The private equity (PE) market in Asia-Pacific (APAC) showed remarkable resiliency last year.
Despite geo-political uncertainty at home and abroad, the region delivered its second best year on record, based on deal value, behind unprecedented results in 2015.
However, even as the market continues its strong run, the days of “buy low, sell high” appears to have ended in APAC. Shifting profits and compressing returns are pushing funds to identify new sources of value with a focus on cost and capital efficiency and M&A opportunities.
Private Equity in APAC: By the Numbers
Bain & Company’s latest annual Asia-Pacific Private Equity Report found that investment momentum eased in 2016 due to a drop in the number of megadeals and softened deal activity.
Deal value slowed but remained solid, decreasing to $92 billion – down from $124 billion in 2015. Deal count also dropped to 892, after peaking at more than 1,000 the year prior.
The market continued to benefit from investor interest in Internet-focused opportunities, mostly in China and India, which comprised more than one-third of deals last year. In parallel, government and institutional investors remained an important part of the private equity landscape, driving 57% of deals worth $1 billion or more, as opposed to 18% for global buyouts. Yet, Asia-Pacific funds are still sitting on an ample supply of dry powder, which has remained largely flat.
After two years of vigorous activity, exits tailed off in 2016, partly due to a weak equity market in China that hobbled IPOs. In other APAC countries, the drop was a function of few remaining large assets that were ripe to sell. This eased exit value in the region from an all-time high of $115 billion in 2014 to a historically normal level of $74 billion. India, on the other hand, was fertile ground for exits last year, as was South Korea and Southeast Asia, thanks to a handful or large exits.
“After a record-setting 2015, we anticipated last year would be a much tougher deal-making environment – one that would make it more difficult for PE funds to generate market-beating returns,” said Suvir Varma, who leads Bain’s Private Equity Practice in Asia-Pacific. “Despite persistent challenges, PE firms rose to the occasion and delivered impressive results – the second best on record. They now face the task of sustaining this positive momentum amid another year of uncertainty ahead.”
The Hunt for New Sources of Value
Deal multiples reached new heights in APAC, outpacing levels in the U.S. – 17x vs. 10x, respectively. This, together with tightening interest rates squeezed traditional profit sources, causing PE firms to rely far less on traditional levers and look to new sources of value.
Bain surveyed about 120 general partners (GPs) and direct investors from across the region and found that about a fifth (22%) said they considered cost and capital gains to be the most important source of returns for deals exited five years ago; 6% cited M&A. Looking ahead five years, these factors are expected to increase dramatically in significance, with 37% of GPs pointing to margin efficiency and more than 20% to M&A. On the other hand, most respondents anticipated multiple expansion and leverage to both to go down.
Revenue growth, while still the most significant factor, is expected to plateau in the next five years.
“Wringing greater value from PE investments is much more of a priority than it has been in the past. It’s also not as straightforward as it once was,” said Sebastien Lamy, who leads Bain’s Private Equity Practice in Southeast Asia. “Funds that will thrive are those that understand they must exercise an entirely different set of muscles to win the best deals and unlock new sources of value.”
According to the survey, more than half of GPs said the top factor for success in this new environment is a plan for creative value creation. Yet, many firms admit that while they have increased their focus in this area, they need to execute more consistently. Nearly two-thirds of respondents said they had developed a value creation plan for more than 80% of their portfolio companies, but only 19% said those plans were implemented successfully and yielded the intended results.
GPs also cited a differentiated view on companies and sectors (46%) through more thesis-based due diligence, which produces insights that enable them to both win deals and realize a profit.
Finally, 36% of GPs said exclusive access to targets via smarter sourcing is essential to ensuring deal success. However, fierce competition is making this increasingly more difficult and few firms in APAC – less than one-third – believe they are operating at full potential on sourcing.
Bain & Company is an American global management consulting firm headquartered in Boston, Massachusetts. It provides advisory services to businesses, non-profit organizations, and governments, and is one of the Big Three strategy consulting firms.