Corporate Financing Analysis - Asian PE Market Growth Stutter Only Temporary - 01 MAY 2017

The maturing and expansion of the Asian private equity industry is ongoing, but as we have seen in 2016 and expect to see across the remainder of 2017, there are plenty of growing pains that come along with the assets class's wider success story. Indeed, across the total value of buyout deals being completed; the tally of successful exits made; and the fresh funds raised through capital commitments, the Asian PE industry has been in contraction mode and analysing the y-o-y data for 2016 would give anyone the impression that the asset class is in a bad state. But by zooming out to view all three indicators for the regional PE industry across a five-year time frame or longer, the initial concerns will be relaxed, as the asset class appears to be in a strong position to grow.

As such, it would seem that despite the recent contraction in broader industry activity, the level of buyouts, exits, and fundraising remains high - and in some cases still at the second highest level on record - on a historical basis. Taking this into account, we are of the opinion that the recent slump in industry activity represents more of a bump in the road, rather than a shift away from the PE industry's much talked about long-term growth trend in Asia. What is more, the fact that the industry has only seen a slight dip in interest, rather than a wholesale turnaround in sentiment suggests to us that it the PE industry is in a strong position to continue growing going forward over the medium to long-term.

2016: The Second-Best Year On Record
Asia-Pacific PE Investment By Deal Value, USDbn
Source: AVCJ

Pointing The Finger Of Blame

A combination of market turbulence, caused by political shocks seen around the world over 2016; and a slowdown in economic growth China, are largely to blame for Asian PE limited partners (LPs) choosing to adopt a more cautious approach towards investing over the last eighteen months or more. We acknowledged back at the tail end of 2016 that the growth of the PE industry in China, which in turn is instrumental to the PE industry across the region, was struggling and would continue to suffer going forward, and this has so far proven to be the case ( see ' The Blip In The Chinese PE Growth Trajectory ' , October 5 2016). While this is not a uniquely Chinese issue or trend, we note that given the rapid growth of its PE industry and the geopolitical and economic importance of the county, PE trends in China serve as leading indicators of emerging PE trends across the Asia Pacific region. We will look at three of those trends below.

Dealmaking: Down, But Not Out

Announced PE dealmaking slowed to a level of USD92bn in Asia across the 2016 full-year period, down from a haul of USD124bn in recorded deals in 2015. The largest deal of the year within this was global PE giant Kohlberg Kravis Roberts' (KKR) purchase of Japanese automotive firm Calsonic Kansei for USD4.5bn. While representing a 25.8% y-o-y slump in activity, the 2016 haul of announced deals still ranks as the second highest on record and just ahead of the USD90bn in deals recorded in 2014 - according to AVCJ and Preqin data. 2015 was always going to be a hard act to follow, however, and we point to the spike in the cost of making M&A deals as the leading factor in the settling down of activity last year. As Bain Capital research shows the average multiple of EBITDA-to-enterprise value for PE transactions in Asia reached a multiple of 17x in 2017, outpacing the previous record high average multiple of 16.6x in 2015. This mean that PE deals being targeted across Asia were significantly more expensive that those being made at the same time in the spiritual home of the buyout industry (the US), where the average multiple was at a seemingly more modest 10.2x last year. The spike in prices in China, in particular, was to blame, with deal multiples in the Middle Kingdom rising to an average high of 30x EBITDA-to-enterprise value, up from 26x in 2015. As a result, the higher price of deals combined with increased competition for assets, thanks to strategic acquirers having been granted more open access to capital market financing once more, saw overall PE dealmaking decline across 2016. Fast-forward to today, and conditions are not that different with the pricing headwinds continuing to blow. As such, we expect any uptick in announced PE dealmaking this year to be incremental at best.

Exits: Overhang Has Already Been Unloaded

Exit activity in the Asian market declined for the second consecutive year in 2016, with combined exits worth USD74bn completed. This was down from exits valued at USD93bn in 2015 and a record USD115bn a year earlier. The largest exit deal of 2016 came in the form of the USD7.4bn equity market spin-off of Postal Savings Bank of China ( PSB), a deal which stood alone as the only bumper PE exit to be completed globally last year. It was also noteworthy as the largest offering to be successfully completed globally in over two years, a situation made possible by a strong level of support from cornerstone investors who combined to buy up around three-quarters of the deal in the pre-sale. What is more, the cornerstones - which included China Shipbuilding Industry Corporation, which put up USD2.2bn, and Shanghai International Port Group, which contributed USD2.1bn - were predominantly state-backed ( see ' Hong Kong ECM Activity TO Enjoy Short-Term Bounce ' , September 28 2016). Despite the size of the PSB deal, we note that it failed to prevent exit activity in China slowing by a third (down 34% y-o-y) from a year earlier, thanks largely to a struggling ecm arena in China that was not especially welcoming to new offerings.

With buyout activity slowing y-o-y it is almost inevitable that exit activity would see a similar movement, and as the numbers show, that has certainly been the case. A key reason for this is that funds are no longer on the rush to spin off portfolio units. Indeed, with the overhang of assets seen just two years previously having now been largely spun-off after back-to-back bumper years for exits, GPs have the luxury of now waiting to sell down assets on a timeframe of their choosing, rather than the one being called for by investors looking for a return at the end of the traditional PE cycle. As research from Preqin and Bain Capital shows, the volume of assets on PE books which are considered to be 'vintage' (those which have been in the portfolio for seven years or more) has now dropped to less than a third at a level of just 29%. This is down from 36% as of the end of 2015 and from 33% in December 2014. Broadly speaking, PE investment portfolios now appear more balanced in terms of timeframes across the investment cycle, a factor which should make for a steady flow of exit activity going forward over the coming quarters and years.

Fundraising: Sat On Record Amounts Of Dry Powder

Fundraising was also down y-o-y in 2016, but in our view this is not a major concern for the PE industry as fund managers remain sat on near-record levels of dry powder that they are primed and ready to deploy for when the right opportunity presents itself to them. Despite the optimism, the headline figures for fundraising suggest a dwindling level of interest in the industry: 2016 saw the annual level of fundraising decline to just USD43bn last year, which represented not only the second consecutive annual decline in inflows, down from USD51bn in 2015 and USD64bn in 2014, but it was also a level below the five-year average for the industry in Asia. What is more, both the total volume of deals and Asia's total share of global fundraising commitments has declined four consecutive years across the same time period, with deal numbers dropping to as low as just 147 in 2016 (down from 226 in 2015, and 224 a year earlier) and the percentage of the global PE fundraising market falling to 9% (compared with 11% in 2015 and as high as 15% as recently as in 2014). Among the depleted haul of deals, by both deal volume and deal value, MBK Partners' bumper USD4.1bn close (the single biggest fund in Asia at present) was the stand-out fundraising deal of the year. The South Korean fund closed with fresh capital supplied by a number of offshore sources, including Singapore's sovereign wealth fund (SWF) GIC, and the Canada Pension Plan Investment Board - a factor indicative of a trend of overseas investors making up an ever-growing share of the financial contributions in the Asian PE arena.

It seems that after putting a lot of cash into funds in the region over the previous couple of years, investors have become increasingly picky over which general partners (GPs) they would be happy to work with. But as we have noted, just because fundraising levels have slowed, this does not mean that pockets are not empty; far from it in fact: the war chest of PE funds focused on Asia remains significant. According to data from research house Preqin, unspent capital focused on the Asia-Pacific region tallied USD136bn as of December 31 2016, almost flat y-o-y (dry powder stood at USD137bn in 2015), and only just below the record haul of dry powder which swelled to as large as USD149bn in 2013. The current stack, we highlight, is well above the historical average for the industry in the region and certainly bodes well for future activity levels going forward.

Drivers Going Forward

Despite the slump in PE activity in Asia in 2016, we are of the view that asset class interest in the region is growing more broadly owing to the fact that traditional core markets of the global PE industry - mainly North America and Europe - are struggling to deliver reliable returns to investors. Indeed, low growth and low investment rates across the West are sending PE investors further afield in search of new opportunities in emerging markets (EMs), with Asia standing in pole position to benefit from this strengthening trend. Why so? Because economic growth across the region is serving to provide a strong base for continued growth of the PE industry and interest from investors in developed markets more broadly. The strongest case to support this view comes in the form of the four growth outperformers that our Global team highlight among the major EMs as the economies to watch at present. Significantly, all four of these growth outperformers (China, India, Indonesia and the Philippines) are in Asia, and all four have undergone a raft of structural reforms over recent years, helping to foster investment and growth (although admittedly China is in the midst of a slowdown at present). Three of the economies - China, India and Indonesia - benefit from a large domestic market, which should provide a cushion against potential weakness in external demand, and will attract consumer-facing companies. Demographic trends vary sharply, with India, Indonesia and the Philippines gaining tailwinds from growing working-age populations while China faces the challenge of an ageing population.