Visibly bright, while private

Besides the similarities in business models, these two companies have something else in common — they are part of a growing wave of tech start-ups in the region gaining large amounts of fundraising from PE investors.

That said, the Covid-19 pandemic has significantly impacted the PE landscape in Southeast Asia — there are challenges in deal making, fund general partners (GPs) face difficulties in fundraising, and companies struggle to reach out to investors as borders remain closed throughout the virus outbreak period.

Yet, players are preparing for the light at the end of the tunnel. Border reopenings, a pick-up in deal activities as well as the introduction of special purpose acquisition companies (spacs) in Asia poised to induce excitement in the region’s PE market are providing bright spots of opportunities.

According to data compiled by Bain & Co, Southeast Asia’s deal value recorded in the first half of 2021 is already on track to surpass the 2020 full-year value. In 1H2021, there were 1,216 deals, valued at a total US$11.5 billion versus the 735 deals valued at US$6.3 billion in 1H2020.

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The momentum is intact. Usman Akhtar, partner and head of Southeast Asia PE Practice at Bain & Co, says there are indications of more vibrant numbers on entry and exit in 2H2021 and 1H2022.

The way he sees it, there are three factors pointing to a broadly-optimistic outlook of the region — “interesting” exit numbers, more pre-IPO stage deals as well as a rise in numbers of newer entrants.

“The exit numbers will look a lot more interesting than they did compared to the past two to three years, because I think we will see some pretty splashy IPO and spac deals. With the news around the listings of Grab and GoTo, as well as other companies such as FinAccel, the numbers would definitely look more vibrant moving forward,” says Akhtar in an interview with The Edge Singapore.

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He takes this as a good sign. Historically, one of the biggest “pains” of the private equity (PE) scene in Southeast Asia is that the so-called “paid-in-ratio” isn’t good enough. “In other words, it is not returning that much cash to the limited partners (LPs), so having a thriving exit landscape is very important,” says Akhtar.

Amid the ongoing disruption and economic uncertainty, PE returns in the broader Asia Pacific remained strong. According to data by Preqin, the median net of internal rate of return (IRR) last year was 12.4%, slightly higher than 12.3% recorded in 2019 and significantly outperforming the global benchmark.

This asset class continued to outperform public markets over the five-year, 10-year and 20-year horizons, investment firm Cambridge Associates found. As at September 2020, Asia Pacific buyout and growth funds’ end-to-end pooled net IRR was 12%, 11% and 11% in the 5-year, 10-year and 20-year horizons respectively, while MSCI Asia Pacific mPME (modified public market equivalent) provided 9%, 6% and 5% returns respectively.

According to Bain & Co’s Asia Pacific PE 2021 report, GPs are optimistic that the trend will hold — more than 70% believe returns will remain steady or increase during the next three to five years.

Besides the PE firms, banks such as Pictet, offering wealth and asset management services, are actively involved in the PE space too. Over the years, the bank has formed a network of close ties with various general partners managing the PE funds and early backing by the bank has helped these managers put the capital they managed by the bank on behalf of its clients, into good use. “The capital allocation by PE firms is extremely good says,” Francois Pictet, a partner of Pictet.

Pictet notices that PE firms do not really think in terms of properly defined industry sectors. Rather, they think in terms of business models – a more bottom-up approach, versus a top-down macro one. “Through fundamental analysis, they focus on business model and cash flow generation, which gives PE a strong discipline. And they will direct more capital into it, they are very nimble. This is a key factor for the success of PE,” he says.

Growth over the years

The alternative investment market in Asia is set to experience explosive growth in the coming years, with private capital assets under management (AUM) on course to reach US$6 trillion by 2025, according to Preqin. In its report released June, the firm says private capital is playing an increasing role in asset allocations across Asia Pacific, as demand to access this fast-growing and diverse region remains robust.

Asia Pacific-focused private capital AUM has expanded almost sixfold over the past decade, reaching US$1.71 trillion as at September 2020 — with US$133 billion raised during 2020 alone. Combined with the US$156 billion in Asia Pacific hedge funds as of Q42020, the region is fast approaching the US$2 trillion milestone for alternatives, the report notes.

When it comes to PE specifically, the landscape has also grown exponentially over the past decade — what was once a very small market has increased massively in size, led by China and India. According to data by Bain & Co, Asia Pacific deal value rose to a record US$185 billion in 2020, up 19% over 2019 and 23% over the previous five-year average.

Naturally, as this market grows and different players become more mature, different sub-trends will form. Akhtar says the region boasts different types of deals — more developed markets like Australia, New Zealand, Japan and South Korea, to some extent, have seen a lot of buyout deal activities whereas markets like China and India have ample growth and minority deals.

Meanwhile, Southeast Asia has skewed more towards growth deals, says Akhtar. “Southeast Asia is a very growth-heavy market. The region, which was previously dominated by buyout deals, was impacted heavily by the growth of tech which has changed the composition of the deal flow.”

“The market has been somewhat lumpy. It has been subjected to certain megadeals, sometimes skewing the numbers by their existence or the lack of existence from one year to another. However, I think it’s still a market that has got a lot more growth potential when it comes to PE penetration because it is still, in some ways, under-indexed in Southeast Asia,” he adds.

Also, the headline figures might not tell the whole story. For example, some of the most notable megadeals that have taken place in the region were driven by ride-hailing giant Grab and its Indonesian counterpart Go-Jek, which has formed a merger with e-commerce unicorn Tokopedia. According to insights provider Crunchbase, Grab has raised a total of US$12.5 billion in funding over 34 rounds, while Go-Jek and Tokopedia have collectively raised over US$8 billion in funding prior to the completion of the merger.

As such, industry players appreciate that Southeast Asia is also a complex region, where the nature of PE does not follow the same template from country to country. Singapore, for example, has very different characteristics from Indonesia and Thailand, even though all three countries are very close neighbours.

“Within the region, you will see differences in level of openness and activity. For example, Thailand has never been a very large PE market, whereas in the last couple of years Vietnam has become a much more interesting market to regional as well as global PE investors relative to its earlier years. So yes, it is a complex space and it is very difficult to master as a PE firm or a GP, and not many have found sustained success,” says Akhtar.

Competition and expectations

Despite the complexities, Southeast Asia is still an attractive one for investors. The region holds a lot of promise to investors, housing one of the fastest growing populations globally, a rapidly expanding middle class and one of the highest digital penetration rates in the world. With a projected annual growth rate of 5.5% per year, Asean is forecast to overtake Europe and Japan to become the fourth largest economy by 2050, supported by the favourable demographics.

According to data compiled by US-Asean Business Council, ISEAS-Yusof Ishak Institute and East- West Centre, over 380 million people or 58% of the population are under the age of 35, roughly 20% larger than the entire population of the US. Asean’s middle class is expected to double in size from 24% to 51% of the population by 2030 and it is estimated that nearly 70% of Asean’s population will live in urban areas by 2050.

Hoping to leverage on the opportunities available in the region, there are many global PE giants such as KKR and CVC setting up shop in Southeast Asia. At the same time, there is no shortage of competition, says Akhtar, as these global GPs are rubbing elbows with institutional investors including government-linked investors such as Temasek and GIC, which have the formidable ability to do direct deals due to their familiarity with the markets.

Competition also comes from different types of investors outside of the PE gap. Crossover investors — defined as investors who are active in multiple segments of the private investment markets are building their presence in the growth equity space, says Akhtar. This includes the likes of Softbank Vision Fund, Tiger Global and Sequoia entering the market with growth equity vehicles as well as early-stage vehicles.

“Combined with the PE firms that are more willing to invest in late-stage rounds of tech companies, the landscape has seen a mishmash of global GPs, government-linked investors, and growth equity venture capital investors who sometimes overlap in terms of the deals participated. This is something that has taken place for a while now in this region,” says Akhtar.

Not all investors share the same level of optimism. Brahmal Vasudevan, CEO of PE firm Creador Capital Group, argues the region has been stagnant in recent years. There were many waves of excitement among global GPs in the region specifically for opportunities in markets such as Indonesia and Vietnam, yet the returns have not matched the expectations, says Vasudevan.

In general, he says, returns have been disappointing. Investors, hearing about the success stories in other emerging markets, such as those from BRIC (Brazil, Russia, India and China), have gotten their expectations too high. They expect to see the same kind of returns in Southeast Asia. “Unfortunately, some GPs realised along the way that they could have gotten better returns by deploying their funds in the US and countries like China and India,” says Vasudevan.

The problem, he adds, is that the deal sizes in Southeast Asia are not very large, hence not being able to deliver the return expectations of large funds. In fact, there are very few deals over US$100 million in the region, says Vasudevan. There are also many country-specific funds that have delivered weaker returns compared to those with a pan-regional approach.

Akhtar does not disagree entirely. He points out that yes, for economies smaller than any of the BRIC countries, such as Malaysia, there is always concerns among GPs regarding the number of investable assets and deal sizes. “Of course, there has been growth, but I think it is still early innings,” he adds.

Liquidity challenges

One of the biggest challenges in the Southeast Asian private markets landscape is exit — this has been historically one of the largest pain points, says Akhtar. It has not been consistently vibrant, having its ups and downs even in recent years.

In the first half of 2020, the region’s investors saw 28 exits, according to the Southeast Asia Exit Landscape Report 2.0 by Golden Gate Ventures and Insead. Of these, the average valuation at exit is US$27 million. This includes two IPOs and 26 acquisitions or secondaries, valued collectively at US$7 million and US$379 million respectively. In comparison, the first half of 2019 saw 50 exits.

Broader Asia provided a different story. Asia Pacific deal value rose to a record US$185 billion, up 19% over 2019 and 23% over the previous five-year average, according to Bain & Co. Exit deal value totalled US$70 billion, down 24% y-o-y and 40% from the previous five-year average as PE managers waited for better times to sell portfolio companies.

Due to the pandemic, many GPs put planned sales on hold, preferring to wait out market uncertainty. Instead of exits, they pivoted their attention to keeping portfolios in the black.

Within Asia Pacific, the most common exit is via IPOs, making up more than 60% of exits by value, almost double the previous five-year average. As stock markets remained open even during lockdowns and investment activity recovered quickly after the first quarter, PE funds were able to complete sales in the second quarter that had been initiated earlier, but stalled during the peak of the crisis, the report added.

While liquidity has been a concern in broader Asia, Cambridge Associates managing director Vish Ramaswami says more liquidity can be expected in the near future. Of late, there is an increasing number of Asia PE and venture capital-backed companies being listed on the Nasdaq, stock exchanges in India, Hong Kong, and increasingly, China — especially on the Star Market. Started just in 2019, the Shanghai-based bourse has been described as China’s answer to the Nasdaq.

“There’s definitely more liquidity available for PE and venture capital-backed companies in markets like South Korea, Japan, Australia, Hong Kong and Singapore. These are mature markets, where finding an exit is not an issue especially for PE-backed companies with the availability of avenues such as buyouts.

“Based on the portfolio of funds that we have invested our clients’ capital in, liquidity has been strong over the last couple of years. For many managers, exits and proceeds in 2021 have been robust. Of course not every fund experienced this, but this is what we have observed,” says Ramaswami.

The caveat, however, is that there may be temporary swings. The NBFC crisis in India, China’s EdTech crackdown and the Covid-19 pandemic has shown that there may always be events that would make it difficult for investors to exit.

Interestingly, there is a key attribute of PE — they are willing to take a longer view than many market participants. A PE fund can take positions in the portfolio companies for as long as a decade, or a year, or two more.

“That’s a long runway for a portfolio company to have to pivot and they are also not immediately buffeted by share price plunges or short sellers. A good manager would know how to react to these crises, which helps the market to see which are the more resilient and savvy ones,” says Ramaswami.

Will spacs improve exit prospects in Southeast Asia?

The special purpose acquisition companies (spacs) frenzy took Wall Street by storm last year. Also known as blank check companies, there were over 250 spac filings raising more than US$75 billion ($102.85 billion) recorded in 2020. The momentum continued in Q1, when a total of US$88 billion were raised by 320 spacs, according to S&P Global Market Intelligence.

In Asia, Singapore has allowed spacs to list on the Singapore Exchange (SGX) since early September, kicking off the race to issue the first of such listings in the city-state. Pegasus Asia, Vertex Technology Acquisition Corp and Novo Tellus Alpha Acquisition are three of the spacs that have listed on the SGX so far.

Meanwhile, Hong Kong Exchanges and Clearing has allowed special purpose acquisition company (SPAC) listings starting this year. Parties that have applied for the listing include China Merchants Bank-backed Aquila Acquisition Corp and Chinese PE firm Primavera Capital.

Indonesia has also been reported to mull over spac listings on its local bourse, yet details have been sparse.

Malaysia is one of the few Asian countries which has had a spac framework since 2009. Amid development in other markets, however, its capital markets regulator has revised its spac framework to facilitate greater access to fundraising in Malaysia.

Usman Akhtar, partner at Bain & Co, says he is interested in seeing whether this would lead to a growth in success stories of public debut for fast-growing homegrown tech companies in the region, be it via spac or a traditional IPO route. This would bring even more attention to the space in Southeast Asia, because general partners (GPs) will start to feel like the region has got a vibrant exit environment.

With easier access to a spac listing, will companies in Southeast Asia go public earlier, instead of staying private for longer? It is a possibility, says Johnny Lim, director at Resource Law. He explains that in the ordinary course, a fast-growing company would go through a seed financing stage, followed by venture capital and private equity funding (in the form of Series A, B, C as well as potentially D, E and F funding rounds).

Each new funding round would be accompanied with a higher valuation, and a round of negotiations with new or existing investors. This goes on until it reaches a certain stage of maturity to be sufficiently attractive for a trade sale or it is able to achieve the financial condition required for an initial public offering.

“With spacs, one possibility is that a fast-growing tech company may grow to a certain size, say at Series C but not be profitable yet. It is likely subject to a longer runway — needing more time and funding to become profitable. At this stage, apart from choosing to grow via the traditional route of Series D, E, F, the company can also consider a business combination with a spac.

“The latter is already pre-funded, and a potentially faster and less-tedious growth path to access the capital markets rather than going through D, E, F then seeking a direct listing. The business combination (or de-spac) would also carry with it the advantages of a spac, particularly the certainty of upfront funding and certainty in valuation,” says Lim.

Akhtar says that a spac listing would provide a fast-growing company with some valuation assurance, therefore also offering some of the benefits that a private market fundraising would typically provide. Therefore, a strong, supportive and healthy spac industry could encourage companies to go public earlier.

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