Focus: Asia – Europeans look for eastern promise

After years without significant buyout and venture capital opportunities in Asia, firms are now gearing up for a major growth in the flow of deals as conglomerates restructure and technology ventures increasingly require capital.

The optimism, it should be said, does not extend to all parts of the region but there appear to be strong grounds for bullishness on the opportunities in markets like Japan, Korea and parts of south-east Asia.

Much of the changed outlook is due to the trauma Asian companies have gone through in recent years, thanks to the economic crisis sparked in 1997 as well as the 10-year Japanese recession.

As a result of these tough times, the traditionally diversified conglomerates are expected to increasingly divest themselves of non-core activities, creating significant buyout opportunities.

Meanwhile, the emergence of high-tech industries in many parts of the region is fuelling demand for venture capital.

As a result of these factors a growing number of western private equity firms have set up shop in the region, typically with offices in Japan and Singapore or Hong Kong, and billions of dollars have been raised for venture capital funds.

Accurate statistics are hard to come by but the consensus is that the buyout market and the venture capital industry, particularly in high-tech, have begun to produce deals and many expect this trend to mushroom in the coming year.

Much of the buyout market, however, will depend on whether Japanese keiretsu really do restructure and are willing to sell off bits of their corporations in MBOs. This in turn will depend on the emergence of an entrepreneurial class among Japanese middle and junior managers.

“The MBO market is emerging in Japan and we know the deals will come but we’re not sure exactly when,” says Jane Crawford, chief executive of 3i Asia-Pacific.

She adds that the sheer size of the Japanese economy and the degree of restructuring occurring means there could be a huge number of transactions further down the line. The company opened its Tokyo office, in a joint venture with Industrial Bank of Japan, two years ago, along with a Singapore office specialising in technology venture capital.

“We’ve spent the time here building an infrastructure, recruiting people and marketing, as we think when the buyouts come they will come very quickly,” she says.

The buyout business has been slower to develop in Asia than venture capital and, of 3i’s 15 investments so far in Asia, 12 have been technology ventures in markets such as Singapore, Malaysia and Hong Kong.

Anil Thadani, chair and founder of Schroder Ventures in Asia, argues that the buyout market is already taking off outside Japan as a result of conglomerates restructuring: “There are a lot of opportunities for basic financial engineering to create value,” he says, adding that in the economic growth years of the eighties and early nineties companies didn’t need to concentrate on core business and were in acquisition mode.

“So you had absurd transactions like a Singapore shipyard purchasing a chain of coffee shops simply because they had the money to do it.”

In the pre-crisis days the private equity markets in Asia were extremely under developed, despite the huge economic activity in the region. As well as the reluctance of companies to sell off divisions or subsidiaries there was also a lack of good private equity expertise, as many funds recruited private equity investors from other disciplines, notably investment banking.

“Many people thought you could easily turn an investment banker into a private equity specialist but then found the two are very different,” says Thadani.

Today, post-crisis, many of the region’s corporates have stabilised their businesses and are now looking to go back to basics, which is likely to mean a lot more buyouts.

Andrew Smith, managing director of PPM Ventures (Asia) compares the evolution to the UK recession, noting that the British private equity market only began to emerge after the early nineties recession. During recession companies are fire fighting and negotiating with their banks, he says, but when those immediate problems are resolved and general economic conditions improve they are willing to look at selling off businesses.

“With improving economies they also know they will get a better price for those businesses from people like us,” says Smith.

But like other buyout specialists in Asia, Smith hits on the lack of management expertise in the MBO sector as a potentially serious barrier to market development. Asia simply does not have enough internationalised managers who understand the concept of buyouts and can run companies on a private equity basis, he says.

“Our business is backing management teams rather than simply buying assets and we’ve been able to get around the problem in some cases by bringing in quality managers from another part of the group concerned or from a multinational,” he says.

This dearth of managers who can drive the buy-out forward means it is inconceivable to consider buying a company without having lined up a management team to run it.

Things could be changing, however, particularly in markets like Japan where a lot of junior and middle managers have had exposure to western business either from studies abroad or by working in the overseas subsidiary of a Japanese company.

“The next couple of years could see the emergence of that class of managers who can take MBOs forward,” says Smith.

Yoshito Hori, chief executive of Apax Globis Partners, which opened its Tokyo office last year, agrees that it is a challenge finding local managers with the right kind of entrepreneurship but points to other factors facilitating the expansion of the venture capital industry, such as the arrival in June of the US exchange for high-growth companies Nasdaq and a new high-tech market launched by the Tokyo Stock Exchange that will make it easier to launch IPOs.

“The Japanese venture capital market has historically centred on later stage investments and passive investors but there is a growing entrepreneur culture and the Japanese stock market is soaring by 50 per cent a year, which helps.”

Technology is the main focus of venture capital funds in the region, he says, as in other parts of the world and there are a growing number of funds devoted solely to technology investments.

“There’s a lot of money coming in for technology investments and a lot of technology projects are looking for money but I can’t see them all being funded,” says PPM’s Smith

Nevertheless, the development of high-tech ventures in Asia marks a big step forward for the regional economy. Traditionally much of the technology industries in Asia were essentially sub-contractors for western firms, making phones for AT&T or assembly work for Hewlett Packard.

Since the economic crisis there has been significant consolidation among that large number of sub-contractors and a new technological revolution in places like Taiwan, Hong Kong and India in cutting edge software programming or e-commerce.

“These developments have led to a wave of new investment opportunities and undoubtedly many of those companies will not be around in a few years – but those that do well will do very well,” says Thadani of Schroder Ventures.

His fund is about 70 per cent buy-out oriented and 25 per cent to 30 per cent technology. “We’re all trying to recruit people with a technology background at the moment and we don’t want technology to dominate our fund because that’s not where our main expertise lies and there are obviously higher risks if you’re just in one sector.”

At 3i the aim is for a 50:50 split between buyouts and technology investments across the region and Apax Globis has a three-way split for its $200 million fund between early stage financing, expansion investment and buy-outs.

The funds flowing into the region are coming from a variety of sources. There is some investment from local sources and 3I, for example, is jointly managing a $100 million venture capital fund with the Singapore government, which has provided the finance.

But, according to Thadani, the majority of investment is coming from the US, although a growing share is from Europe. He is concerned that there could be too much money chasing too few deals at the moment.

“Asia just doesn’t have the $2 billion-$3 billion deals you see in the US and Europe,” he says.

As to where the cash is going, on buyouts the market is strongest in north Asia. “There are a lot of opportunities in Korea, where there’s been a lot of restructuring, and obviously Japan is potentially a huge market,” says Andrew Smith.

The difficulties all venture capital funds operating across the region face are the sheer size and diversity of the area. Each country is at a different stage in terms of economic recovery and there are numerous languages, races, legal and regulatory systems and levels of corporate governance.

“Each country has its own set of issues, which in some cases reduces their attraction for private equity investment,” says Smith. Much of south Asia, he says, is a frustrating place to try and do business.

“A lot of what we expected to happen has not happened and, while some transactions have come to fruition, many others have not been consummated.”

One of the main barriers has been over-regulation and bureaucracy so that, while in Europe some deals can be agreed on the basis that regulatory approval will be forthcoming as possible that approach cannot be considered in many Asian countries.

“You have to expect problems along the way and get as much of the deal as possible agreed up front in terms of commercial, regulatory and legal issues,” he says.

While China and India are likely to be extremely attractive markets in the long-term they are at an early stage and regarded as difficult to do business in due to over-regulation and lack of transparency. In China the greatest concern for venture capitalists is the lack of complete control over funded projects and currency risks.

The large variation between countries means adaptability and knowledge of the region are a prerequisite to success.

“Each country has its own peculiarities, business ethics and legal and accountancy standards, so you can’t just parachute in someone from the US and expect them to do a deal in Thailand,” says Anil Thadani.

He is particularly keen on the opportunities in Thailand, though others are cooler and argue the government has not done enough to create an environment where foreign investors feel confident.

One of the problems in Thailand and Indonesia has been the virtual lack of bankruptcy laws, which meant that during the economic crisis companies were not forced to pay creditors and so restructuring was held back.

Nevertheless, the future for European private equity firms in the region is promising and some argue they stand a stronger chance of capitalising on the growing opportunities than their US rivals.

This is because, while Asian venture capitalists have historically taken their inspiration from US firms the Asian way of doing business is arguably much closer to the European approach.

Before the economic crisis the Asian venture capital industry was highly relationship oriented and focused on low-risk, low-reward investments, says Jane Crawford.

The crisis and resulting restructuring has attracted a host of US and European funds to the region and at the moment there is a battle to see which style of private equity triumphs, she says.

The US style is more aggressive, shorter term and focused more on cost cutting while the European approach is a softer variant, with more emphasis on growth and building relationships.

She says: “The Asian approach is traditionally more long-term and based on relationships, which I’ve found makes them more open to European investors and gives us a good chance to take advantage of the growing number of deals.”