PE shops still drawn to Asia, amid global woes

U.S-based buyout firms with well-established operations in Asia remain active overseas despite the worldwide economic downturn.

In the Asia-Pacific region (which does not include Australia, New Zealand and India), U.S. firms are remaining bullish on the two mainstay countries of China and Japan.

Combined, deals by U.S. sponsors in those two countries made up 82% of all deals in the region, which includes Hong Kong and Taiwan in the tally with mainland China, according to Thomson Reuters (publisher of PE Week).

Worldwide, buyout shops stymied by shuttered capital markets have been chasing growth-capital deals that require little leverage. And that’s led many of them to China.

Majority-stake deals are possible in China, with the exception of heavily controlled industries, such as financial services and media. However, the country has proven much more fertile ground for growth capital deals, which typically involve equity investments in exchange for minority ownership.

Even reserved forecasts for China’s economic expansion in 2009 call for GDP growth of 6% to 7% at minimum. In addition, about 40 million people are expected to enter China’s middle class every year for the next 10 years, creating a mass of consumers that will fuel domestic consumption in that country, says Paul Edgerley, a managing director at Bain Capital.

Bain Capital is one of several U.S. buyout shops that have raised funds with significant allocations to China deals. Others include The Blackstone Group, The Carlyle Group and Warburg Pincus.

“Being part of growth in China is like being part of technology in the early ‘90s; it’s just a great place to be,” Edgerley says.

Many mid-market firms, too, have entered China. In August 2007, San Francisco-based Francisco Partners acquired an undisclosed interest in DarwinSuzsoft, an information technology consulting services provider, for about $48 million. Earlier that same year, Washington, D.C.-based Thayer Hidden Creek acquired PCT China Inc., a provider of telecommunications services.

Other mid-market shops, including American Securities Capital Partners, Arsenal Capital Partners, Baird Private Equity, Blue Point Capital Partners and Pfingsten Partners are well-positioned to execute deals, having set up offices in China to help existing portfolio companies identify add-ons in the region, take advantage of cheap manufacturing costs, and access a burgeoning consumer market.

On May 28, Boston-based Bain Capital was reported to be the frontrunner in an ongoing bidding battle with fellow mega-firms Kohlberg Kravis Roberts & Co. and Warburg Pincus for a 20% stake in Chinese electronics maker Gome valued at about $500 million.

TPG has also been active in the region. On May 26, the Fort Worth, Texas-based firm announced plans to invest $80 million in the form of convertible bonds in Daphne International Holdings Ltd., a retailer of ladies’ footwear with locations in mainland China. Upon conversion of the bonds, TPG would own about 14.5% percent of the Hong Kong-based company’s equity.

Tough going in Japan

The slow pace of deals in economically battered Japan has prompted many firms to seek greener pastures. Some observers believe the country could see a meaningful pick-up in M&A in the next 12 to 24 months.

At present, however, many retirement-aged business owners remain reluctant to sell their companies at today’s depressed valuations. The same is true for big conglomerates that have non-strategic assets to unload.

But the macro-environment in the country is an obstacle. The GDP in Japan contracted at an annualized rate of 15.2%, as of March 31, thanks in part to an export-driven economy that depends on the buying power of the United States and other countries.

For some U.S. buyout shops this year, maintaining offices in the deal-stifled nation has become too big a resource drain to continue. Turnaround firm Sun Capital Partners, for example, closed its Tokyo office in February, after spending only two years there.

In April, Merrill Lynch Global Private Equity disbanded its Tokyo digs after the firm reportedly struggled to no avail to find deals. Also in April, Asia-focused private equity firm Unitas Capital, formerly known as CCMP Capital Asia, said it has closed its Tokyo office to focus on deal opportunities in the rest of the region, according to a Reuters report.

But the retreat of some firms could benefit others. With fewer buyout firms in Japan looking for deals, competition will be thin when deal flow does return to the island nation. Although many elderly owners of privately held companies are not looking to cash out, many will partner with a firm that will both buy their interests and continue to build on the company legacy, says James DeGraw, a partner in law firm Ropes & Gray’s Tokyo offices.

Dallas-based Loan Star Funds is one of the most active U.S. buyout firms in Japan, having closed nearly 40 deals in the country in the last 10 years, according to Thomson Reuters. Other U.S. firms active there include Bain Capital, The Carlyle Group, and the Riverside Co.

Riverside, which manages more than $2.7 billion in assets and has Asia offices in Tokyo and Seoul, is working on one current deal that it hopes to close sometime next month. The Cleveland-based small deal specialist plans to acquire a Japanese software company from its elderly founder by the end of July, according to Stuart Baxter, a managing partner at the firm.

The deal agreement stipulates that the founder keep a seat on the company’s board to help steer it through the transition phase.

Baxter, who also serves as the fund manager for Riverside Asia Fund—the firm’s first Asia-dedicated investment vehicle—said the firm plans to close four additional platform deals and two add-ons in Asia this year. Still in fund-raising mode, the Riverside Asia fund has a target of $100 million, earmarked to acquire companies valued at up to $50 million.

Meanwhile, a deal struck on May 26 by SG Investments, an investment fund unit of Goldman Sachs, highlights the deal opportunity at the larger end of the market to rejuvenate and possibly consolidate companies as they reorganize.

Through the deal, SG Investments and Hong Kong buyout shop MBK Partners will team up to acquire a 98.3% stake in underperforming theme park Universal Studios Japan, according to a Reuters story.

A version of this story appeared this week in Buyouts, an affiliate publication to PE Week.