Asia-Pacific private equity: Working through a multiyear transition. After a second year of disappointing results coming off a decade of record capital inflows, it is increasingly clear that the private equity (PE) market in the Asia-Pacific region has hit a wall of reality. Amid slowing economic growth and a difficult deal environment, many PE funds have struggled to deliver on the skyrocketing expectations of the pre-2011 boom period. Investors have cut back new commitments as they wait for earlier bets to pay off. This downtrend is scarcely what investors imagined when they flooded into hot markets such as China, India and Indonesia, eager for exposure to double-digit economic growth and expanding legions of middle-class consumers. What’s become evident, however, is that the situation on the ground has been much more difficult than anticipated.
With economic growth slowing—most notably in China—and some markets hampered by currency and governance issues, many companies acquired at peak prices during the boom years have come under pressure. But because a large number of deals in Asia were structured with minority stakes, the industry has found itself with a limited ability to affect outcomes. Meanwhile, volatility in the IPO markets has made it difficult to exit even winning investments. The result is that funds have been forced to hold on to aging portfolio companies for longer than they would like, and growing piles of unspent capital have ensured that competition for any new deals is intense, keeping valuations high.
A look behind the headline numbers, however, provides ample reason for optimism. The extended downturn in the Asia-Pacific region is forcing a healthy shift in the behavior of PE firms (general partners, or GPs) and their investors (limited partners, or LPs), which is already setting the stage for a new period of more sustainable growth. Given the region’s persistent challenges, progress will not be immediate. But a burst of new activity in early 2014 has given the industry some welcome signs of momentum.
LPs continue to express confidence about Asia’s long-term growth potential. But as they wait for earlier commitments to prove out—especially in overinvested markets like China and India—they are slowing the pace of new Asia-Pacific investments to the benefit of previously dormant developed markets like North America and Western Europe. In addition, they are shifting their focus to a “newer” set of emerging markets like Sub-Saharan Africa and Latin America.
At the same time, LPs are becoming increasingly selective with their commitments in the Asia-Pacific region. A clear flight to quality is taking place, accelerating a shakeout among GPs. Over time, that promises to reduce the market’s overcrowding and eliminate those PE firms having trouble producing results. The transition is proving slow and painful, but it will ultimately help restore growth.
The GPs weathering this transition are progressively shifting their focus and raising their game. The best are sharpening their investment model by taking a more activist approach to deals and more closely defining where they create the most value. At their portfolio companies, they are insisting on a seat at the table so they can stay actively involved throughout the ownership period. Like their LPs, they are also extending their geographic focus as they search for potential deals. And they are diversifying their risk by opening their portfolios to a broader set of investment vehicles, such as real estate, infrastructure, hedge funds and public equity