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Private equity managers turn their focus to Asia-Pacific opportunities

The quest for returns in a maturing market

Despite larger deals, broader investment and strong returns in 2017 underpinning another solid year for Private Equity (PE) in the Asia-Pacific (APAC) region, a more challenging environment is emerging as the market matures and competition rises. With high valuations and a dwindling pool of attractive deals expected, fund managers may need to develop new capabilities to boost top-line growth and maintain a competitive edge.

Key insights

  • 2017 was seen as a watershed for the APAC private equity market but funds must prepare for changing business conditions
  • Debt restrictions and trade concerns are weighing on China, APAC's largest private equity market
  • Amid stiffer competition and a dwindling pool of deals, funds must embrace technology to drive innovation and spur top-line growth

Investors seeking to diversify portfolios propel record year
Softness in traditional markets has prompted investors to turn to the APAC region to seek products and managers to diversify their portfolios. The region's private equity industry achieved its best all-around performance in 2017, with larger deals and more active global investors.1 Deal value climbed to a record high of USD 159 billion during 2017, a rise of 41 percent year-on-year and 19 percent higher than the previous peak in 2015. The total number of individual transactions (1,015) was slightly down on 2016 but the average deal size soared 47 percent to USD 156 million. Meanwhile, the number of deals valued at USD 1 billion or more nearly doubled to 27.2

Consortium deals rise as more company owners welcome PE funding
Growth was driven by investor confidence in the region due to an improvement in the macro climate and by relatively attractive valuations compared to Western markets, which have become expensive due to rallying equity markets in recent years.3 High equity market valuations have prompted large institutional investors such as Singapore's Temasek to shift investment to private markets, encouraging public pension funds to follow.4 More “dry powder", money raised but not yet invested, was put to work by significant global players accelerating the flow of large deals, such as the USD 18 billion sale of Toshiba's chip unit to a Bain-led group.5 With capital better organized and the abatement of market volatility, the region saw an increase in consortium transactions. Almost two-thirds of deal volume involved multiple investors, about 15 percent higher than the previous five-year average from 2012 to 2016.6 The rise in pooled transactions triggered a sharp increase in USD 1 billion-plus deals as general partners (GPs), institutions and government affiliates competed for targets.7

High equity market valuations have prompted large institutional investors to shift investment to private markets

The market has also been spurred by company owners showing a greater willingness to turn to private equity for funding and cede control. The value of buyouts nearly doubled to USD 72 billion in 2017, representing 45 percent of total deal value compared to an average of 38 percent between 2012 and 2016.8 A rise in public-to-private deals to a new high of 17 percent of total deal value also underpinned PE investment.9

Challenges may lie ahead
While 2017 was seen as a watershed year, more challenging business conditions may be approaching due to increased competition and uncertainties in global trade. China, which accounted for almost half of the region's PE activity in 2017, has shown signs of strain as domestic credit restrictions take hold, and trade relationships with the United States remain unclear. Although venture capital and private equity investments have reached record highs in 2018, with USD 56 billion invested up to August 29, fundraising has failed to keep pace.10 Yuan-denominated funds have been affected, with fundraising running at USD 6.9 billion, or a little over a tenth of the full year total for 2017, according to data provider Preqin.11 The shrinking pool of dry powder could eventually affect investment returns. Up to 90 percent of operating funds could fail to hit their targeted returns, said a report by Chinese research firm Fuhang .12

Embracing digital innovation and transformation is expected to be a key priority for Asia-based private equity firms

The maturing market has resulted in more global firms setting up funds, driving up competition. More than 70 percent of APAC GPs said competition increased in 2017, especially from regional and local private equity companies, raising the difficulty of securing attractive deals while fuelling expectations of more modest returns. A majority see a dwindling pipeline of high-quality deals
and excessively high valuations as their top two challenges.13

Funds must look to technology
The maturing market will have implications for investment decisions and portfolio management, and firms may need to be more creative about where they invest their capital and their capital structure.14 To maintain returns, firms will need to help their portfolio companies boost top-line growth, which may require the development of new capabilities.15 Embracing digital innovation and transformation is expected to be a key priority for Asia-based private equity firms, given the region's companies often lack sufficient market data and analytics capabilities to drive commercial excellence.16 “Many Asian organizations lag behind in actual adoption and risk ceding a competitive advantage to companies that have built advanced analytics capabilities," a report by McKinsey noted in March 2018.17 Building these capabilities may also be important to help portfolio companies defend their position against digital disruption.

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Sources

  1. Bain & Company (March 15, 2018) Asia-Pacific Private Equity Report 2018
  2. Ibid.
  3. Reuters (July 21, 2017) Blackstone's Asia move shows eastern promise
  4. Ibid.
  5. Bloomberg (June 21, 2018) Japan needs some shake, rattle and roll
  6. Bain & Company (March 15, 2018)
  7. Ibid.
  8. Ibid.
  9. Ibid.
  10. Reuters (August 30, 2018) Winter ahead: China private equity industry faces turbulence after debt clampdown
  11. Ibid.
  12. Ibid.
  13. Bain & Company (March 15, 2018)
  14. Dechert (2018) 2019 Global Private Equity Outlook
  15. Bain & Company (March 15, 2018)
  16. McKinsey & Company (March 2018) Advanced analytics: Poised to transform Asian companies
  17. Ibid.