A sneak peek to the future of private equity in Southeast Asia

Global private equity (PE) firms are stepping up their focus on investment opportunities in Southeast Asia, with deal-making in the region expected to pick up in 2013.

Having operated in China and India, PE firms are diversifying their holdings through Southeast Asia where the market is nascent. Successful firms identify the institutions, adapt to the differences, leverage on market inefficiencies, and produce best-in-class returns.

Deal Execution

Like the rest of Asia, personal relationships are predominant when it comes to deal origination and transaction flow. PE firms face the challenge of building local relationships, and to gain early access to attractive deals and avoid overpaying, they cultivate a network of sourcing agents, industry insiders, and locally connected partners.

As family-owned businesses become more receptive to PE firms, relationships with those that form the bedrock of their economies also bring access to deal flow. Firms can also form alliances with industrial corporations in the region to give them first looks at acquiring business units which may be divested.

Particularly on the larger opportunities, PE firms also compete with strategic investors. There have been occasions where nimble PE firms trump better offers by strategic investors. PE firms also sometimes prove flexible on investing via quasi-equity instruments with control rights which can meet investor objectives.

Relationships also play a critical role in due diligence because PE firms target smaller companies where information often is less transparent.

The relative absence of formal institutions, particularly where regulations are opaque and subject to interpretation, results in investors having difficulty obtaining precise information, mitigating real risks, and taking investment decisions.

Portfolio Activism

The more time spent in asset management, the better the returns. This will become important because as Southeast Asian markets mature, investors will not be able to solely rely on macroeconomic factors to enhance their returns.

Although adding value is believed to be one of the critical aspects of successful investing, the role of PE firms in Southeast Asia tends to be limited.

Investors find that unless they have tight relationships with portfolio companies, they will fail to provide significant additional value. Interdependence and collaboration between all parties are preferred, not least to successfully steer towards the exit process.

To boost value creation, fund managers need to complement their deal teams by recruiting dedicated and competent managers who combine experience in both banking and operations. For effective performance monitoring, their internal portfolio operating partners establish priorities and set timelines for achieving them as soon as deals are closed.

Value adding is also a way that firms can increase its influence over portfolio companies. Investments in Southeast Asia are typically minority plays as foreign investment restrictions require that the investors hold only minority stakes where investment agreements are unlikely to give minority investors legal rights to direct their companies.

The most imperative way of influencing them will be to demonstrate the added expertise brought by the PE firms.

Such PE firms pave the way for exit from the time they begin structuring their investments by ensuring tax efficient structures or by incorporating holdcos in listing-friendly jurisdictions. Operational expertise in the form of assistance in regional expansion and facilitation of further capital raising are key enablers.

Sales to strategic buyers remain the most probable exit route in Southeast Asia. Some PE firms have benefited from the demand for Southeast Asian assets, by selling investments to buyers at a substantial profit.

As many of the investments in Southeast Asia are still at a relatively early stage, it will be compelling to see how future successful exits will be achieved.