Playing to new rules
The Asian economic crisis of 1997 did not give rise to the birth of a private equity market in Asia but it was responsible for changing the way private equity houses looked at investment opportunities in the region so comprehensively as to make the new template virtually unrecognisable compared with its predecessor.
Tang Kok Yew (KY Tang), the Hong Kong-based chairman of UBS Capital's broadly-based Asia Pacific operations, neatly sums up the way in which the region's private equity industry has been transformed during the last five years.
"Prior to the 1997 Asian economic crisis, private equity in this part of the world was based very much on classic pre-IPO minority investments," he says. "In other words, you took a 10% or 20% equity stake in a company that was six months or a year away from an IPO at a p/e ratio of five, and hope to sell out again at the time of the IPO for a p/e of 15, tripling your money in the process."
That was nice work if you could get it, in the days when IPOs in Asia were routinely oversubscribed by 100 times or more. But that model of working has gone flat, as shown by the performance of private equity as an asset class since the crisis.
According to a study published by Cambridge Associates, investors in the broad market would have suffered a negative 3% return from the asset class between 1996 and 2001.
That does not mean that it has been impossible to make healthy returns from the Asian private equity market in recent years. But it has called for an entirely new approach to the business which, in turn, has seen scores of players either sharply reduce the size of their operations or close them down altogether.
For those that have taken their place the key word has been control. "Up until 1997 Asian families were generally very reluctant to give up control of their companies, and in any case bank financing was cheap and plentiful, so there was no incentive for them to do so," Tang says. "The Asian financial crisis put paid to all of that and allowed a totally new model to emerge."
With the emergence of this new model came new players into the Asian private equity market. By consensus there are five dominant houses operating in the region today: the Carlyle Group, CVC Asia Pacific, JP Morgan Partners, Newbridge and UBS Capital. All have enjoyed a degree of success in spreading their investments across the Asia Pacific region, although UBS Capital claims to have achieved a broader geographic diversity of its portfolio than its peers. "We have done eight buy-outs in five different countries across the region," says Tang, "which is more than any other private equity player in Asia, and the reason we've been able to do so is because we've invested in the necessary infrastructure.
"We now have five offices in Asia, located in Hong Kong, Singapore, Seoul, Tokyo and Sydney."
Mando warms up the market
UBS Capital's first deal was the buy-out of Mando Climate Control in Korea in 1999, which Tang says was a transaction that acted as a critical pathfinder for future transactions in north Asia.
"Funding of that size for a buy-out had never previously been raised in the region and plenty of people, including ourselves, questioned whether or not it could be done," he recalls. "In the event virtually all the Korean banks approached contributed to the debt facility and we closed the transaction very successfully, which really set the pace for other deals."
For UBS Capital, those other transactions included Mando Corporation and Haitai Confectionery in Korea, the $200m Wong's Circuits LBO in Hong Kong, the buy-out-cum-leveraged recapitalisation of SDL Leasing in Singapore and the restructuring and recapitalisation buy-out of NS Electronics in Thailand, which saw it take a 69% stake in the semiconductor manufacturer for $55m in February 2000.
A co-investor in several of the UBS Capital transactions in north Asia has been JP Morgan Partners, which in May 1999 set up a fund worth $1.1bn, some 25% of which was invested by JP Morgan Partners itself, with the balance coming from prominent institutions and families from throughout the world. Its Hong Kong-based chief executive officer, Andrew Liu, reports that about half of the fund has been committed to investments principally in north Asia, the bulk of which has been channelled into buy-outs. Of those, Korea has accounted for the lion's share, with JP Morgan Partners a lead investor in the high profile buy-outs at Mando Corporation and Haitai Confectionery.
In Hong Kong, meanwhile, JP Morgan Partners led the buy-out of the semiconductor company ASAT in 1999, which is recognised as having been Asia's first US-style LBO supported by a high yield bond and a leveraged loan facility.
In terms of size, all these deals will be eclipsed by the forthcoming LBO of Kumho Tires in Korea, a $1bn-plus transaction in which JP Morgan Partners and the Carlyle Group are the lead investors, and a debt facility of some $700m is being arranged by JP Morgan alongside a group of leading Korean banks.
For its part, the Carlyle Group has had a presence in the region since January 1999, when it set up Carlyle Asia Partners LP, and by the end of 2001 some 9% of its worldwide private equity investments had been accounted for by Asia. It now has a staff of 18, six of whom are based permanently in Seoul, with two in Singapore and the remainder in Hong Kong.
"In terms of our priority markets Korea has been by far the most important," says Michael Kim, president of Carlyle Asia, which made its main splash in the region with its $450m all-equity acquisition of KorAm Bank in November 2000. "Korea has been the deepest market in the region and provided the best quality dealflow - and investors have also made money in Korea, which is not something that can be said of all the Asian markets."
Aside from its investment in KorAm, Carlyle teamed up with CVC Asia and PPM Ventures in the buy-out of Mercury from Daewoo Telecom in 2000, and in the same year it also made its first foray into the Taiwanese market with the buy-out of the cable TV multi-systems operator Taiwan Broadband Communications.
Most recently, Carlyle also took its first step into the mainland Chinese private equity market with the $125m investment in the Pacific China department store chain.
Local coverage needed
Another of the more prolific private equity players across the region is CVC Asia Pacific, a 50:50 joint venture between CVC Capital Partners and Citigroup, which has offices in Hong Kong, Australia, Taiwan and South Korea and is in the process of opening an additional outlet in Tokyo. According to a Hong Kong-based company spokesperson, CVC Asia has now invested 40% of its $750m fund, participating in landmark transactions such as the buy-outs of Mando Climate Control, Haitai Confectionery and Mercury in Korea, Wong's Circuits in Hong Kong and Li & Fung Distribution in Singapore.
The successful private equity operators in Asia all insist that the region needs to be given comprehensive and dedicated coverage, and that suitcase investors winging their way in from Europe or the US are unlikely to meet with much success. Even for those with a physical presence in the region, investors warn, the market is challenging. "The first observation I would make about Asia is that each market is very different," says Kim at Carlyle.
"I would say that differences from market to market in Asia are far more pronounced than they are in Europe. Korea, for example, is a very different proposition from the PRC or India."
A hard market
A by-product of the fragmented nature of the Asian market, from a legal, cultural, linguistic and economic perspective, has been that each new transaction that private equity firms have taken on has involved a colossal amount of preparatory work and due diligence. "On the whole, deals do take longer to close in Asia than in the US or Europe," says JP Morgan Partners' Liu. "The Kumho Tires deal that we and Carlyle are now in the process of concluding involves about $300m in equity, so $150m each, and we have been working on it for nine months."
That is a short period compared with the time UBS Capital spent working on its NS Electronics transaction in Thailand, affectionately described by Tang as having been a "nightmare" in terms of the time and logistics involved, given that the entire deal took two years to close.
"We had to negotiate with 23 Thai and foreign banks in a country which, at that time, did not have a clear bankruptcy code. During the negotiations, eight of the 23 banks went bust and had to be rescued by the government. We therefore had to be constantly negotiating with the banks and various parties from the ministry of finance, the Thai Central Bank, and the national debt restructuring committee," says Tang.
Another deal involving major complexities, says Tang, was the $200m Wong's Circuits LBO in Hong Kong closed in August 2000. "Wong's was complex because it was a multi-jurisdictional deal," he explains. "It was a Hong Kong-based company registered in the Cayman Islands with most of its production facilities located in mainland China, which meant that we needed security over Chinese assets, which is always challenging. But the company was also listed in Singapore, which meant that we were dealing with Singaporean takeover legislation, and it has operations in the UK and the US.
"All in all, we had seven sets of lawyers on our side, seven on the banks' side and seven on the company's side. It took about six months to close the deal, and at the end of it we were physically and emotionally drained."
Covering all the angles
Making absolutely certain that there are no holes left in the due diligence process is essential, because a common characteristic of all the leading private equity investors in Asia is their reluctance to take minority stakes in target companies and their insistence on playing a very active, hands-on role in the management of the company.
That does not mean telling Mando Climate Control where to sell air conditioning units, or advising Haitai Confectionery about the optimum sugar content of chocolate biscuits. Instead, it means investors drawing on their international expertise to ensure that senior management is of the highest quality - irrespective of nationality or age.
"Control over our investments is an important priority for us," says Liu at JP Morgan Partners, "and one element of control is retaining the right to change the management team if things don't work out."
Already, as Liu explains, JP Morgan Partners has been proactive in installing new senior executives in virtually all of the big ticket investments it has made in the region aimed at augmenting existing management teams.
For example, Liu says that in the case of Mando, JP Morgan Partners was able to complement a very strong management team by appointing to the board a number of people with experience of the global automotive industry harnessed at Lucas Varity (in one instance) and Ford (in another).
That management team, says Liu, has already proved its worth. "When we bought Mando it was already a great company, but we set out a number of important strategic objectives aimed at making it even stronger," he explains. "Those included cost cutting, improving the quality of the product and reducing its dependence for revenue generation on Hyundai. Already, many of those objectives have been achieved and the company has taken great strides in securing orders from global manufacturers such as General Motors, Ford and DaimlerChrysler. So the management team at Mando has surpassed our original expectations in meeting the strategic objectives we laid down for them."
Liu says that JP Morgan Partners has been known to take minority holdings in companies, although this is the exception rather than the rule.
The same is true for UBS Capital. "In exceptional circumstances we will look at minority participations," says Tang, "although the nature of those investments will be very different to what they were before the 1997 crisis. For one thing, they would be much bigger stakes. Prior to 1997 we saw a lot of deals worth between $3m and $5m being done; today I very much doubt that we would look at anything below about $25m."
Even then, says Tang, three conditions would have to be met for UBS Capital to take a minority holding in a target company: "First, we would only do so in countries where there is a sufficiently well developed legal and financial infrastructure," he says, "which means that a market like Australia would be fine, whereas one like Indonesia might not be. Second, we would only take minority holdings in companies and countries where there is an understanding of and an acceptance of the sort of corporate governance standards that we require.
"And third, we would only invest in companies where we can negotiate strong minority protection rights and have them being legally enforceable. Usually in cases, we would also sit on the board and be able to exert strong influence over strategy, financial management and all key business decisions."
Local shop for local people
All private equity firms operating in Asia appear to agree that is essential - probably more so than in most other areas of the financial services industry - for them to present themselves as local companies, even though they may have foreign names and overseas parents.
That is chiefly a reflection of the fact that for most management teams in the region, selling a company at all - especially a family-owned one that has been in business for generations - is often viewed with regretful suspicion; selling to a foreign buyer is therefore even less desirable.
"In markets like Korea and China selling out to a foreign barbarian is seen as a last resort," says one private equity investor. "When you're sitting across the table with a potential seller you have to look and sound like a compatriot."
In Japan, too, private equity firms say that understanding of local sensitivities, and the capacity to present themselves as domestic (gaijin) companies rather than international opportunists is a must in the buy-out business. "Japan is only just coming round to the idea that private equity investors are not necessarily vultures intent on buying distressed assets cheaply, breaking them up and selling the parts off for big profits," says one Tokyo-based observer.
Small wonder that the international firms should aim, wherever possible, to staff themselves mainly with local professionals.
At 3i in Tokyo, managing director of Asia Pacific buy-outs Mark Thornton says that he is the only gaijin member of its 10-strong operation, and that the decision to make 90% of the team Japanese nationals was a conscious one. His co-senior MD, Yoshi Suzuki, is a Japanese national who was previously with Chase's investment banking division in Tokyo, and he bears responsibility for origination and marketing in the local market.
"I bring the 3i know-how and execution capability," says Thornton, "while Suzuki-san brings the knowledge of the Japanese market and Japanese sensitivities. As a gaijin who speaks no Japanese it would be very difficult for me to lead the business here. So we're trying to achieve the best of both worlds: importing the international experience and simultaneously respecting the local ways of doing deals."
The necessity to think, act and behave like locals is perhaps one reason explaining why a number of heavy hitting private equity players remain conspicuous by their absence in Asia, with the likes of KKR and Hicks, Muse of the US and Cinven of Europe not yet having dipped their toes into the market. Those on the ground in Asia give two other explanations for the non-appearance of some of the US firms.
"I think many of the US private equity firms have yet to venture out here because they have had some very bad hits to their portfolios in recent years and they are ensuring they get their domestic housekeeping sorted out first," is a polite explanation given by one competitor.
The fact that the likes of KKR have probably developed a reputation for an aggressiveness that would be antithetical to most Asian tastes - and which the film Barbarians at the Gate has unforgettably etched on to memories across the globe - is a slightly more controversial explanation offered by several others. In the meantime, the five dominant players report that they are happy to have the market more or less to themselves. *