In DealStreetAsia’s third webinar on July 16, 2020 – Alternative financing & dealmaking: How investors are overcoming pandemic’s fundraising hurdles – we looked at the overall opportunities set for various private capital strategies when the COVID-19 pandemic continues to batter businesses around the world.
The panellists at DealStreetAsia’s fourth webinar were Harold Ong, managing director at Indies Capital Partners; Katrina Cokeng, co-founder and group CEO of Xen Capital; and, Kyle Shaw, the founder and managing partner of ShawKwei Partners.
Alternative financing providers believe there is still time before opportunities in this crisis start to become evident as central banks globally have been quick with relaxed lending norms to support businesses.
In conversation with DealStreetAsia’s managing editor Michelle Teo, our panelists talked about their investment approaches in the pandemic times, the changing alternative financing landscape, attractive asset classes and shift in strategies with the geopolitical environment.
Watch the video of the webinar or read the transcript below, which has been edited for brevity and clarity.
Michelle Teo (MT): The pandemic has wreaked havoc on businesses, markets and the broader economy. The assumption is that in such a market or crisis, there will be plenty of opportunities.
Harold, let’s begin with you. Indies Capital has just had his first close of $100 million for its third special opportunities fund. Maybe you could tell us – what are these special opportunities?
Harold Ong (HO): In this environment, there’s a lot of market dislocation, obviously. Perhaps we haven’t seen the bottom yet from the real economy perspective. That obviously takes time and the stimulus provided by governments and subsidies has obviously helped the economy to keep going.
Some sectors have been hit much harder than others – hospitality for example. Sectors that are tech-based tended to do better.
That said, the opportunities that we look at are quite broad. We look at traditional deals as well as tech businesses. Tech is getting far more entrenched in economies all over the world and Southeast Asia is no different.
In this period, we’re actually seeing opportunity sets that come about for various reasons. One reason may be that they just need more capital because they are growing a lot faster. That would probably be the minority of transactions, but we’re certainly seeing it in logistics and anything e-commerce related.
There are, of course, the more traditional businesses that are not doing as well. We are being patient – the opportunities will come but perhaps the real economy hit hasn’t happened in full. We are pretty flexible across the capital structure in the use of traditional, mezzanine type deals, as well as more structured transactions. We’ve been very busy during this downturn. But we’re being patient as to what sort of deals, we want to look at.
MT: It’s a special opportunities fund but is it really opportunistic, or more strategic?
HO: It’s actually a bit of both. So, strategically, who are we trying to back with our special opportunities fund? It’s actually very established business groups and conglomerates with strong underlying cash flow. But perhaps because of market dislocation in this pandemic, certain business lines have been adversely affected or funding lines are unavailable from traditional bank channels. So, we can replace that.
We don’t see ourselves as true distress buyers. We want to support very good business groups: whether that’s in expansion capital, acquisitions, refinancing scenarios, debt buyback or, in certain cases, even rescue financing.
MT: Katrina, can you provide some insight into the sort of assets or asset classes that investors on your platform are allocating or perhaps reallocating to at this time?
Katrina Cokeng (KC): To provide a little context, Xen Capital is a full-fledged alternative investment platform. We connect accredited investors with opportunities across the whole alternative space.
Compared to the pre-COVID timeframe, we have seen a pretty big shift among our client base – accredited investors and family offices – from longer-term closed-end fund opportunities to shorter-dated opportunities and more open-ended structures. Also, away from the earlier stage, riskier venture capital opportunities towards more private credit, income-oriented products.
MT: Apart from the market dislocation that Harold was talking about, what are the other factors that are driving investor interest on your end?
KC: In addition to the market dislocation, which is creating a need for investors to diversify and explore other opportunities, we’re seeing a lot of tailwind or trends around geographic diversification, especially for Greater China-based investors.
This has been a fairly common theme for the last 12 months but it is probably accelerated today. A need to book assets out of Singapore, for example.
The other trend is with a lot of Asian countries, there is a generational shift in wealth. People are now looking to have a more organized structure, especially around family offices or multi-family offices and trying to invest on a more systematic basis.
MT: Kyle, perhaps you could talk about various approaches that one can take for an asset or a company – is it about getting into distressed debt first and later equity or perhaps a rollup strategy at your end?
Kyle Shaw (KS): This is an obvious statement but the pandemic is truly global, and unlike anything, we’ve seen. We have had crises: whether the global financial crisis, SARS or the Asian financial crisis, but they were more concentrated within a region.
When I talk to people all around the world, they have a different interpretation of what’s happening – what the pandemic means and how it’s affecting them. And I found it very curious that there’s not a common theme that you can follow.
The same is very much true for companies. Depending on the industry and the company that you’re dealing with, you probably would have to adjust your strategy.
In the early days of this pandemic, we thought that illiquidity would be an opportunity. But yet, central banks globally have been so free and liberal with lending, that the terms are more relaxed and easier than they were pre-pandemic.
There are truly distressed companies, but they’re generally so far gone, that there’s just no hope. Maybe we can venture into growth capital. In today’s world, if you’re growing your business – and a small percentage of the universe are doing very well in this environment – if they need capital, banks again are freely lending to them.
The IPO markets are hot as a pistol, equity markets are very strong. And so, probably if you want growth capital, there are cheaper alternatives than private equity that are readily available.
That leaves succession planning – companies where the owners have reached a point in their life where they want to retire, or maybe don’t have a natural succession. That part has probably accelerated.
And then, there are consolidation plays. Those are very attractive to us because if you are already in a particular portfolio company and know the industry well, then looking to acquire or merge with a supplier or a customer is relatively straightforward. Due diligence can be expedited, and it can be compelling – a win-win for both.
As of today, those are opportunities. I would say ‘stay tuned’ because this pandemic has been very erratic and perhaps we’re going to have a W shaped recovery, where we go up and down. Certainly, at some point, the liquidity spigot will be turned off.
MT: Is it just about the money, though? Given that the market is flush with capital, what else is it that businesses or borrowers are looking for when they come to you instead of the banks?
HO: First of all, I don’t think liquidity exists in every single pocket. Obviously, equity markets are at a high, but there’s a real dichotomy in terms of what’s doing well and what’s not. The new economy sector has obviously done a lot better.
We do concentrate a lot more on Indonesia, so I’ll talk about that market in particular. The liquidity situation is still not great. Banks are being very careful with where to put out capital. They have been told to support businesses and give holidays on repayments and are not really in the mood to take on a lot of new credit.
There are companies facing a lot of liquidity issues. The capital markets in Indonesia are not quite as open as they are in the US. Certainly, new deals such as bond deals on the DCM [debt capital market] side will continue to struggle. That’s where we come in.
MT: Apart from liquidity though, are there other aspects that they come to you for?
HO: Yes, they do. We’re looking at a transaction now where it’s the opposite – a business that is doing better in this crisis because it has to do with online delivery.
There’s an opportunity for more capital to go into business, and it’s actually to build infrastructure and grow. We’re looking to support that business – fundraisings are probably going to take longer in this environment. Part of our business is being an equity replacement.
And it works well in this kind of environment because we can probably move a little quicker or be nimble.
MT: A question from the audience: what is the typical cost differential between alternative financing or the kind of approach that you take versus bank borrowings?
HO: For good credit and to support key clients, banks will still be there. But if you look at some of those, for example, that need to refinance high yield bonds that are coming due now is certainly not the time to go and tap the high yield bond market. To replace that with debt borrowing may be difficult because the business is probably leveraged. Now, it may even be more leveraged, at least from an EBITDA to debt type perspective.
And so, you need to look at alternatives. Are you able to do a kind of debt buyback scheme? Are you able to put in different funding lines to take you through the next couple of years? You’re not going to end up paying bank debt – it’s not LIBOR [London Inter-bank Offered Rate] plus a few percentage points type of business model. In a structured type transaction, you would look for a double-digit yield circa 10 per cent and you share in the upside. If things go well, you try and have the kicker really provide some of that upside to the investor. You get a more mezzanine or even 20 per cent type of returns.
MT: Let’s shift gears to look at the crisis. How can an earlier crisis inform your investment process now?
KC: It’s really hard to extrapolate from the previous crises. What we’re experiencing now is unprecedented from a health standpoint.
We’re seeing a huge range of attitudes amongst investors from one extreme to the other. There are some who are just petrified that things are falling off a cliff, want to hold on to liquidity and don’t want to touch anything in the capital markets space.
On the other hand, we have investors who just see a huge amount of opportunity and are very active. You especially see that with a lot of activity that’s occurring so far and not just in the western capital markets but in Asia as well.
For us, the challenge is how do we provide a lot of different things on the shelf to satisfy this wide range of expectations about the future; a wide range of risk appetites and also liquidity needs.
MT: Harold, how does this compare to the previous decade’s crises?
HO: As I’ve said, some of the real economic impacts will probably be seen in the next 3 to 12 months. There’s going to be plenty of opportunities – we’ve already seen a lot during this period. But we are being a bit careful.
There’s also this dichotomy between certain businesses that are doing better in this environment and others that are not. That’s probably something we didn’t see in the last crisis because the technology was not quite as big a segment.
Things are very different in traditional businesses versus online. We have continued to see funding rounds and demand for tech businesses in particular who actually need capital for growth, not for liquidity issues or rescue financing.
Of course, there are also those on the tech side that need that. Not all businesses have done better during this crisis.
In this environment, we’re seeing a lot more demand. We have seen that throughout this pandemic. In fact, as I’ve said, we’ve been very busy. We’ve actually closed on four different transactions since this pandemic happened. As a whole, we continue to see opportunities.
MT: Kyle, how has this informed your investment process? How do you do due diligence and manage the existing portfolio companies?
KS: It’s the same. If I think back to the global financial crisis in the fall of 2008 till late spring 2009, there were opportunities to do deals because of liquidity crunches. At that point, you just had to be very quick. It was an extremely stressful period because the banks were all struggling. This time has been different because the stress came in mid-March, in the financial system, but it was over in two weeks.
And since then, we’ve recovered and so there was really none of that stress that caused you to have to be making quick decisions. We’re actually still in a position where we can look at things, talk about them and think about how we want to do the due diligence, we need to do. The challenge is of course because of the restrictions on travel.
In this environment, that makes collaboration with other GPs quite a good thing; quite logical, especially if that GP is in another location and you’re both covering the territory in which the company operates.
It also means that you need to work with consultants, advisors, lawyers and accountants, to do some of the groundwork. Probably the biggest impediment is that it slows us down in the initial review of a deal.
Before COVID, we would get on a plane, visit people, take a look around, kick the tires, and that would help you form your impression of whether or not you really want to do serious due diligence. Right now, we’re a bit precluded from doing that. We’re stuck just looking and thinking about it. If we do have somebody on the ground who can go visit, then that’s a second alternative.
Once we get serious about something, I don’t think there’s really much of a change in how we operate. It’s probably in the initial phase – where you think, do I really want to spend time and effort on this?
MT: How do you price or evaluate assets at this time? If buyers have become more cautious, have sellers adjusted their expectations accordingly?
KS: Like most of the industry, we have the same expectations on returns. We need to get 20-25 per cent gross returns on our investments, over a number of years. We are not looking for a six or 12-month return and typically think in a three to five-year range.
The challenge is predicting the future. And trying to forecast how the company will perform. That is extremely problematic because of the nature of the pandemic. We tend to operate with companies that have customers in many locations.
So now you’re really layering on a level of complexity. How are the customers of that portfolio company going to react? How’s the supply base going to react?
Ultimately, we’re all concerned about consumer demand. What happens when you have such high unemployment and eventually, some of the safety net from the governments is taken away in terms of payments to these people? It’s a very uncertain future.
The complexity of Asian politics and the geopolitical position, especially with the biggest player out here – China – has also created a level of uncertainty that none of us have seen in the last 30 to 40 years. How to judge the impact of hostilities between countries – what does that mean for demand and competition? How are we going to react in this environment?
This is a really difficult time to forecast the future. For any investor who has capital, you are probably better off being prudent and brave, rather than throwing money at something and hoping for the best. There are certainly enough warning flags out there to suggest caution.
MT: How about you, Harold? Does this mismatch apply in your case too?
HO: I completely agree with Kyle. The past issues happened pretty quickly, especially in Southeast Asia. Yes, there was a crunch in the GFC (global financial crisis) but it was a short-term liquidity crunch, and perhaps a few sectors declined. Things then recovered very quickly, and domestic demand was going up.
This time, it could be a lot more elongated for reasons we’ve already mentioned. Unemployment and disposable income could be an issue. A lot of it is about the experience set of the investors within the firm having been through these cycles and being able to differentiate between what happened in the past and what’s happening this time.
MT: What about the expectations of both sides – sellers or buyers?
HO: The expectation set hasn’t quite moved unless people are really in that liquidity crunch situation. Unlike traditional pure equity, we don’t always have to price equity. We have other forms of collateral and ultimately it can be more credit – if it needs to be more credit as an instrument. And so, people are not taking a hit on their equity valuation.
I think that’s what Kyle was talking about – where there’s still a huge mismatch and people don’t want to take a hit during this downturn.
In a sense, we can be an equity replacement tool for some entrepreneurs and businesses that need money. Perhaps in the shorter term. And perhaps a little bit more flexible in the way we structure things because we have both a credit and an equity mindset.
MT: What about you Katrina? What are you hearing from the investors?
KC: There’s obviously a huge amount of uncertainty. With everything that’s happening from a geopolitical standpoint, they are probably thinking about the ramifications on the economy and different sectors. And also, the different opportunities from a geographic standpoint.
You have seen something like ByteDance – there was a huge frenzy a month ago to buy those shares at a very high price. And then with everything that happened with India and the US, and you see a lot of those geopolitical tensions impacting a private company.
People are probably a lot more cognizant of that. With regards to our Chinese investors, there’s probably a sentiment right now to be more focused on Asian opportunities because of the climate of uncertainty and the impact of the pandemic on the US and Europe.
MT: To follow on what you just said, there’s a lot of focus on Asia and global GPs have raised huge Asia focused vehicles. From your point of view, how has this changed deal-making in this part of the world?
KC: It’s really been about shifting the focus of opportunities that we have on our platform. The split about six months ago was probably more 50-50 between closed-ended versus open-ended opportunities. And we had a lot more VC or earlier stage opportunities as well and less of the kind of income-oriented like mid to single-digit opportunities. It’s been a pendulum swing towards that these days. Almost 80% is shorter-term, open-ended strategies or more credit-focused; more conservative or preservation oriented; and 20 per cent more focused on things like technology and healthcare.
MT: What about secondaries at your end Katrina? Has the market and your view sort of adjusted to the pandemic? Are you seeing a lot more opportunities?
KC: There are certainly opportunities but probably not as many as we would have thought. Echoing what Kyle and Harold said, from a sell-side standpoint, unless people are really distressed – we probably saw a lot more opportunities back in March, when even family offices had to meet margin calls. And so there was a need to get out of things that they could get out of. But right now, we’re not really seeing a lot of pressure from a sell-side standpoint.
MT: What about for you, Kyle in terms of competing with the big domestic GPs and huge Asia focused funds? Does that change deal-making for you?
KS: Not really. They’ve always been there and had deep pockets. It sounds trite but a few billion here or there extra is not going to make any difference. They have their strengths and focus on that. But that’s a narrow part of the market. There’s quite a wide piece available for everybody else.
Typically, we’re looking for deals $50 million to $100 million US, for us to write a check against. It’s unlikely that those very large mega-funds are going to compete with us. It wouldn’t really be economical for them.
But we do think that the largest share of deal flow is in the small to medium size businesses out here in Asia, especially if you’re talking about succession and consolidation. Even when you’re talking about new technologies – things that are still in a relatively young stage of their life – are going to be lower price and lower value.
MT: Under today’s circumstances, how do you protect your own interest based on the kinds of deals that you’re making? In traditional loans, you have covenants. From your end, how do you protect your interest and that of the LP?
HO: In our more traditional business, where we do mezzanine and structured equity, we generally take the collateral. And that can be in the form of property or real assets. It can also be in the form of shares, a lot of which, for example, is in offshore structuring.
You can protect yourself a layer further by putting in a repo type structure, where you actually own the shares and then have an option to buy it back. But in general, most of our deals, particularly on the traditional side, do need to come with collateral. As I said earlier, it also negates the need to price the equity, particularly when you’re in a state of the downturn or pandemic. That generally helps to get deals across the line. Because entrepreneurs are more sensitive about their equity valuation over anything else. We’re also doing a lot of work in venture debt type structures. We look at tech businesses as well. It’s not true venture debt because we generally cover companies that are slightly larger, more mature.
So we’d like to call it more mezzanine or structured credit or equity for tech businesses.
MT: From the other side, what should business taking up these alternative financing options that you’re offering, be ready for?
KS: They should be ready for a new world. Things will change dramatically for them. A capital infusion will change things. Typically, you’re bringing in new people as well because the company wants to grow and use the capital in some way: new businesses, facilities, or product lines perhaps, but also corporate governance.
A good lawyer can help with the sort of protection you need as a lender or as a minority shareholder. As a majority shareholder, you need good corporate governance. I think the phrase ‘trust but verify’ is very important.
For us, as a GP, we need to be involved in the business enough to make sure that we understand what’s going on. As recent headlines have shown over the last several months, corporate fraud is not uncommon. The company is going to have to get used to a more invasive, or more comprehensive set of corporate governance rules and requirements going forward, in order to make the GP comfortable that he is fulfilling his or her fiduciary responsibility with the company.
MT: Katrina you said earlier that the expected discounts have not quite materialized in the secondaries market. Is it because the PE portfolios have not been fully marked to market and if the effects of COVID-19 have not been fully accounted for?
KC: The secondary market is obviously a marketplace driven by supply and demand. On the buy-side, we see people gravitating towards certain names that are seen to be benefiting from this pandemic. On the sell side, it really depends on how distressed the sellers are. And if they need capital. From what we are seeing, most sellers don’t need to sell right now and will sell for the right price. It comes down to pricing and other factors as well – like how tight the cap tables are. But to be honest, we’re not really seeing big drops as we thought we would see a few months ago, heading into this.
MT: This is a question for all three of our panellists. We have talked about the amount of capital and dry powder in the market. I’m wondering how that’s impacting the way you stay competitive, with large amounts of capital chasing after a limited number of high-quality assets and presumably driving up certain multiples.
HO: Fundamentally, our business lines are traditional alternative capital in the form of private credit, mezzanine and structured type transactions and a lot of that is in Indonesia. We have a full team down there. A lot of the global players, I daresay, will struggle to do due diligence in an environment where it’s very difficult to travel.
On the mezzanine side, there are no other players at the moment that we’re aware of that does this at scale. That’s our competitive advantage in essence because our products are very much an alternative to traditional kinds of private equity.
MT: What about you Kyle? Is it going to be more challenging exiting? What is more acceptable vis-a-vis the public markets?
KS: Exits are actually going to be kind of interesting in the second half. If you have a business that was prepared or if it came through COVID well and if you have the right sort of profile for that business in the future, there’s going to be a lot of demand. Not just financial buyers but also corporate buyers who are looking to deploy some of their cash.
There’s going to be a fair number of companies that are in a bad shape and no one’s going to want to own. The vast majority are in the middle – doing okay, not great, but maybe nobody wants to buy them or the valuation won’t be very robust. We are in a hugely speculative market right now.
If you ask me what I wish I had done six months ago, Zoom comes to mind – buying that stock. Tesla would be another one that I think I wish I’d bought.
But who would have thought Tesla would go up four times? The kind of people making those bets and investments are day traders and people who are very short term oriented. That’s not our game.
We’re investing for multiple years. We can’t buy it today and sell it next week because we’ve read the tea leaves and figure maybe the bubbles are ready to pop. So, leave those people aside – the speculative forces will play out until the regulators stop them, at some point.
But until then, you just play your game.
MT: Do you have a view on the fintech lending space?
HO: We look at fintech companies as well in this kind of cycle. But I think we’d be very careful about which area of fintech lending.
MT: Does venture debt fit the bill for larger LPs interested in Asia as a market?
HO: It is a very interesting sector. If you look at the US, 10 per cent of every equity dollar into venture companies, ultimately also gets invested as venture debt – somewhere between 10 to 15 per cent. That’s still very small within Southeast Asia. There are a number of people who do it pretty well, particularly for earlier stage companies in Series A and Series B.
It’s very interesting and we should start looking at it. It will continue to grow as it becomes a bigger part of the economy in Southeast Asia, just like it has done in the US, China and elsewhere.
MT: How have the average ticket sizes been affected due to the epidemic? Is this a time for bargains to acquire majority stakes? Or are you going to be more cautious?
KS: If we find a deal that makes sense, I don’t have any issue about writing a bigger ticket size. I don’t think they’ve come down in value. We typically look for anywhere from $50 million to $100 million. We can go bigger than that. If the right sort of deal came along, we would have an appetite for it.
I don’t think you reduce risk by writing a smaller check. In today’s environment, bigger deals are probably more attractive than doing very small deals. There’s more heft to the business, more substance to it and more room to grow.
MT: Indies Capital usually invests in mature startups at the pre-IPO stage. Is the special opportunities fund considering growth stage companies in tech as well?
HO: Yes, we do. It’s a little differentiated between our private equity secondaries platform. That one generally takes direct equity stakes and we’re buying secondary shares of more mature stage tech companies from early shareholders.
On our credit platform – we’ve just raised, as you mentioned earlier with the first closing of Indies Special Opportunities Three – that fund, for example, would do credit or structured equity-type transactions for the same cohort of tech companies that we would look at, which is the more mature stage players.
We can offer a mezzanine or structured equity-type structure. So it’s not true venture debt but structured, perhaps, in a more traditional sense. But we can do that from a credit fund as well.
MT: Katrina, do you have any last any comments to add to the last few questions? For instance, ticket size?
KC: We haven’t seen much impact on ticket size. It’s more about shifting focus to the types of opportunities – there is a lot of interest in technology, healthcare, life sciences, etc. Even education with more digital education. Capitalizing on a lot of the trends that are benefiting from the pandemic. As far as we are seeing in terms of the fundraising, things are just taking longer. A lot of the GPs that we speak to, depending on where they are in their fundraising cycle, are certainly prepared for a longer fundraising process.