Thomas Granger and Arwel Lewis, Walkers assess the 'rapid growth and success of China's private equity industry' with Hong Kong as the central hub for the Asia Pacific equity industry
The rapid growth and success of China's private equity industry has dominated attention throughout Asia and with Hong Kong operating as a natural base for PE firms looking to action opportunities in the PRC, it is no surprise that Hong Kong has again been the focal point for private equity professionals in Asia.
The private equity focus over the past 12 months has also extended to Indonesia – one of the most active emerging markets in the region, with economic growth confounding the global slowdown. At the other end of the scale, Japan's private equity industry continues to struggle to gain momentum, although some success has been seen on the fund raising front in recent months.
In a recent speech, Hong Kong's Financial Secretary John Tsang lauded the success of private equity in Hong Kong, which together with China accounts for over half of the total private equity in Asia. Today, there are some 375 private equity companies now based in Hong Kong – with over 250 of these locating their regional headquarters there, taking advantage of the jurisdiction's close links to China.
China's burgeoning private equity industry approaches something of a watershed in 2012. Amid record levels of fund raising and inward investment, Chinese yuan denominated funds are competing with the initial dollar fund entrants to the market and the market is crowding at the same time that exits are being compromised by China's lengthy IPO approval process. The pressure is now on PE firms to produce the top notch returns that investors expect.
Whichever way you slice the data, there can be no mistaking the impression that private equity has had in China recently. Venture capital fundraising in China pulled in US$28.2 billion in 2011, which was an annual increase of 152 per cent, according to China's Zero2IPO, with 382 venture funds completing fundraising, up 141 per cent on 2010.
Ernst & Young's recent report on the industry pointed to more than US$35 billion raised by PE firms targeting investments in China over the past decade, with the vast majority of that collected over the last 10 years. The initial domination of this space came from global firms such as CVC Capital, Carlyle and Goldman Sachs – which achieved billion dollar plus fundraisings and strong returns. Today, it is the domestic Chinese firms leading the way, accounting for 80 per cent of all private equity deals in China in Q4 2011, according to Ernst & Young, with names such as Hony Capital and Fosun Group featuring strongly. With domestic LPs now coming into the picture and the encouraging policies to attract foreign GPs to establish funds in the local currency, the flow of capital into the yuan-denominated funds has been perhaps the industry's most notable recent trend. Hony Capital, which is seen as one of the best performers in China, has managed to raise close to US$4 billion from investors, while Fosun Group, which last year signed a US$100 million deal with Carlyle to make investments in China said recently it plans to increase its overseas investments with undervalued European projects in its sights.
The attractiveness of China as an investment destination is quite clear from the numbers within a sector report from Bain & Company and the European Union Chamber of Commerce, which reported a record US$16 billion of investment from private equity companies finding its way to China in 2011. This wave of investment, which is helping to drive economic growth, provided evidence of a healthy rebound from the weakness that followed the global financial crisis in 2009 and was concentrated on the technology, retail and industrial goods sectors.
Despite the impressive fund raising taking place in China, seemingly unaffected by global economic difficulties, China's PE industry is undergoing a phase of consolidation. The influx of new entrants to the industry in China has put upward pressure on prices, which has led to some concern – particularly for local currency funds - that the returns generated will not match those of previous years. The lengthy approval process for IPOs also means that many of the firms backed by private equity or venture capital will not make it to listing. As domestic growth slows, Chinese companies are looking overseas to expand, which is creating a new role for private equity, while GPs are looking to ensure they have the ability to impose operational changes on portfolio companies in order to remain competitive.
For Japan, pockets of strength have materialised in what has traditionally been one of the toughest markets in the region for private equity to build momentum. Fund raising remains difficult in Japan, not only still recovering from the tragedies of 2011, but where market participants have been hamstrung by a lack of dealflow in recent years, while culturally, private equity has always been viewed with some suspicion. For many firms, the thought of engaging with outside investors – particularly from overseas - that would restructure and not retain the business over the medium to long term is quite alien while government assistance for troubled companies and the availability of local financing have also conspired to depress dealflow. Limited domestic opportunities prompted local group Unison Capital to slash one of the biggest Japanese funds by around 25 per cent late in 2011, while global firms Carlyle and Advent International had also scaled operations in Japan.
Despite the difficulties in private equity fund raising in Japan, in what has not exactly been the most benign global environment, there have been some more positive signals over the past six months, from both domestic firms as well as from heavyweight overseas players. Japanese domestic manager Next Capital Partners was in the spotlight at the start of 2012 with an initial close of its second domestic fund. With US$50 million (Y4 billion) in place and another US$80 - US$140 million (Y6 – Y 11 billion) eyed, the fund aimed at turning around promising but struggling companies has had some success in a tough climate.
On a larger scale, US giant Fortress had already made significant progress with its second domestic real estate opportunity fund, with a first close around the US$200 million level and plans to reach US$1.3 billion. Industry reports indicated that the strong reception Fortress received with its initial Japanese real estate fund from 2010 – almost fully invested and doing very well – helped garner support for the latest fund. GreenOak, the manager launched by a group of former Morgan Stanley real estate stars, has also been active in the segment with recent reports indicating a US$200 million close for its debut Japan real estate fund. Reports point to the trough in commercial property values and the masses of CMBS debt due for refinancing, with a late 2012 target of US$500 for the fund.
While outbound private equity remains weak in Japan, notwithstanding the strong yen, inbound investment has been surprisingly robust in particular in the distressed real estate sector and strategic warehousing transactions. Market commentators are taking the view that Japanese real estate is undervalued compared with the rest of Asia, with some very substantial real estate sales taking place and buying by real estate investment trusts. One notable deal illustrates the trend, with China Investment Corp and the Government of Singapore Investment Corporation-backed Global Logistic Properties establishing a joint venture to invest in the Japanese logistics industry. With 15 Japanese properties in sight, this is one of Japan's biggest real estate deals this year valued at approximately US$1.6 billion.
Indonesia's economy is proving to be one of Asia's brightest performers, with strong economic growth and a stock market outperforming regional neighbours. Indonesia's Jakarta Composite Index hit record highs in early April, having added over eight per cent since the start of 2012 in the wake of a 6.5 per cent economic expansion in 2011 at a time when most of the world was contracting. The nation's fortunes have turned around dramatically since the Asian Financial Crisis and the symbolic return to investment grade for the first time since then along with the solid fundamentals have combined to create an extremely active private equity market, with international and domestic firms focused on opportunities in the financial, resources and infrastructure sectors amid robust demand from international investors.
Leading the charge is Indonesian private equity group Northstar Pacific Partners, which is backed by TPG and raised a spectacular US$800 million plus in 2011 in the largest Indonesian private equity fund raising to date. TPG alongside CVC Capital are widely acknowledged as the leading deal makers in the region, accounting for some 50 per cent of the US$1.8 billion worth of PE transactions since 2005, according to Thomson Reuters, while KKR and Carlyle are also key in South East Asia.
Domestically, the new breed of private equity managers in Indonesia, including names such as Antara Capital and Falcon House Partners are planning to raise private equity funds targeting Indonesia, as the local industry continues to expand following successful fund raisings in the past from managers such as Quvat Capital Partners, Saratoga Capital and Ancora Capital. The new funds coming to market are varying in size between US$300 and US$400 million, however Yawadwipa Companies, one of the newest groups to emerge is targeting a US$1 billion fund. Focused on Indonesia, this would make for the biggest private equity fund yet in the region.
Political interference in IPOs and a low ranking in the various surveys which measure the scale of corruption within economies provide two notable challenges to the growth of the industry, which commentators expect to produce over US$1 billion of deals in the coming years. M&A trends look decidedly positive, according to Kroll Mergermarket's latest regional briefing. With domestic companies looking to grow and overseas investors looking to join the party, foreign direct investment rose nearly threefold to US$13.3 billion in 2010, with FDI expected to reach US$20 billion for 2011. With inbound deals dominating M&A activity in Indonesia, international investors are expected to continue to show strong demand for the remainder of 2012, particularly as weakness persists in Europe and the US. Dealmaking is also expected to be spurred by the general elections in 2014, with firms looking to deploy dry powder before that date to avoid political instability which has been more notable by its absence in the last few years.
Elsewhere Mongolia remains the stand-out emerging market in the region with private equity funds continuing to jostle for investment opportunities in mining firms with quality assets, while mining equipment and services companies also rank high on their lists. Myanmar is also emerging as one of the last frontier markets in Asia and reappeared back on the radar for investors after a visit by US Secretary of State Hillary Clinton in December 2011, the first by a US Secretary of state in more than 50 years. It is not entirely surprising to see firms now laying the groundwork for a private-equity fund to invest in Myanmar. As opportunities increase in some of the newer emerging markets and private equity in China carves out a greater role in supporting targets for international growth, Hong Kong will remain central to the fortunes of the industry in Asia.
Arwel Lewis Arwel Lewis is a partner with Walkers' Global Investment Funds and Corporate Groups.
Thomas Granger Thomas Granger is a partner with Walkers' Global Investment Funds Group.
Walkers Bermuda, British Virgin Islands, Cayman Islands, Dubai, Guernsey, Hong Kong, Ireland, Jersey, London and Singapore.