James Klein, partner at Penningtons Solicitors, examines the potential opportunities for private equity firms in Asia-Pacific, given the particular challenges and risks faced in the region.
James Klein, partner at Penningtons Solicitors, examines the potential opportunities for foreign, including UK, private equity firms in Asia-Pacific, given the particular challenges and risks faced by foreign funds seeking to invest in the region.
Foreign private equity firms are increasingly seeking to establish a presence in Asia-Pacific, through raising capital, executing acquisitions and opening local offices.
The primary sources of institutional equity capital appear to be North America and Greater China, with Europe reportedly holding third place.
UK-based firms, including Baird Capital Partners Europe and Victoria Capital, enjoy a significant presence in the region, as do global funds with a UK presence, such as Blackstone, Apax Partners and CVC Capital Partners.
As private equity activity in Asia Pacific is expected to expand over the next 12 months, there has been speculation that UK and other foreign firms will seek to increase their activity in the region, particularly in Greater China, India and South-East Asia.
However, given the inherent challenges and risks faced by foreign investors as a whole in this region, it may be difficult for some firms to initially source and close deals.
Not surprisingly, it is expected that Indonesia, the fourth most populated country and the largest economy in South-East Asia, will be a hotspot for foreign investment in 2012.
Further, the Indonesia Stock Exchange has expanded at a rapid pace since 2009. Some caution to beware of the ‘buzz’, however, as the number of foreign private equity deals that have actually closed in Indonesia is relatively low.
This is largely because foreign funds find it difficult to understand local perspectives of doing business in Indonesia.
For example, target companies are frequently family-owned and still managed by the original owners, who are emotionally attached to their business and may not agree to a private equity deal except at an unrealistically high valuation. Alternatively, owners may require a share in future profits or a possible claw-back provision, to which investors are not willing to agree.
Indeed, foreign firms, including UK-based funds, may find it difficult to navigate the business culture of a number of countries in Asia-Pacific.
A fund’s ability to source deals is often dependent on whether it has personal relationships in the target country, an in-depth understanding of local markets and a local presence. Therefore local firms tend to have an advantage over foreign funds in winning deals.
Foreign firms may wish to consider the possibility of operating with a local partner, which would result in greater credibility, access to the market and the local connection that is often needed to successfully negotiate.
However, foreign firms should conduct in-depth due diligence of any potential partner with whom they wish to invest, as well as of the target company, prior to entering into a transaction.
This will help to guard against the risks of corruption and fraud, which appear to be greater in some countries in Asia-Pacific than in developed countries.
UK firms should be aware that they may incur criminal liability or unlimited fines under the Bribery Act 2010 if a partner or target company engages in bribery and is found to be ‘associated’ with the firm.
The partner or target company will be ‘associated’ with the fund if it performs services on behalf of the fund. The relationship between a private equity firm and a portfolio company or partner has not yet been tested under the Bribery Act and so it is unclear whether a firm could be held liable.
Even in the absence of such liability, a firm should conduct due diligence in order to mitigate the commercial risks of suffering from reputational damage and a diminished value of the portfolio company, which could result if corruption or fraud perpetrated by the partner or company later comes to light.
Foreign funds must also consider whether they are willing to deal with local laws and regulations, which are generally not as navigable as those in developed countries. For example, investors acquiring mining companies should ensure that the business holds a valid license to develop, which has not been revoked due to local government changes.
In addition, foreign funds must face the fact that there may not be many deals to be had based on an LBO structure and should consider whether they are willing to acquire a non-controlling, minority stake in a business.
Where existing management has the operational expertise and commitment to good corporate governance to enable it to create value, this may not be an issue, but such businesses may be few and far between.
Finally, foreign funds are currently faced with the reality that private equity opportunities in Asia-Pacific are still being identified and that buyer demand outweighs supply. If the predictions of future private equity growth in the region are realised, foreign firms, including UK-based funds, may gain access to the markets.
However, firms must bear in mind that they are operating in an already crowded environment and face particular competition in the form of investment from Mainland China.