Private equity or PE is a form of equity investment in companies that are predominantly not listed on any stock exchange. Capital for private equity is raised from institutional investors and high-net worth individuals, and it can be used for funding start-ups to develop new products and technologies (venture capital); financing organic growth and acquisitions (growth capital, buyout) strengthening balance sheets (special situations); or as Singapore investors are more familiar with to develop, manage and exit a property. CapitaLand Investments (CLI) and Mapletree Investments both have private equity funds focused on various property asset classes. CLI is one of the top 10 globally and the third best-performing year to date, according to Bloomberg. Back in 2014, City Developments’ (CDL) profit participation securities (PPS) was a private equity offering with a couple of partners.
Private equity investments are typically made by private equity funds through a fund partnership that has a closed-ended structure with a certain fund term. Many private equity funds have a life of 10−12 years. Private equity funds are typically structured as limited partnerships, where the private equity manager has the status of a general partner (GP) and the investor serves as a limited partner (LP).
When the GP identifies suitable investments for the fund, LPs are asked to contribute capital. This process is known as a capital call or drawdown. The GP makes investments in portfolio companies during the first four to six years of a fund term. During this period, the GP seeks to invest in eight to 12 portfolio companies and every time a new investment is about to close, the GP will send LPs a separate capital call.
After an investment in a company has been made, the GP seeks to increase its value through active ownership over three to six years by driving growth (organically or via acquisitions), improving profitability and enhancing operational efficiency. Once the value-creation goals are achieved, the GP seeks to exit the portfolio company, typically through a trade sale to an industry buyer, a secondary sale to another private equity fund, or an initial public offering.
Once the GP has sold a company, distributions can be made to the LPs. Distributions could be through private equity waterfall, a colloquial term for the way partners distribute their share of the profit in an investment. Distributions of profit are usually agreed upon in certain legal documents. In the waterfall structure, LPs are often paid first, after expenses, including fees. The GP, who also receives fees, is usually the last to get paid. Some early distributions can occur already during the investment period of a fund, as a result of recapitalisations and dividends from portfolio companies. Distributions continue until the last portfolio company has been sold.
Thereafter, the fund is terminated, which typically happens at the earliest 10 years after a fund has been established. However, some private equity investments in Singapore are known to terminate after five years.
Pros and cons of PE investing
There are advantages and disadvantages of investing in private equity. According to academic research highlighted in a report by LGT Bank, long-term returns have historically been higher than for listed equity. Private equity investments have a low correlation to short-term movements in public markets. The management of a privately-held company has more flexibility than a listed company. Usually, a strong alignment of interests exists between the management of private companies and their investors.
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On the other hand, the private market is not liquid; it is difficult to find a seller for one’s stake. The investment period can be as long as 10 years and the performance depends on the private equity manager. During the investment period, cash flow could be challenging. For instance, it could be difficult to ascertain when a private equity fund calls for or distributes capital.
Whatever the pitfalls and challenges, according to the Monetary Authority of Singapore’s Asset Management Survey 2020, assets under management (AUM) of private equity increased by 54% y-o-y to $375 billion, while venture capital (VC) AUM rose by 16% to $16 billion.
Not all hunky dory
According to Bain & Co’s review of 2021, the amount of committed but unallocated capital waiting to be invested in Asia-Pacific-focused funds reached a new high of over US$650 billion, a level that will fuel investment activities in the region for years to come, the review says.
“Returns rose and private equity again outperformed the region’s public markets by four to six percentage points across 5-, 10-, and 20-year horizons,” Bain says of 2021.
Bain is cautious about this year and beyond on account of China. China’s private equity market may lose momentum. “Global LPs are increasingly concerned about China’s slowing economic growth and increasing investment risk, given rising geopolitical tensions and tighter industry regulations. Political and economic uncertainty also cast a cloud over the region’s exit market in the second half, particularly China’s,” Bain says.
In 2021, exit value fell and the value of IPOs dropped 50% y-o-y. The closing of the US IPO channel for Chinese companies reduced the number of Chinese firms listing in the US in 2H2021. Although more than 60% of Asia Pacific GPs remain confident about the region’s macroeconomic outlook this year, only 35% of China GPs are confident, according to Bain’s survey. Exits will be more challenging, and China-based companies will need to find alternative exit channels to the US IPO market, says Bain, adding that negative sentiment among global LPs has also slowed Greater China-focused fundraising.
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On the other hand, India’s private equity market may benefit. China and India are similar in population, growth rates, and state of development. For Asia-Pacific-focused funds attracted to the Internet and tech sector, India’s increasing digital penetration and strong domestic IPO market are likely to be a powerful lure.
High valuation continues to be the No. 1 concern of Asia Pacific GPs. To deliver strong returns, successful funds increasingly take a comprehensive approach to value creation. Other Asia Pacific countries enjoyed a robust exit climate throughout 2021. Technology company exits were strong in India and Southeast Asia. India’s domestic stock exchanges achieved a record IPO value, fuelled by looser listing requirements and strong liquidity.
However, private equity funds hold ageing portfolios with significant exit overhangs. The share of Asia Pacific private equity portfolios with a vintage of greater than seven years increased in 2021, with significant overhang in the 2015 to 2017 vintages according to Bain. The exit trend in 2022, especially via IPOs, continues to be affected by a range of challenges including Covid-19 containment measures in China, the performance of global equity markets, and geopolitical tensions.
