Will private equity bring more prosperity and equanimity?

By Wilson P. Tan

First Published in Business World (05/19/2014 – p.S1/2)

THE PHILIPPINES is poised to still be among the top performing economies in Asia this year, although some analysts predict a growth rate slower than the 7.2% growth target in 2014. Yet it would seem that we are proceeding well: the stock market is slowly but steadily recovering, new initial public offerings (IPOs) are entering the market, and investor confidence remains high. It is still an auspicious time to look at the rise of private equity (PE) in the region, and how it may more deeply impact business and investment for the rest of 2014.

The concept of PE is familiar in more developed markets but is relatively new in Asia, particularly in the Philippines, where a few PE firms and funds have been established in recent years. However, analysts believe that the still-sluggish world economy will lead more PE firms to look towards Asia Pacific as the region matures economically, politically and financially. We can see this in our own country with the rise in foreign investor confidence and upgrade in investment-grade credit ratings, which logically will increase the likelihood of PE transactions.

WHAT IS PE?

PE is defined as investors and funds that invest directly into private companies or conduct buyouts of public companies that result in delisting. PE usually comes from institutional investors and accredited investors who can commit large amounts of capital for long periods of time. They invest or buy into companies to provide funds for technology development, expanding working capital, making acquisitions, or strengthening a balance sheet. PE investments are often used to turn around a distressed company or to allow for a liquidity event such an IPO or sale, at which time the PE fund exits at a profit above its initial acquisition costs.

In the recently released Ernst & Young survey report “A maturing market: Asia-Pacific private equity outlook 2014,” regional business leaders and executives believe that general partners (GPs) and institutional investors are increasingly looking to tap the region’s potential. While there is still some way to go before regional executives fully embrace PE, there is a growing understanding of its benefits and opportunities.

Interestingly enough, the report points out that regional PE firms no longer see cash-rich corporate buyers as threats, but rather as friends. This comes in the wake of slower IPO activity in the region, limiting exit options for Asian PE firms. In fact, the survey noted that a number of PE firms across the region have already benefited from the demand for assets by exiting portfolios to corporates at a good profit.

There is also an anticipated increase in buyouts across the region, particularly in the more mature markets, and possibly for secondary buyouts as well. Executives believe that this trend is a sign that the Asian PE market is reaching a new level of maturity. Nevertheless, they also believe that overvalued targets will offer the greatest hurdles, followed by regulatory challenges for foreign PE firms who are unfamiliar with local investment landscapes.

RECENT PE ACTIVITY IN ASIA

While there are many significant insights in the EY report, it is important to look at the context to get a view of the bigger picture.

Last year opened with high hopes for a revival in PE investment, which unfortunately did not materialize. Activity moved at a much slower pace and buyouts remained relatively tame — a carryover of slow economic activity from the previous year. Most foreign buyouts focused on Greater China, and the largest inbound transaction was completed in Japan. However, aside from these, there have been few megadeals in the region — in fact, 67% of deals have been below US$100 million.

Despite the less-than-desirable market conditions, several PE firms continued to raise funds, which reached well into billions of dollars. Others, however, focused on exits with the completion of 206 exits worth US$36 billion — a trend that some analysts felt was a harbinger of market expectations, indicating possible further market volatility.

In 2014, it is expected that PE practitioners will continue to add assets to their portfolios through acquisitions. With several funds closed in 2013, profiting PE firms are likely looking to increase new acquisitions in the year ahead. The difference, survey respondents believe, is that these acquisitions may focus more on control buys as opposed to minority investments. PE firms may seek a louder voice in how portfolio companies are managed, and allow GPs to place managers in vital positions to monitor company performance. These activities, of course, will be restricted by government regulations that limit investment. Respondents also believe that GPs in Asia are expected to add value to portfolio companies by enhancing operational performance, sharing vision and strategy, strengthening corporate governance and providing more sophisticated financial decision-making systems.

THE BENEFIT TO PRIVATE COMPANIES

An important part of the conversation is to look at how PE firms can bring significant benefits to private, family-owned companies and other small and medium-sized enterprises (SMEs). Given the increasing role that SMEs are playing in regional economic development, PEs may need to find ways to overcome the reluctance of family-owned companies to having parts of their company bought by “outsiders,” with the attendant perceived loss of control over their own companies.

Giving up control is anathema to most Asian business leaders, so PE firms need to reassure prospective partners that control of the company will remain in the family’s hands, while still being clear that the PE firm will want to influence decision-making. One area where PE firms may have an advantage is with private companies with succession issues, like enterprises where the founders are nearing retirement yet their descendants are unwilling or unable to manage the family business.

In addition to the tangible benefit of access to capital, which is often a limiting factor for SMEs, PEs should also emphasize other intangible benefits, such as sharing best practices to help the family-run business or SME grow to the next level.

This means that PE firms will need to invest more into building their brand in emerging markets, focusing on how they can add value. They must build rapport with family-business leadership, which requires a level of sensitivity that is not found in other deals or in most western markets. They should also have a ready strategy and answers for the business owners regarding the details of the deal, the PE firm’s history, and their eventual exit plan.

PE firms must also make it clear that they have long-term intentions. This creates a bridging perception that PE firms are possible partners, rather than just profit-seekers. They should demonstrate that they have a strong track record of value creation in previous portfolio assets, as well as providing operational and financial advice, assistance with international expansion and recruiting foreign talent, and expertise in regional markets.

Certainly, the insights provided by the EY report offer much food for thought but are in no way ironclad predictions. How PE performs in the region in the coming year will depend on many factors, which will be unique to different emerging nations. It is to be hoped, however, that with the impressive progress the Philippines has made in recent years, our local business communities will gain a better understanding of how PE can help their companies flourish in an increasingly global world.

Wilson P. Tan is the head of assurance of SGV & Co.

This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the author and do not necessarily represent the views of SGV & Co.