South China Morning Post

Private equity firms sharpen their focus

Asia's private equity markets have not been crushed by the downturn that has dried up deal flow in Europe and North America, but they have been transformed by it nonetheless.

By Vinit Bhatia and Chul-Joon Park

Published on September 21, 2009
min read


Asia's private equity markets have not been crushed by the downturn that has dried up deal flow in Europe and North America, but they have been transformed by it nonetheless. Deal value in Asia fell by a third last year from 2007, less than half the fall-off suffered in the developed economies, and is already showing strong signs of recovery. However, the relatively mild decline has intensified competition across the region, driven by two forces. First, global private equity funds have stepped up their focus on Asia. And second, several large local funds, particularly in China, have joined the competitive fray. Over the past year, 189 new funds emerged wielding US$40 billion in capital to invest. In this new climate, leading firms have started to recognise they need stronger teams and deeper industry expertise. Many expect to focus on specific industry sectors and organise around them. How well they execute this shift will be important not only to the private equity industry. The businesses in which they invest will increasingly rely on the specialised sector insights of their private equity backers. The move towards sector specialisation has gained momentum because its benefits are powerful. In deal generation, it marks a private equity firm as a serious player, increasing the volume and quality of deal flow. In due diligence, it can speed a firm's ability to identify good deals and bring to bear proprietary insights that provide a competitive edge. Following an acquisition, it helps the firm quickly set the right strategic direction, improve performance and build value. When the time is ripe to sell, the firm can better identify the right potential buyers and present the sale in the most compelling light. Firms that specialise around sectors begin by identifying high-potential sectors in play, defining them clearly but keeping them broad enough to ensure they will yield a healthy stream of investment opportunities within a reasonable timeframe. Because they no longer have the winds of growth at their backs, private equity firms will select sectors by weighing their ease of entry, competitive dynamics and availability of acquisition targets. Building these sector skills will be especially challenging for Asian private equity firms that operate across national boundaries. Beyond barriers of language, regulation and business cultures, firms will need to overlay their local country focus with transnational sector expertise. As firms start to increase their activity, they will pick their spots carefully. Instead of trying to land deals across a wide range of companies and industries, they will zero in on attractive industry sub-sectors. They also mobilise sector teams to gather unbiased information from the field by interviewing customers, suppliers, competitors and creditors that help to get an early read on impending shifts in relative market share, earnings volatility, profit pools and other industry-shaping trends. They use this intelligence to develop concrete, and sometimes counterintuitive, investment theses. In this new environment, powerful analytical skills will remain important, but they won't be sufficient by themselves. Look for the managing directors of sector-oriented firms to be more visible in the industry segments they cover. Instead of waiting for bankers to pitch deals, activist directors will spend more of their time cultivating relationships with industry insiders, trading the latest sector intelligence. Crucially, they will work to earn the trust of management teams at companies that are high on their target lists, an especially critical factor in Asia where entrepreneurial owners remain sceptical of accepting private equity capital. Our analysis has found that an acquirer can typically buy a sector leader for a lower price relative to its competitors just before a cyclical rebound. As they continue to help local industry become more competitive, private equity firms wielding well-tuned sector expertise will be holding a trump card. Vinit Bhatia is a partner in the Hong Kong office of Bain & Co and a member of the Asian private equity practice; Chul-Joon Park is a Seoul-based partner and leader of the private equity practice for Asia.

Asia's private equity markets have not been crushed by the downturn that has dried up deal flow in Europe and North America, but they have been transformed by it nonetheless. Deal value in Asia fell by a third last year from 2007, less than half the fall-off suffered in the developed economies, and is already showing strong signs of recovery.

However, the relatively mild decline has intensified competition across the region, driven by two forces. First, global private equity funds have stepped up their focus on Asia. And second, several large local funds, particularly in China, have joined the competitive fray. Over the past year, 189 new funds emerged wielding US$40 billion in capital to invest.

In this new climate, leading firms have started to recognise they need stronger teams and deeper industry expertise. Many expect to focus on specific industry sectors and organise around them.

How well they execute this shift will be important not only to the private equity industry. The businesses in which they invest will increasingly rely on the specialised sector insights of their private equity backers.

The move towards sector specialisation has gained momentum because its benefits are powerful. In deal generation, it marks a private equity firm as a serious player, increasing the volume and quality of deal flow.

In due diligence, it can speed a firm's ability to identify good deals and bring to bear proprietary insights that provide a competitive edge. Following an acquisition, it helps the firm quickly set the right strategic direction, improve performance and build value.

When the time is ripe to sell, the firm can better identify the right potential buyers and present the sale in the most compelling light.

Firms that specialise around sectors begin by identifying high-potential sectors in play, defining them clearly but keeping them broad enough to ensure they will yield a healthy stream of investment opportunities within a reasonable timeframe. Because they no longer have the winds of growth at their backs, private equity firms will select sectors by weighing their ease of entry, competitive dynamics and availability of acquisition targets.

Building these sector skills will be especially challenging for Asian private equity firms that operate across national boundaries. Beyond barriers of language, regulation and business cultures, firms will need to overlay their local country focus with transnational sector expertise.

As firms start to increase their activity, they will pick their spots carefully. Instead of trying to land deals across a wide range of companies and industries, they will zero in on attractive industry sub-sectors.

They also mobilise sector teams to gather unbiased information from the field by interviewing customers, suppliers, competitors and creditors that help to get an early read on impending shifts in relative market share, earnings volatility, profit pools and other industry-shaping trends.

They use this intelligence to develop concrete, and sometimes counterintuitive, investment theses.

In this new environment, powerful analytical skills will remain important, but they won't be sufficient by themselves. Look for the managing directors of sector-oriented firms to be more visible in the industry segments they cover. Instead of waiting for bankers to pitch deals, activist directors will spend more of their time cultivating relationships with industry insiders, trading the latest sector intelligence.

Crucially, they will work to earn the trust of management teams at companies that are high on their target lists, an especially critical factor in Asia where entrepreneurial owners remain sceptical of accepting private equity capital.

Our analysis has found that an acquirer can typically buy a sector leader for a lower price relative to its competitors just before a cyclical rebound. As they continue to help local industry become more competitive, private equity firms wielding well-tuned sector expertise will be holding a trump card.

Vinit Bhatia is a partner in the Hong Kong office of Bain & Co and a member of the Asian private equity practice; Chul-Joon Park is a Seoul-based partner and leader of the private equity practice for Asia.