Trading Places: Although Reviled in Europe, Private Equity Comes Of Age In Asia

Private equity may have attracted disdain and notoriety for asset stripping in parts of Europe, but in Asia it has gone from being a ‘slightly dodgy’ industry to one which is gaining legitimacy.

That’s the view of Navis Capital co-founder and INSEAD alumnus Nicholas Bloy. Speaking to MBA students at the Singapore campus, who were weighing up their career options, Bloy said that, in the ‘90s many would have been looking to go into management consulting or investment banking rather than private equity, which was “far from mainstream.” But that has now changed. He says most, if not all, of the students attending INSEAD’s second Asia Private Equity Conference held at the school’s Asia Campus in Singapore, would be looking to get into private equity. “So it really shows how far it's come in the last 15 years.”

Before the Asian financial crisis, prestige was linked to publicly-listed companies, he said, with private equity deals mainly focusing on minority investments. But this then changed during the financial crisis of the late ‘90s.

“The concept of prestige is not so much that doing IPOs is a prestigious activity for practitioners,” Bloy told INSEAD Knowledge on the sidelines of the forum. “But the point is business owners and entrepreneurs perceive there to be prestige in being the owner, the CEO, the controlling shareholder of a publicly-listed company. And so IPOs themselves were seen as prestigious by entrepreneurs.”

“Now, in a way that crowded out private equity capital … And so private equity, prior to the Asian crisis, could be considered the capital of last resort. And it might find its way into deals but typically they would be minorities. Nobody, no entrepreneur worth his salt was interested in selling control to private equity.”

“During the financial crisis, you saw billions of dollars wiped out and a lot of firms go to the wall. And it's after that, that there's a shake out within the industry and things presumably get on track after that.”

The PE model in Asia of minority stakes was found to be “fundamentally flawed” during the Asian financial crisis, he said, as “most, if not all, of the investments lost money.”

“The reason they lost money is of course it was a crisis environment so it's not easy to make money. But also in that environment, the misalignment between an incumbent controlling shareholder and that new minority investor really got revealed.”

“And of course many of the private equity practitioners during that period tried to risk-manage that potential for misalignment by having what they considered to be very protective shareholders' agreements. And on paper they did protect themselves. But the reality in the more emerging parts of Asia during the financial crisis was that those protections could not be enforced. Even in a court of law it was unenforceable. And so those protections weren't worth the paper that they were written on.”

“The value destruction was massive and the recapitalisation needs of Asia as a whole -- and of many, many hundreds, if not thousands of Asia companies -- enabled control deals to really start to take off because the amount of equity that was required to go into a company to solve its debt problems was so much that inevitably there would be a change of control simply by the sheer dilution of existing shareholders in order to pay down the debt. So much new equity came in: the new equity provider almost invariably became the new controlling shareholder. And that's really when it started.”

Fast forward to the global financial crisis of the late noughties which, as Bloy puts it, “opened the kimono.”

“In good times it's quite easy to make money, whether you're a great investor or an average investor or even a poor investor … It takes a receding tide to really reveal who was relying on timing, who was relying on assets, ever inflating assets, creating much higher multiples to which they sold and who was really generating real intrinsic operating value.”

“Going forward, there may be a bit of a shake out. But the reality is that in private equity, because it's a long running asset class, it has a long holding period. It's not that a problem today causes a firm to shut down tomorrow. Many of the firms that might have made poor investments two or three years ago, they're still with us. They still own their portfolio companies; they've still got to manage their way out of it.”

In Asia though the pain may be somewhat less acute as the recovery kicked in earlier. Consequently, there’s less likelihood of a shake out. “Many (PE firms) will just about do okay, because they've got holding power and they've got stamina. In fact, the crisis hasn't been long enough really to create a shake out. The ingredients of a shake out were there but the pain didn't last long enough.”

“A lot of what was driving Europe and North America was too much leverage and so those growth rates were clearly unsustainable. And so now, most investors in Europe and North America realise that for the next two decades the economic growth rate, industry growth rates, company growth rates in Asia, are going to be two, three, four times greater than that of their home markets. And so there will be, and there is already starting, a massive shift in the geographic allocation of assets from the industrialised markets into Asia.”

Also while private equity is gaining legitimacy in Asia, in parts of Europe – in Germany particularly – the industry has been likened to a plague of locusts. It’s because, as Bloy puts it, PE ‘thrives on driving efficiency’ that it has become so reviled.

“I would say that the industry has become quite stigmatised, particularly in Europe. And I think the reason for that is that in an environment where you don't have growth, how do you create a good equity return? You have to focus on other levers and typically those levers will be cost reduction, shuttering a factory, relocating jobs to cheaper locations. It's a socially and psychologically painful way to make money. And of course it does attract attention amongst politicians and voters and so on.”

“Now you contrast that with Asia where virtually none of our returns comes from firing people. In fact we're creating jobs, by the tens of thousands, hundreds of thousands, millions, because we're growing and we need to add factories, we need to add capacity, we need to hire new people. So I think the fact that private equity in Asia has a good name and private equity in continental Europe has a bad name, is really just a reflection of what drives an equity return in those markets. In Asia, it's growth. In Europe it's largely financial engineering, which of course is reviled in and of itself and it is focused on driving often painful efficiency gains.”

While many limited partners are currently looking to place their bets on big returns from China and India, Bloy told the INSEAD PE conference that Southeast Asia may also present opportunities. But even though he is working for a fund with some three billion dollars in assets and is based in Kuala Lumpur, Malaysia only accounts for five to ten per cent of his firm’s portfolio.

“The cold market, the overlooked market is where the opportunities are. And I think if you look at the flow of funds, private equity funds across the region right now, yes, India is hot -- in my opinion, too hot. There are too many funds. I heard the other day there are approximately 500 private equity funds in India, up from probably only a handful in 2003, which is the first time Navis invested in India. And a lot of money is flowing into India, and the same thing into China.”

“And only a fraction of the money that's flowing into India and into China is flowing into Southeast Asia. And that seems like an anomaly to us, because actually when you look at Southeast Asia in the aggregate -- which I think one can do now because of the ASEAN (Association of Southeast Asian Nations) free trade agreement, where tariffs on 90 per cent of goods and services are down to zero -- you have the conditions for cross border growth, cross border M&A across this whole free trade area. When you aggregate that economy, it’s approaching $1.8 trillion (with a population of) 600 million people. Now India is an economy that has more people but its economy is only $1.3-1.4 trillion. So ASEAN is bigger but it is only getting a fraction of the money that's going to India.”

As fewer PE firms are chasing deals in Southeast Asia, consequently, he says, it’s “much cheaper” to buy a company there.

“We compete perhaps with local entrepreneurs, multinational companies, strategics and so on, but very rarely are we competing with other private equity firms. Whereas any deal in India, any deal in China is hotly contested by five, ten, fifteen private equity firms, all desperate to pay the price to get the deals.”

He says his company’s strategy is to look for national champions in Southeast Asia which can then be turned into regional ones, with the process assisted by regional FTAs.

“That's the most attractive investment. It doesn't really matter what the starting point is whether it's Thailand or whether Malaysia but take a great brand, take it into its contiguous markets. Instead of addressing in the case of Malaysia, less than 30 million customers, you address the full 600 million consumers in ASEAN. So to us that's a very, very powerful opportunity.”

Nicholas Bloy was the keynote speaker at INSEAD’s second Asia Private Equity Conference 2010 staged by the INSEAD Private Equity Club at the school’s Asia campus in Singapore in early October.

[This article is republished courtesy of INSEAD Knowledge
http://knowledge.insead.edu, the portal to the latest business insights and views of The Business School of the World. Copyright INSEAD 2023]