Equity

Trends in the Asia-Pacific Private Equity Markets

Bain & Company published its “Asia-Pacific Private Equity Report 2020” near the end of the first calendar quarter. The report does not reflect a detailed look at market dislocations caused by the COVID-19 pandemic but looks into deeper substantive elements of the PE market and the trends that will likely characterize the market regardless of the pandemic’s effects.

The overriding trend is that 2020 will mark a transition from growth to downturn and disruption. Even without the stresses created by COVID-19, ongoing US-China trade tensions and the United Kingdom’s Brexit strategy will disrupt supply chains in Asia. Without considering the plunge in oil prices, the Report also notes that oil supply disruptions from tensions in the Middle East will add further stresses. Concerns over climate change and pockets of unrest and geopolitical uncertainty will further destabilize the markets.

In the Asian PE market, 96% of PE fund general partners (GPs) expect the values of their funds to decline within the next two years, and more than half of those GPs expect those declines to be moderate to severe. Most funds will be unable to sustain their historic returns in the face of those declines.

The PE funds that survive this onslaught will likely be the ones that internalized lessons from the 2008 economic downturn and developed strategies to benefit from uncertainties. In this context, the Bain Report identified four characteristics of successful PE funds:

  • Success is a function of controlling PE deals and exerting active management over portfolio companies;
  • Larger deals and a PE fund’s ability to attract co-investments without sacrificing control are critical for PE fund growth;
  • Picking a winning company takes precedence over investing in particular industry sectors;
  • Strategic timing of entries and exits in portfolio companies, and specifically avoidance of exits during a financial crisis, leads to stronger returns.

Another insight from the Report is that when faced with economic uncertainties and financial challenges, successful portfolio companies changed both their strategy and their management processes to develop those strategies. This insight emphasizes the quality of leadership teams that can distill signal from noise to focus on the most vital elements that will affect their companies. Effective leaders prepare their companies for risks before the risks become reality. They control costs without cutting too deeply, prepare for strategic partnerships, and retain effective talent.

Within this framework, the Report predicted how these trends will affect a few Asia-Pacific industry sectors that have attracted PE investment capital over the past ten years.

  • The internet and technology asset sectors have attracted an outsized amount of PE investment. The successful companies in these sectors are the ones that have adapted Western business models to the unique features of the Asia-Pacific countries. For example, Grab gained an advantage over the Uber, which is the world’s leading ride-sharing company, with its better understanding of the needs of drivers and riders in Indonesia, Vietnam, and Thailand. Grab’s management team saw that motorcycles, rickshaws, and tricycles accounted for a substantial amount of transportation in those countries and adopted a strategy that included these transportation modes
  • Implementation of Software as a Service (SaaS) had been limited in parts of the Asia-Pacific market due to weak high-speed internet infrastructure. Improvements in high-speed service have given rise to large data centers, with China and India drawing a majority of the PE investment dollars.
  • Cross-sector technologies are making strides in healthcare, finance, and other service sectors. Lower-cost wearable technology has facilitated remote monitoring of patients. Mobile payment systems and trading applications are supplanting traditional financial services. Inexpensive access to big data and web analytics has further boosted the sales and marketing prospects of these technologies.
  • Artificial Intelligence (AI) systems have presented opportunities for startups to disrupt or reinvent whole industries. Much of the AI investment from PE funds has shifted from broad, cross-industry AI applications to more industry-specific solutions.

If, as the Bain Report predicts, the Asia-Pacific PE market is due for a downturn, investors will be forced to address the record-high valuations that many disruptive companies may currently be enjoying. Those valuations will contribute to a correction that is likely to come before the end of 2020.

The PE funds themselves are pointing to the difficulties of evaluating younger and less-established companies that have inflated share prices and that are not amenable to traditional valuation techniques. Moreover, many of those businesses have never made a profit and show no sign of turning profitable any time soon. Well-run PE funds are adjusting to this new reality by seeking greater control over deals and exerting enhanced management over portfolio companies.

The Report concludes that PE investors in the Asia-Pacific market experienced mixed results in 2019. Notwithstanding the predicted downturns, PE firms are still positive about future market returns but expect to see fewer attractive deals in the market. At the end of the day, intelligent investors know that periods of uncertainty will always create opportunities.

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