Private equity managers hope to benefit from trends in Asia

A growing number of business founders in Asia who traditionally restricted private equity firms to minority partner status have begun, selectively, to let them take controlling stakes in their companies.

Industry watchers say that trend is both an opportunity for private equity firms to play a bigger role in the region, and a challenge for an industry that has relied on the region's stellar growth as much as, or more than, its abilities to make a business leaner and meaner in delivering returns for their limited partners.

In 2005, private equity investors in Asia would have been “singing the praises of GDP growth alone — dynamic founders, minority stakes, how Asia is different from the West,” said Cyrus Driver, Mumbai-based managing director and head of India private markets at investment manager Partners Group, Zug, Switzerland.

Going forward, the gap between Asia and the West should narrow, with the focus in Asia shifting to “control investing,” and a private equity firm's “ability to add value post-investment becoming a critical differentiator,” said Mr. Driver.

Having more opportunities to buy 50%, 60% or 70% of a business in Asia is one thing; having the skills in-house to capitalize on that opportunity is another thing, said Vish Ramaswami, a Singapore-based managing director with Cambridge Associates LLC, and the firm's head of private equity and venture capital research for the Asia-Pacific region.

A survey of private equity firms in Asia released recently by business advisory firm AlixPartners LLP and London-based PEI Research & Analytics, showed 66% of respondents saying private equity firms in the region have lagged their counterparts in the U.S. and Europe when it comes to value creation. The same survey found 86% of respondents citing the prevalence of minority stakes in Asia as a factor limiting the scope for operational change.

Ready or not, observers predict a growing number of control opportunities in emerging Asia for private equity firms.

Slower growth in the region, succession issues and changing attitudes among entrepreneurs about the imperative of maintaining family control of the businesses they founded are all playing a part in putting more companies in the region in play, industry veterans say.

The past year or two has seen “a lot more transactions” where the founders of a business or the founders' families have sold a controlling stake to a private equity partner, a recognition of the pressing need to transform their companies and the role private equity partners can play in achieving that, said Ray King, a Melbourne-based partner with Mercer's investment business and the firm's head of research on private equity managers in the Asia-Pacific region.

Opportunities for control deals — allowing private equity firms to pursue “wholesale” rather than “incremental” value creation — will increase, spurred by succession issues, a growing focus on core competencies seen in markets such as Korea and decisions by some entrepreneurs facing growing competition to turn to private equity partners better positioned to pursue a global opportunity set, said Chin Chou, the Hong Kong-based CEO of Morgan Stanley Private Equity Asia.

Even in China, where MSPE Asia has focused almost exclusively on minority investments, “we've completed one control deal” recently and are in the process of completing another control deal for a “Hong Kong company with China ambitions” — opportunities that never would have been available a decade ago, said Mr. Chou. He declined to name the companies.

“In our deal pipeline 10 years ago, most ... would have been minority deals, because the good businesses were just not available for sale. But today, the majority of our deal pipeline is control situations, buyouts,” said Partners Group's Mr. Driver.

Recent data from Preqin Ltd., a London-based provider of alternatives industry data and research, show deals in Asia involving private equity firms taking a minority stake in a business at 60% of total private equity deals year-to-date through July 14. In comparison, they accounted for 69% and 71%, respectively, for calendar years 2013 and 2012.

During the same period, deals in which a private equity firm took a majority stake or a controlling stake in an Asian firm climbed to 32%, from 25% in 2013 and 20% in 2012, according to Preqin.

By contrast, Preqin's data show minority stakes accounting for only 25% of the private equity deals in the U.S. and 28% of deals in Europe, year to date.

Meanwhile, data from industry tracker Asia Private Equity Research Ltd., Hong Kong, show the portion of overall fundraising for Asia-focused private equity funds dedicated to buyouts, or control investments, jumping to 44% in 2013 and 32% in 2012, from well under 20% in 2010 and 2011.

Funds dedicated to “growth” or minority investments dropped to 36% in 2013 from 52% in 2012 and 64% the previous two years.

In a telephone interview, Kathleen Ng, a managing director at APER, said a $6 billion Asia buyout fund raised by KKR & Co. LP last year helped lift that year's total. While the proportion dedicated to buyout funds eased to 31% of the $17.7 billion in Asia-focused private equity funds raised for the first half of 2014, that still amounts to a significant rise from earlier in the decade, she said.

Some market veterans point to a more challenging economic environment — from slowing growth to restrictions on initial public offerings in key markets such as China — as the factor driving entrepreneurs into a fuller embrace with private equity partners.

Others cite generational change as well as changing attitudes.

Opportunities for control investments are growing now in Asia amid generational transitions that, in some markets, are seeing the baton passed from a founder's children to grandchildren who've been educated at top universities around the world, said Eng Aik Meng, a Singapore-based senior adviser with TPG Capital. In many cases, that new generation comes back to Asia more open to considering what a private equity partner could do to take the company to the next level, he said.

Still, even if control-style deals are likely to pick up market share in Asia, many industry veterans say minority investments should continue to predominate.

With the bulk of businesses in Asia controlled by a single private or government shareholder, minority investments will remain the prime opportunity for private equity money management firms for the foreseeable future, said MSPE Asia's Mr. Chou.

In China, which should garner roughly 50% of the firm's MSPE Asia IV fund, which closed July 7 at $1.7 billion, minority deals requiring “thoughtful diligence” in finding “really good companies, with committed entrepreneurs, an alignment of interests and a very good entry price” should dominate the opportunity set and continue to offer excellent returns for investors, Mr. Chou said.

And with sentiment toward China decidedly mixed now, valuations there are as attractive as they've ever been, he said.