Generational change in Asian PE

Jean Salata, CEO & founder, Baring Private Equity Asia Interview by Joe Marsh.

Founded in 1997 by Jean Salata, Baring Private Equity Asia now has around $9 billion under management, 70 investment staff and seven offices across the region. Headquartered in Hong Kong, it also has branches in Beijing, Jakarta, Mumbai, Singapore, Shanghai and Tokyo.

BPEA is focused on both in-country and cross-border deals in the region and between Asia and other parts of the world. It closed its sixth fund at $4 billion in February last year, and in January US-based fund house AMG bought a 15% stake in the firm.

Salata is responsible for all BPEA’s investment and divestment decisions as well as its strategic direction.

His other roles have included executive vice- president of finance at Shiu Wing Steel and management consultant with Bain & Company in Hong Kong, Sydney, and Boston. He has served on the boards of more than 10 portfolio companies.

Q Can you summarise Baring PE Asia’s investment approach?

Our investment approach is to run a broadly diversified portfolio across the region, mainly focused on buyout investments but also incorporating some growth capital deals.

Another part of our strategy is that we make an acquisition and then see opportunities for ‘bolt-on’ acquisitions. This is a way of taking what is a fragmented industry and trying to build a large-scale player.

Q Which sectors do you focus on, and are there any you avoid?

We’ve invested a lot in education, in the industrial sector, in consumer-related businesses, health care, IT services, food – a fairly broad range.

One area we’ve avoided is the e-commerce and internet bubble we see now in Asia generally. It’s hard to value businesses when they’re not making a profit. This is a venture capital strategy, and we’re not set up for that.

Q What is your typical deal size, and has that changed over time?

Our sweet spot for deals is somewhere between $300 million and $1 billion in enterprise value.

The average deal size and number of large buyouts has dramatically increased over past three to four years. There’s been a big increase in number of deals in the $200 million to $400 million equity cheque range.

Q Why is that?

There’s more generational change taking place. Moreover, Asia’s economy is bigger than it used to be, so companies are bigger. China is literally five times the size it was 10 years ago.

It has also been a very challenging time for exits in the past few years – emerging markets have been in a bear market in Asia. It’s a lot harder to get liquidity now, so there’s a lot more secondary activity. A lot more funds are looking to exit investments held for a long time. There’s a first generation of buyouts maturing now after eight, nine or 10 years.

There’s also more cross-border activity, with more opportunities to buy into companies that are not necessarily based in Asia but have an increasing presence there.
In addition, we see a lot of activity in the take-private space, focused on listed acquiring companies whose share prices have been depressed because of market conditions.

A combination of all of these factors is creating more deal flow in the upper end of the market.

Q There is clearly more competition these days for Asian capital when it comes to fundraising. How do you compete for limited partners’ money?

We are certainly seeing and creating more co-investment opportunities for our LPs. The fact we can find and close more larger deals than in the past opens up the possibility for more co-investment alongside our own investment.

We’re not really seeing any ‘crowding-out’ effect or LPs going direct into deals we’re competing for. Most of the time on larger deals there are GPs and they have LPs investing alongside them.

But one change is in the club-deal arrangements that you used to see eight or nine years ago, where two or three PE firms would team up on a very large transaction. Now a single GP will bring in two or three co-investors rather than partnering with another fund.

There’s a lot more flexibility now to tap investment capital to bring into larger deals.

Q Are you seeing more demand for PE from family offices in Asia?

Family offices are certainly a growth area, but still a relatively new segment in Asia.

Also private banks are another source of capital looking to get more exposure to alternatives, as people move from stock portfolios to more broadly diversified portfolios.
Private clients still represent a small portion of our investor base, but I would imagine that they will become more important over time.

Q Has there been any change in the way private banks access private equity?

There is a higher level of interest from private banks, including in doing direct, co-investment deals alongside general partners, so there are more direct syndication or club-type deals happening in Asia.
We also see that happening quite a bit in China for domestic deals. Many fund management groups are specialising in direct syndication deals for RMB-based investors now.

Q What are the main obstacles you see for private equity investment in Asia right now?

In China, the main challenge is regulation. There are different rules as to who can invest in which types of markets depending on whether you’re local or not local. This makes it difficult to invest in some areas.

Then there’s the issue of exiting through the A-share market. While it’s possible for a foreign investor, it’s pretty cumbersome. It involves very long lockups and a lot of opaqueness around getting approvals.
Both of these factors increase the risk of any investment you make where you’re contemplating an onshore exit in China.

That’s why we tend to focus on businesses that we can control or sell through trade sales or take public in Hong Kong, and on sectors with zero restrictions on foreign investment. For example, consumer product businesses are generally fine.

Likewise in India, the challenge is around regulation and government approvals. Even once you’ve struck a deal, getting all the necessary consents to get paid can take a year or more.

Last July [French bank] BNP Paribas agreed to buy Sharekhan, an Indian brokerage that we have shares in, but the deal is still pending regulatory approvals.

Q But India seems like it has become more investor-friendly with Narendra Modi in power. Do you agree?

We are generally positive on India, we think it has a bright future. We have been big investor there in the past few years. For example, we bought a controlling stake in [outsourcing provider] Hexaware in 2013 and acquired CMS Info Systems [Indian’s largest cash-management firm] in 2015 for about $300 million.

Certainly the Modi government is much more business-friendly [than previous administrations] and there are some very enlightened people in the Indian government. They are they have the right frame of mind.

But as you get deeper into the hierarchy of the bureaucracy, there are still entrenched parts of the government that have a certain job or mandate that they need to perform, and that can be a hurdle.

The intention is there at the highest levels to encourage investment, but there is still a lot of work to be done to translate this into a smooth process for investors.

Q There has been a lot of concern raised about the transparency of private equity fees on carried interest and so on. How concerned are your LPs?

Institutionalisation of our business has always been a big priority for me – to ensure that we are managing it up to global standards.

As for the issue of fees, in Asia it’s relatively straightforward. For instance, carried interest in Asia has always been calculated using the so-called European ‘waterfall’ model.

That means that it’s only payable once you have returned all the capital of the fund plus an 8% hurdle rate of return to your investors at the preferred return.

The bigger issues with carried interest in the US arose as a result of clawbacks on carry that had been paid out on a deal-by-deal basis, which is not the case in Asia.

Q What about portfolio monitoring or portfolio company fees?

As far as how fees are charged within the fund itself, Asia has not really had much of a history of transaction fees or portfolio monitoring fees being charged. Here, with us and I think with most funds, 100% of these fees go to the fund anyway, so there’s no conflict.

Q Are Asian corporates more open to private equity investments now than in the past?

It varies country by country, but generally yes. For example, in Japan I would say it’s less embarrassing than it used to be to sell a business to a private equity firm. It’s now viewed as a normal part of restructuring or streamlining a business.

And in places such as China, the big state-owned enterprises [SOEs] have a policy of bringing market-oriented investors – as they call them – into the company they invest [in] in a joint deal.
It’s not because the SOE needs your money, but more to have an investor with money at risk in the same deal and to bring in international management expertise and practices.

We’ve done a few of these ourselves. We acquired a 40% stake in [UK cereal-maker] Weetabix last year and we are working with [Chinese SOE] Bright Foods, the controlling shareholder, to expand Weetabix in China.

Q Where are you at in deploying the latest $4 billion fund?

We’ve announced three investments so far: CMS in India; Vistra, a corporate trust services provider; and we just announced a third investment in January [2016], into HCP, a Chinese cosmetics packaging business.

Q When would you like to have it fully deployed?

Based on historical experience, it’s been about three or four years per fund – we like to have vintage diversification.
My sense is that we’re heading into a period right now where there will be a fair amount of investment activity as markets become more turbulent.

If companies are looking for financing and there are fewer opportunities to transact in the public markets then that opens more opportunities for private equity to step in.

Q Is it harder to find good assets and deploy funds these days?

We’re actually seeing a lot of deal flow. This is a function of the deteriorating market conditions in Asia for the past few years, and that [deterioration] is picking up momentum now even more.

As things get more difficult, there are fewer and fewer options. Credit is becoming less available, public markets are becoming more difficult, there aren’t too many other places to turn.

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