After three years of historic, or near historic, performance in the Asia-Pacific region, the private equity industry showed no signs slowing down in the first half of 2017. Our analysis of data from the Asia Venture Capital Journal shows that investment value soared 30% to $57 billion compared to the same period in 2016, while first-half exit value doubled to $51 billion.
What’s increasingly clear is that PE investors are unfazed by the many geo-political and market shocks that have shaken global markets over the past several years, not to mention soaring asset prices and slowing growth in critical markets like China. In many ways, the maturing industry has settled into its own, drawing momentum from a unique set of fundamentals rather than bouncing along on the macroeconomic trends. The most important metric is that the industry is returning capital to investors on a steady basis and the top tier firms are doing so at extraordinary returns. That is showing up in the fundraising numbers: PE funds focused purely on the Asia-Pacific region raised $35 billion from investors in the first half of 2017 versus a first-half average of $26.9 billion over the previous five years.
As encouraging as these results are, however, general partners (GPs) focused on the Asia-Pacific region will also face some stiff challenges in the years ahead. In an age of superabundant capital, competition is coming from a wide variety of players, including sovereign wealth funds (SWFs), pension funds and large corporations, such as China’s BAT companies (Baidu, Alibaba and Tencent). An abundance of buyers makes it increasingly difficult to find attractive proprietary transactions in the Asia-Pacific region. That has helped drive already steep Asia-Pacific multiples to unprecedented levels, even as GDP growth slows across the region and interest rates begin to rise, blunting two powerful sources of value.
The combination of heightened competition, inflated multiples and a slowing macro environment hasn’t deflated the ample opportunity to earn superior returns in the Asia-Pacific region. But it does mean the sources of profit are changing. While funds operating in these markets have long been able to count on economic growth and multiple expansion to power returns, those days may be over. Growth in the region remains strong by global standards, but multiples are exceptional, too. This means that GPs will have to work harder than ever to find good companies, increase their value and exit them with market-beating returns.
The stakes couldn’t be higher. While capital continues to flow steadily into the region, it is landing with those PE funds that can demonstrate sustained, market-beating returns. These same funds are also the ones most likely to appeal to big LPs as co-investment partners. At a time when the industry’s sources of profit are changing, we find that the best GPs are focused on shoring up three key areas of the PE value chain:
- Smarter sourcing, including enhanced local networks, to find more proprietary deals and develop the differentiated insights necessary to gauge risk, assess potential and gain the confidence to outbid rivals at auction.
- Enhanced due diligence that views the target holistically, incorporating advanced analytics and a thesis-based approach to develop the kinds of insights that give a fund the confidence to weigh risk and value effectively.
- Creative post-acquisition value enhancement to overcome two major challenges to effective portfolio management in the Asia-Pacific region: a preponderance of deals featuring minority stakes and a marketwide talent shortage.
These are heady days for Asia-Pacific private equity but the best firms are already preparing for challenges ahead. A key set of questions can help assess where your firm stands on its full-potential journey:
- Has your firm defined a sweet spot with crystal clear criteria that identify which deals you like and which you don’t?
- Are you confident your firm knows of all the potential opportunities in your market?
- Can your firm develop sharp, proprietary insights about the companies it targets?
- Do your sourcing and due diligence capabilities give you a competitive advantage?
- Do you have an established panel of industry advisers and an expert network that you can tap into for sourcing deals and adding value post-acquisition?
- Has your firm developed a repeatable model for creating value in its portfolio companies, with a high degree of buy-in from the deal partners?