Private Equity Investing in Southeast Asia - A Region and A Rebound Not to Miss

Despite 2020 being an unprecedented year for many businesses and countries, with shutdown measures to contain COVID-19, the private equity (PE) industry in Southeast Asia actually grew by 4% in the first half of 2020¹.

PE deal activity increased by 107% in the second half of 2020 versus the first half². Moreover, Singapore saw growth in the number and value of PE deals last year, a bright spot amongst the decrease in overall investment activity across Southeast Asia³.

While an increasing number of PE investments have for the past decade or so been focused on China and India because of their relatively large market size and strong economic development, the focus on Southeast Asia is gaining momentum as a result of the US-China trade war, and President Biden’s tough stance on China.

Southeast Asia has long been an integral part of global trade due to its strategic location and is situated in the confluence of major trade routes. The region’s steady growth is driven by an increasingly affluent middle class, fast-growing domestic consumption as a result of increased wealth, rapid industrialisation and urbanisation, export growth, an increasingly well-educated workforce, and growing infrastructure spending. Despite a resurgence in COVID-19 cases and reintroduced restrictions across the region, Southeast Asia is still set for a 4.8% rebound in growth in 2021⁴. Thus, we are confident the region’s strong fundamentals will continue to offer exciting opportunities for PE investments in the coming years.

However, PE investing in Southeast Asia has its challenges and risks, therefore, we share our insights on how we mitigate them in order to improve our probability of success and limit risks in these complex investment markets.

Difficulty in Sourcing Deals

While there are many companies operating in Southeast Asia, the smaller scale of such companies relative to those in Western markets means few meet the criteria of adequate size and attractiveness for foreign investment funds. The prevailing PE business model of Western buyout firms to source and execute the biggest and most complicated transactions, may not be as effective in Southeast Asia. Our PE team in Southeast Asia focuses on the underserved mid-market and specific sectors to increase our chances of success in sourcing and closing the right deals in Southeast Asia.

Many successful family-owned businesses in Southeast Asia fly under the radar. By having strong local networks, knowledge and relationships with entrepreneurs and advisors, our PE team are able to create healthy pipeline deal flows. Additionally, we believe in flexibility when it comes to deal terms, types of investment structures and have completed investments using convertible debt.

Corporate Governance

A key challenge impeding PE’s growth in Southeast Asia, especially for the emerging markets, is complex corporate governance structures, a lack of transparent bookkeeping and inaccurate market information. PE firms must be prepared for thorough and sometimes time-consuming and expensive due diligence. In some Southeast Asian countries, corruption may also restrict entrepreneurship growth. Foreign investors will also need to be wary of governments that do not provide sufficient/strong legal frameworks to protect their investments.

We mitigate corporate governance risks/challenges in emerging markets by using the following tools:

• Background Checks: Reference checks, criminal, bankruptcy and adverse media checks.

• Due Diligence: Performing the necessary commercial, legal, financial and tax due diligence in order to identify and address potential red flags and reviewing relevant disclosures or seeking additional information on how these risks are managed by the company.

• Monitoring: Identifying and ongoing monitoring of environmental, social and governance risks

• Active Engagement: We view active engagement with our investee companies as a long-term process and our investments typically have board participation or observation rights, whereby we manage risks by constructive engagement

Valuation Challenges

Pricing an investment target is a tricky exercise that is a combination of both art and science. What makes it more challenging in Southeast Asia is having too much capital chasing too few quality deals, which can inflate private valuations. This can deter potential investments and reduce prospects for profitable exits. Pricing can also be influenced by structural benefits like liquidation preferences and preferred returns.

COVID-19 has also caused abnormal disruptions to the operations of many businesses justifying the need for normalisations to a business's financials. Whether businesses rebound to pre-COVID-19 conditions or have experienced structural changes often remains to be seen. Therefore, we ground our valuation perspectives with a deep understanding of local markets, the macro environment, a realistic assessment of the investee company’s growth projections and sound structuring to maximise reward/minimise risk.

Sources

1 Vistra Presentation - 2021 Private Equity Market Outlook and Trends in South East Asia

2 Bain & Company Southeast Asia Private Equity Report 2021

3 https://www.straitstimes.com/business/singapore-only-sea-market-to-see-growth-in-private-equity-deals-deal-value-in-2020-report

4 June 7 Report by Oxford Economics, commissioned by the Institute of Chartered Accountants in England and Wales (ICAEW)

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