With both the U.S. and global economies hurting, and senior lenders as stingy as ever, buyout firms have been downright fastidious about where they spend their money, since buying a company these days means contributing a lot of equity.
But talk to a buyout pro about Asia and you get the sense that the purse strings may be a little looser in that region. The reasons for this enthusiasm may vary from firm to firm, but most investors point to a few major factors: China, the region’s largest country, has tremendous upside potential; corporate divestitures are a real possibility now; and, at least for the time being, the number of investors is small enough for those firms already in the region to stay competitive.
“Most international funds have an open mind to Asia because it doesn’t have the same capital overhang that exists in the U.S. and Europe,” says Jack Hennessy, a partner with Baring Asia Private Equity Fund. “Asian private equity as a percentage of GDP is still approximately one-tenth of that in the U.S.- a largely underserved market which makes for a less competitive environment.”
Indeed, private equity fund raising and investment levels have dropped in Asia, as they have all over the globe. According to Thomson Venture Economics, publisher of Buyouts, Asian private equity funds raised $1.3 billion in the first half of 2002, compared with $3.5 billion in the first half of 2001. Deal flow was just $545.2 million, compared with $2 billion in the year-ago period.
But even with the drop in fundraising, there’s enough capital that’s already been raised to fund billions of dollars worth of LBOs. Private equity pros are especially excited about corporate divestitures, which historically haven’t been available in Asia. “The Asian buyout market was nonexistent prior to 1999, due to family groups being unwilling to give control to outside groups,” says Cory Palfrey, portfolio manager for the private markets portfolios at Morgan Stanley AIP. “Then restructuring occurred in 1999,” thus making it easier for outside investors to take ownership in Asian corporations.
In fact, the biggest LBO ever in Asia would be a corporate carve-out of Kumho, a Seoul-based conglomerate that is selling its tire unit. Back in February, JP Morgan Partners and The Carlyle Group reportedly offered $1.2 billion for 80% of Kumho Industrial Co., Korea’s second-largest tire manufacturer. The deal has been stalled, but the transaction is expected to close by the end of this year. (Carlyle and JP Morgan could not be reached by press time.)
Not surprisingly, Kumho isn’t the only conglomerate looking to shed some of its subsidiaries. But an equally rewarding opportunity for buyout investors may be divestitures from U.S. companies. Several domestic corporations set up Asian units in the late 1990s but are now looking to narrow their geographic focus as they reevaluate their business models and cut operational costs.
“The opportunity for private equity firms like ours has been to buy Asian subsidiaries from US companies in distress,” says Hennessy. “2002 is reminiscent of 1998, when U.S. companies sold off their Asian operations because of the 1997 Asian financial crisis.”
Hennessy stresses, however, that these Asian units are not really distressed companies, though their parent companies may be. “Many of the Asian subsidiaries are not distressed because their U.S. parent companies hold most of the debt,” he says.
All the while, Asian companies have become less dependent on U.S. exports, which helps them stay somewhat insulated from U.S. economic problems. “Asian economies have a meaningful dependence on its exports to the U.S., but these economies are not as reliant as in the past,” says Palfrey. “China is becoming a big export destination, and consumer spending is becoming a large factor.” Palfrey adds that the addition of China into the World Trade Organization was an important step.
Hennessy echoes this sentiment. “Strong domestic Asian demand, particularly in China, has assisted Asian companies to lessen the impact of weak U.S. demand,” he says. “China is now in the top five markets of most technology sectors. Chinese and Taiwanese companies have been quick to exploit this opportunity and are well ahead of the U.S. global leaders.”
Indeed, the technology in places like China, Taiwan and India-and more importantly the low cost of manufacturing and supporting technology in those countries-is one of the factors that makes Asia so appealing right now.
China, in particular, has caught the eye of several LBO shops, because of its size as well as its technological advances. “China is full of investment banks running around with buy-side mandates for U.S. firms who want to buy market share in China’s domestic market and world class, low-cost R&D and manufacturing capacity,” Hennessy says.
Adds Palfrey: “U.S. firms have been looking at entering many Asian companies, mostly Chinese companies, driven by consumer play in China. [China has a] huge population, fairly middle class, and the capacity to consume.”
However, Hennessy cautions that deals in countries like China don’t happen overnight. “U.S. firms have been prudently cautious with acquisitions in China and India, many dating before they marry’ their suitors in order to crystallize the benefits of an acquisition.”
But on the whole, deal flow is expected to increase, and Asia’s economies are expected to improve. “In five to 10 years, we see many good changes in Korea, along with China joining the WTO, [and] structural improvement will bring followers,” says Palfrey. “That bodes well for those economies in the longer term.”