking, insurance and fintech — making sure they do not miss opportunities in the sector, Asia Pacific is expected to see a surge in the number of deals in the sector by 10-15 per cent in 2018.

In Asia Pacific, the number of deals in the segment grew around 7-8 per cent in 2016-17.

With a large un-banked population, a growing middle class and low penetration levels for most financial services, deal activity is increasing in the region, “driven by the macro trends and a lot of fund flow from North Asia — China and Japan– into South East Asia and Australia,” Stephen Bates, a Singapore-based Partner at KPMG deal advisory for financial services, told DEALSTREETASIA in an interaction recently.

“Five years ago, PE and sovereigns were really focused on real estate, infrastructure, healthcare – bricks and mortar largely. They were looking at very tangible sectors and in the past few years, they have realized that they have missed a lot of opportunities in the financial services and most of the large funds have now got either financial services teams or have set up funds,” Bates noted.

He said that capital from PEs and sovereigns is set to fund about 50 per cent of total financial services deals by 2025 as compared to capital by corporates. Private capital currently contributes about 30 per cent of funding for deals in the sector currently.

Bates was joined by KPMG’s Swiss Partner and Global Financial Services Deal Advisory Lead Stuart Robertson.

“In almost every conversation I have with PEs, around 5 per cent to 20 per cent of the deals are PE-backed and that dry powder will be deployed in Asia Pacific… There are greater opportunities in terms of growth and return and those return opportunities are what PEs are looking to achieve,” Bates added.

Stating that “definitely there are more returns in Asia than there are in Europe”, Bates said deal sizes in the region this year are also likely to be bigger than last year when the average deal size in financial services sector was about $250 million.

A report from KPMG had earlier predicted that going forward, M&A activity in fintech and payments will continue to grow across the region, with opportunities arising from the development of more sophisticated payments infrastructure and fintech businesses. Further, Singapore and China will be a large source of innovation in the financial services sector, it had noted.

Edited Excerpts:

What is your general idea on deal flows in the financial services sector? For Asia Pacific, where do you think deal flow is headed and how do you see the quality of deals in the segment?

Robertson: From the financial services (FS) point of view, we expect a wave of deals to come. If you look at some of the mergers and acquisitions (M&As) history, we see six waves since 1900. Our message to our troops is that a new FS wave of deals is going to begin and from a global point of view if we look at the US, it is very hot there at the moment. What we are seeing in Europe though is the FS has been in a bit of doldrums since the global financial crisis but what we see now is that there is a lot more consolidation across the region.

One of the other global trends we are witnessing is that the big banks are getting stronger now. For the past ten years after the global financial crisis, they have been embarking on more M&As and they will be doing more again. Another driver for M&A is the acquisition of technologies in the sector. Every bank is acquiring and enabling technology like fintech front and centre. It is there with every client we talk to.

In insurance space as well, we expect to see more global consolidation and we have seen big deals in Asia Pacific and we are set to see more globally. That is the global picture, Stephen (Bates) may be able to talk more about Asia Pacific.

Bates: In the Asia Pacific, in 2016-2017 we saw growth in the number of deals of around 7 to 8 per cent. The value of deals has actually come down but there are great opportunities all across Asia with respect to the macro trends that are driving it like growing middle class, need for infrastructure and others. So, we are seeing that deal activity increasing driven by the macro trends and a lot of fund flow from North Asia– China and Japan– into Southeast Asia, including Australia.

There have been lesser funds on the banking side coming into SEA but more on the insurance side. The insurance market is under-penetrated. Market countries like Indonesia have only 1 per cent penetration of insurance products. As a result, we will see a lot more penetration in this region.

When one thinks of SEA as an opportunity in financial services, it is actually very fragmented and not a homogeneous market at all. Each country has its own unique challenges, in particular around Foreign Direct Investment (FDI). What we see as encouraging from places like Indonesia is that those like OJK have started to think about consolidating the banking market and changing the rules around FDI. That should facilitate greater opportunities for people who are not in that market to get in.

In terms of the clients that we are talking to, a lot of private equity (PE) and sovereign funds are looking to invest in non-banking financial institutions in Indonesia and Vietnam. In Vietnam last year, we heard from the regulator that they wanted to consolidate that market — there are over 30 commercial banks — and we have seen at least four or five deals including initial public offerings (IPOs) in the later part of this year. Also, we should expect to see three IPOs up to the 20 per cent threshold. What they want in these markets is strong but fewer banks. They also want banks to support financial inclusion and this is where technology plays a huge part.

Sovereign funds like Fullerton are very focused on financial inclusion investments across SEA and the technology to support that. A part is also being played by some of the new entrants like Go-Jek and others which are effectively ride-sharing apps but are expanding into other services.

Since you mentioned Go-Jek, these new age companies such as Go-Jek or Grab are receiving large funding and expanding in a way where they want to be everything from a ride app to a financial services provider. Where do you see them headed in terms of growth and also their future in comparison to traditional banks?

Bates: Actually what is quite interesting is that the funding behind Go-Jek is PE ultimately. I do think that in the next five to ten years, we will all see these financial or technology companies moving and converge with the banking sector. Eventually, they have a wallet, they take deposits, they provide financial services products, so it kind of looks like a bank and offers products like a bank but it is not regulated in the same way the bank is.

Regulation is going to play an interesting part here but they (tech firms) will continue to challenge the banking industry in the coming times. With the Chinese affluence, by 2019, there will be about $13 trillion of payment transactions in that country and that will be largely done by technology companies, not banks. So, with that emergence of large players in countries like China, we will see a huge expansion but there will be convergence at some point in time. The regulators need to get together and work how they will be married together.

In terms of funding for M&A transactions, where do you see the larger capital coming from or the preferred way that the companies would go to raise funds? This year and next year, how do you see that evolving based on the trends in the past few years?

Bates: Five years ago, PE and sovereigns were really focused on real estate, infrastructure, healthcare– bricks and mortar largely. They were looking at very tangible types of sectors. In the past few years, those PEs have now realized that they have missed a lot of opportunities in the financial services and most of the large funds have now got either financial services teams or have set up funds. Here, in Singapore, we see two of the largest such funds in Temasek and GIC and they have got lots of financial services investments. Most recently, we saw Temasek exit its investment in Bank Danamon.

In almost every conversation I have around PE, 5-20 per cent deals are around PE and that dry powder will be deployed around Asia-Pacific. In the US and European market, there are fairly benign returns to equity which do not correlate to the returns requirements that are for PE. Here in PE in Asia, there are greater opportunities in terms of growth and return and those return opportunities are what PE is looking to achieve.

Would you say then that PE and sovereigns funds would be the larger source of funding for the deals in financial services other than strategic buyers? 

Bates: I think it is going to move closer to parity. It is 30 per cent now and I think it is going to move to around 50 per cent — sovereigns and PE versus corporates. We are going to see a move towards 50 per cent.

Robertson: Maybe by 2025. I think it is also right to say that if you are talking of PEs, we also use the expression private capital because there are a lot of private individuals investors coming into the market. Five years ago, M&A transactions in the financial services sector — banking and insurance — we heard who the buyers are going to be but now we do not know who the buyers are. There are new players coming into the market, individual investors or PE. So, it is a very exciting landscape.

As new investors look more towards Asia, do you think the expectations in terms of returns have also changed over the years from the time that they were just LPs in some funds investing here?

Robertson: Definitely there are more returns in Asia than it is in Europe. Somebody had said that there are not many funding deals in Europe at the moment, especially in banking because the RE in banking is so low. I think there is an expectation of higher returns.

Bates: All of the funds we are talking to talk about double-digit returns in Asia. The fund longevity is still the same but the return over that is much greater in Asia versus in Europe where you have got a benign population and economic growth and a domestic focus because of political trends like Brexit. The political environment in America is also very domestic focused. So, the deal activity in those two big regions is benign and the opportunity to make greater returns is here in Asia.

In this region, we will see more deals from the Asia Pacific players. We used to see a lot of American and European money into Asia, which we still do but the deal activity is going to be more regional consolidation. When I talk to some of the Singapore banks, they are one of the safest banks but that also means they are very cautious. So, we have seen some great acquisitions by DBS to expand into the region but that is very much done on a cautious basis. So, they will continue to look for opportunities where foreign players are exiting.

We talked of Indonesia and Vietnam in terms of pockets for this deal flow. Any other countries that you would say are equally interesting when it comes to financial sector deals. Secondly, how do you see China as a huge market itself and also one which is providing a lot of capital for these deals in the region?

Bates: We have partners from China. What we see there is outbound investments. In terms of inbound from October, the Finance Minister announced that over the next five to ten years there will be an evolution of FDI in some financial institutions but some of them are moving from 49 per cent to 50 per cent in next few years. In others like banking sector, there is going to be a restriction of about 30 per cent. So, we will see opportunities for inbound into China but I think given the plans around the OBOR initiative the knock-on initiative with the focus on investing in infrastructure and others will create more opportunities around financial services.

In terms of other countries in Southeast Asia, we are going to see increasing deal activity in Vietnam. There is a real interest in that economy as it is growing very rapidly. Indonesia is also going to look to consolidate its banking market and there is a lot of activity around non-banking financial institutions. (Same goes for) Thailand as well, the Philippines and also Malaysia.

In Malaysia, ten years ago, it went through a major consolidation. Like we have in Thailand, we are seeing some of the opportunities in foreign acquisition in terms of non-performing loans (NPL) in Malaysia.

What are your views on India, where NPLs have come to the forefront as an issue? Do you see any similar transaction opportunities in that regard in India?

Bates: It is a huge market. We have seen a recent merger in two of the largest banks and what we are also seeing is a very large fraud in the banking sector. So the expectation is that there will be a much larger creation of NPL in the market. What investors are really considering is what structure am I going with to the market and how do I manage the insolvency rules around collecting the NPLs in future. That, in comparison to some other markets like Europe which is far more developed around insolvency, that will be something we will see in the next 12 to 18 months evolving as a market. And how they will then collect the NPLs they will acquire and we will then see a much more professional market evolve.

On post-merger integrations, what are the challenges currently in Asia Pacific when there is a corporate or strategic at play as compared to a PE player?

Bates: Probably when we talk of corporates, the greatest challenge often is to have a cultural fit which is key. When acquiring in a new market, they have to make sure they understand the regulatory environment because corporates often come from a very different regulatory environment. In a lot of these markets, it is also access to customers and distribution channels. So, balancing those three things are key. The other big challenge is technology.

Other than core banking and insurance, we have seen the size of fintech deals grow lately. Where do you see the deal flow in this segment in the coming period?

Bates: I expect to see deal values increase. Certainly, the value of all the deals in terms of multiples are increasing and we are seeing that in countries like Vietnam in particular in both banking and non-banking sector. In the insurance sector, on the bancassurance deal side, the upfront fee has been very high. That is also increasing because of the growth opportunity. The money coming into those companies is coming on the basis that they will yield significant distribution and growth in the underlying business and allow a meaningful exit to PE in the five- to seven-year window. Certainly, we are seeing the value of deals increasing in Asia because the macroeconomic conditions are perfect.

Valuations have been a concern in the region. While that may be true globally, what we hear in Asia is that the underlying assets may not warrant that kind of valuation demanded by companies. What has the trend been like and what are we going to see in future?

Bates: As a value, I would put Asian deals to be one and half times more expensive than Europe in terms of valuation. The reason is in terms of market cap comparison of Asian banks versus European companies or US, it is simple math — one and a half to two times. We see the Asian deals more expensive than what they are in Europe or US, all because of the growth opportunities.

Does that also pose as a deterrent to those who want to clinch deals in Asia?

Bates: It absolutely does. I earlier talked of Singaporean banks being safest but more cautious. Across the market space in banking, in particular, the assets have been increasing but there are some legacy issues as well. The cautiousness is around if they really understand the legacy or NPLs. Vietnam is an example where banks are sitting on NPLs that are three per cent or higher. That means when one is investing, one has to be very cautious. So, in Vietnam, there is a lot of due diligence and efforts being put into understanding the books and the business model.

In terms of exits, in many sectors exits were said to be difficult in the region. Is it the same in financial services from what you hear from your clients?

Historically, the exits in financial sector are driven by FDI rules mostly. A lot of what you see in Vietnam and Indonesia are minority investments and those are much harder to exit. That is also because most investors want to have control, so we are probably not seeing the speed in terms of exits that we would like. In some of the deals, like in insurance side in Indonesia, where we see the ownership is up to 80 per cent, it can happen easily because the investors can have majority. A lot of private capital is coming in where they want majority deals.

Also Read:

Grab launches new venture to foray into financial services in SE Asia

Indonesia mulls imposing cap on interest rates, loans offered by fintech firms

Ant Financial enters Pakistan by acquiring 45% in Telenor unit for $184.5m

Singapore Reporter/s

In Singapore, we are looking to double our reporting team by this year-end to comprehensively cover the fast-moving world of funded startups and VC, PE & M&A deals. We want reporters who can tell our readers what is really happening in these sectors and why it matters to markets, companies and consumers. The ability to write precisely and urgently is crucial for these roles. Ideal candidates must have to ability to work in a collaborative, dynamic, and fast-changing environment. We want our new hires to be digitally savvy and ready to experiment with new forms of storytelling. Most importantly, we are looking for hard-hitting reporters who work well in a team. Collaboration and collegiality are a must.

Following vacancies can be applied for (only in Singapore).

Following vacancies can be applied for (only in Singapore).   

  • A reporter to track companies/startups that have raised private capital, and have the potential to become unicorns. SEA currently has over 40 companies with a valuation of over $100 million and under $1 billion.
  • A reporter who can get behind the scenes and reveal how funding rounds are put together, or why they’ve failed to materialise. She/he in this role will largely focus on long-format stories. 
  • A journalist to track special situations funds, distressed debt and private credit (from the PE angle) across Asia.

Singapore Reporter/s

In Singapore, we are looking to double our reporting team by this year-end to comprehensively cover the fast-moving world of funded startups and VC, PE & M&A deals. We want reporters who can tell our readers what is really happening in these sectors and why it matters to markets, companies and consumers. The ability to write precisely and urgently is crucial for these roles. Ideal candidates must have to ability to work in a collaborative, dynamic, and fast-changing environment. We want our new hires to be digitally savvy and ready to experiment with new forms of storytelling. Most importantly, we are looking for hard-hitting reporters who work well in a team. Collaboration and collegiality are a must.

Following vacancies can be applied for (only in Singapore).

Following vacancies can be applied for (only in Singapore).   

  • A reporter to track companies/startups that have raised private capital, and have the potential to become unicorns. SEA currently has over 40 companies with a valuation of over $100 million and under $1 billion.
  • A reporter who can get behind the scenes and reveal how funding rounds are put together, or why they’ve failed to materialise. She/he in this role will largely focus on long-format stories. 
  • A journalist to track special situations funds, distressed debt and private credit (from the PE angle) across Asia.