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Winna Brown

According to a Preqin investor survey conducted in November 2020, Southeast Asia is amongst the top three emerging markets that’s ideal for PE (Private Equity) and VC (Venture Capital) investments in the next 12 months. As the impact of COVID-19 starts to fade away, the deal activity is really expected to bounce back to normal levels. I’m Winna Brown, a Private Equity partner at EY, and today’s episode of EY’s NextWave Private Equity podcast, we will explore the investment landscape in Southeast Asia and the key trends shaping its attractiveness to PE investors.

To help us explore this topic, I’m really delighted to be joined by my colleague, Luke Pais. Luke is an M&A partner who’s based in Singapore and he’s EY Asean Private Equity leader. Luke, welcome to the podcast.

Luke Pais

Thank you, Winna. Good to be here.

Brown

So, Luke, I’ve heard you describe the current environment as the golden age of private equity in southeast Asia. Can you share some of the qualities of the region that really makes you feel this way?

Pais

Thanks, Winna. So, that’s a good question and maybe I should start with talking about some of the key attributes of the region. I guess, firstly, what I would say, is that southeast Asia has got a very good blend of developing an early emerging market. So, if you look at markets like Singapore and Malaysia, there’s a good set of legal frameworks, there’s a good set of practices, and that sets the tone for the region. Then we have economies like Indonesia and Vietnam, as well as Thailand and Philippines, that offer very nice growth and they are very rapidly growing. And then we have early emerging countries like Cambodia, Laos and even Myanmar. I mean Myanmar’s had some issues recently, but it’s got vast potential. So, there’s a great mix of countries, and I think within that, therefore, there is great, great value to be had. I guess the other point to make is within these countries, right, apart from Singapore and Thailand, which have got an average age of 40, if you get all of the other countries, the average age is early to late 20s. So, if you think about that, you’re talking about another 50 years of good growth, and when you look across the world and look at which regions of the world have that kind of growth segue, I’d say southeast Asia stands out quite nicely. I guess the other related point is we are a very welcoming region when it comes to foreign capital. In other markets there may be certain barriers and certain difficulty in doing business, but southeast Asia is not the case, right. So, I think that is one important factor that the dynamics of the region are very, very vibrant. So, you have local champions, but those local champions are not translated into regional champions. And again, if you look at what the entrepreneurs are looking for, they’re looking for partners who can help them to achieve that. So, that’s where private equity can play a part as well. If you look at our region right, there is, there are a lot of family conglomerates. I mean most countries have large family conglomerates, and of course, in some countries they are bigger than others; but those family conglomerates in some ways operate like private equity, and today, especially with the advent of COVID-19, they are taking a very long, hard look at their own portfolios, the capital allocation within the portfolio, the returns coming out, and we are seeing a striking trend of, number one: reallocating capital from areas which are, I’d say, relatively more mature with lower returns to higher growth areas and private equities kind of partnering with these families to recycle that capital. Then of course, the other issue that comes in with family conglomerates is succession planning. Succession planning is a big one, because if you look at the last, I’d say, 40 to 50 years, which is the period within which all of the large family conglomerates have grown, they’re now getting to the second generation, and in some cases getting to the third generation, and that handover process is taking place. And as these new generations come in, they are looking to do things a little bit differently. They are quite open, you know, having been educated in the US and in Europe, to actually partnering with third-party capital to grow their business. So, these are some of the very interesting dynamics that are playing out. I think, given the long-term growth story of the region, it is actually a really golden era for private capital to play.

Brown

Firstly, it almost seems to me that you can step back and view southeast Asia almost as a region that’s, you know, in of itself like a portfolio strategy, if you will. Because you’ve got the younger up-and-coming countries, you’ve got the older, more established countries, and so, you can almost come in there and view the whole region as almost like your portfolio, and you’re de-risking your capital by investing across the region. I don’t know, that’s how it’s sung out to me. But also, some really great prospects, as you say, between, because they have been very regionalized and local, as you say local champions, there’s an opportunity here for private equity to help with global expansion. And so, that’s really a great opportunity to create value. And to your point, these companies have been family owned for generations and succession planning. So, you know, they’re looking for opportunities to exit. So, those two must be really enticing for investors and private equity to come into the region. Is the private equity sector mostly local private equity firms or is it the big global conglomerates that have basis in ASEAN?

Pais

By and large you find mid-market companies that are looking for growth capital, and historically, a lot of those were minority growth stakes, but I think in the present time we are seeing that, you know, now that the product and the private equity is quite well understood in the region, entrepreneurs are also probably less fast about how much equity the fund is asking for and they care much more about making sure they find the right partner. So, when a private equity is actually pitching to an entrepreneur, it’s not so much a conversation of money, right? I mean, valuation certainly is very important piece of the puzzle, but the other piece of the puzzle, which I think funds that I have spent time here, spent a large amount of mindshare and time cultivating, is chemistry and the dynamics in the relationships. That counts for a lot. So, sometimes you find entrepreneurs willing to take a lower valuation because they prefer to, certain types of value that a particular fund can bring, or they like the individuals that they’re dealing with. So personal relationships count for a lot and certainly the successful funds have spent quite a lot of time in the region. So, there is a big body of mid-market PE that plays here and that’s a combination of global funds and regional funds. And we are also seeing that in certain countries, like Indonesia, country-specific funds have emerged and sometimes these country-specific funds generate the opportunities and then partner with a regional fund to do the larger checks. So that’s been the traditional model across the region, and that’s kind of played out for the last probably 20 years and reached a very good level of maturity. There’s a lot of money available. But we’re also starting to see now some new strategies, because historically, the predominant theme of private equity investing has been this concept of the rising middle-class consumer. That’s not gone. That will stay for the next 20 years. And frankly, if you take sectors like consumer and health care and education and financial services, they all kind of qualify in that bucket. Now, in addition to that, if you think about the theme of urbanization, there is a strong desire to have good quality of life in vibrant cities, right. And I think, that’s a big theme. I think that’s still playing out. Now, if you look at what topics that particular theme touches on, there’s infrastructure, there is real estate, there is digital technology real estate, which is broadband technology and data centers and all of that. So, there’s a lot of demand for good quality infrastructure. And I think what we’re starting to see is there are specialist pools of capital are now coming into play in that space. So, there’s quite a number of infrastructure funds that are actively investing. Renewables has become a big topic. I think real estate is an asset class that is quite close to the hearts of most family conglomerates and investors, and we see private equity funds playing the game as well. Then the newer themes are, of course, there’s quite a vibrant tech ecosystem, a lot of young companies. So, we see tech funds and the venture capital community has kind of matured over the last few years and the most recent topic has been impact. So, I think all of the large houses, some of the medium-sized houses, they are all setting up their own impact funds. Sometimes you see a fund as having these multiple strategies. I guess the last one I’ll touch upon is probably credit, because credit has historically been a domain of the banks. In fact, if you wind back all the way to the ‘80s and the ‘90s, most family conglomerates in the region had the desire or the aspiration to own a bank as part of the conglomerate, and many of them did. So, they actually had banks as part of the enterprise. Then the Asian financial crisis hit. Once the Asian financial crisis hit, any company with a large amount of debt was in trouble. A lot of the entrepreneurs that were running businesses then are running the businesses today and those scars still remain. And therefore, the — if you look at the last many years — the attitude to debt has been relatively more conservative. Therefore, when you look at corporate balance sheets and you look at, even the 2008 financial crisis, what we saw is that the balance sheets were reasonably healthy because the entrepreneurs’ attitude to leverage are suitably cautious as a result of the ‘97 crisis. So, that is now changing a little bit and we start to see the credit, private equity credit product coming in. It’s still a very small percentage of the market. I would say the only issue pacific market where it is much more deeply prevalent is Australia, but we are seeing credit funds emerge and being part of the strategy. So, that’s kind of the field of play. Maybe one other interesting point will mention, is if you look at the family conglomerates themselves, they function like private equity funds. And in some ways, you know, they collaborate with private equity, but they can also compete with private equity. Singapore is also a big hub for private wealth management. It’s attracted a lot of international capital. Now, the way that evolves is, firstly, a lot of these funds find their way into other private equity funds or the capital markets, etc. But what you see now is that many of these families are actually setting up their own family offices, and they higher direct investment teams, either from PE funds or from banks, etc. And then they start their own direct investing as well. So, I think the entrepreneurs in the region are not short of money and capital options. It’s really then about helping them to pick the right capital option that suits them.

Brown

Well, it sounds like when you talk about the region, it’s really evolving very rapidly. It has, it’s playing in every sector, both the traditional sectors and the new up-and-coming areas. Clearly, there’s a lot of opportunity to add value for growth. There’s a lot of capital that’s ready to invest. What’s the secret sauce? How do you deploy a successful strategy as a private equity firm in ASEAN? Is understanding the culture and investing in the relationships and bringing insight to the table? Like what’s the secret sauce that you’ve seen?

Pais

I think, Winna, you hit the nail on the head. Earlier, you know, if you look at the thought of the private equity cycle in this region, a lot of funds had a very centralized office and that was typically in Hong Kong. And they would kind of fly out and meet entrepreneurs and make the investment. That’s all changed and I would say being very close to the ground is quite important. I think what you still see in the region is that Singapore is the hub. So, a lot of the capital sits here, because, you know, you have the private wealth in the private capital management frameworks that are quite well set. Singapore’s a nice home for capital and a lot of the people that then invest in the region sit here. But I would say that most of the funds have now got either on-the-ground offices in some of the key markets, like Vietnam and Indonesia and Philippines, or, at the very least, they have nationals and from those countries that are part of their teams and that basically fly in from Singapore. So, you’ve got to cultivate the relationships. You’ve got to meet the families. You cannot fly in, meet somebody for the first time and expect to do a transaction. A relationship has to be built over time and certainly the successful funds have invested in that relationship and built those relationships over a long period of time. I would say, the second thing is, that second in win for success is about being very clear about the value you can bring to the table. You know, now there’s a lot of money and in a way businesses are spoiled for choice. If you look at most sectors, you know, when you look at the private equity checklist, only a subset of the companies actually meet all that criteria. And when a company does meet the criteria, there is many, many, many funds that are chasing them to invest in them. And therefore, I think what’s become quite important is the discussion shifts from valuation to value proposition. So, the entrepreneur says, okay, you can meet my valuation, that’s great; but what value do you bring to the table? And there, the entrepreneur’s got a set of requirements and a set of aspirations, and I think they will select the fund that can best meet those aspirations. And certainly, if they’ve developed a relationship with someone and the entrepreneur feels like that team understands them well, that will be the team that they choose. So, I think that value-add aspect is quite critical. At the same time, what I will also say is if you look at the history of private equity in this region, right, and you kind of correlate returns to growth, I think over the last 20 years growth has been the big driver of returns. Today, most sectors as they’ve matured, I mean growth stays put or valuations have increased, and therefore, you’ve got to find returns from the operational side of the business. Now, the reality of the matter is, most funds are kind of learning how to do that in this region. So, there are some funds that, of course, have let’s say a much more robust and deep operating culture. For a large number of funds in this region, the investment folks also sit on the board. They’ve got to pick their battles and they’ve got to pick the areas they get involved in, but increasingly, what we are seeing is the value creation conversation with the entrepreneur is happening much earlier. As part of that, I think also funds are the seeking a lot more control, and they’re seeking a lot more influence in the way things are done. And it also will, you know, can be a very positive thing, because we are seeing that funds are getting quite innovative in the way they offer this value creation. So, for example, one of the recent trends we have seen is that some of the funds, when they do the deal with the entrepreneur, they agree to actually foot the bill for some of that initial value creation. There was one fund that had proposed a model where they said we will try out new things and we will help you to fund that cost and if the particular idea works, then we will seek reimbursement. And if the idea does not work, then it’s on our tab. That’s where you start to see these innovative things emerge, but I think in summary, you’ve got to be on the ground, you’ve got to build the relationships, you’ve got to have a very clear and concise value creation thesis, and you’ve got to really be able to articulate to the entrepreneur what value you bring.

Brown

I think you’ve painted a really clear picture of how private equity needs to be thinking about the investments and the relationships in order to be successful. And really, it makes common sense if you sit back and think about it. So, Luke, what’s your sense though of what the future holds for private equity in the future, and specifically, I mean there are so many areas that you’ve identified that are up and coming, where do you think investors should be focused? And what do you think is that next area of growth that will really change the dynamics of the region?

Pais

I think what I would say to this is if you look at where the region stands today, I would say the growth period, you know, golden growth has slowed, right, so growth has slowed. Most sectors have reached a certain stage of maturity where you have the top tier of players that have emerged. It’s slightly harder to move market share now, and therefore, companies have to do things slightly differently. So that probably involves number one going through a lot of business model and transformation and digital transformation. I think, ESG (environmental, social and governance) is starting to play an important part as well. And I would say, most companies at this time are at the start of that curve. Now, in the backdrop, the region has actually got very great dynamics. And frankly, we expect that dynamics to play out over the next 20 years, 30 years. Because of the fundamental aspirations of the growing, the rising middle class. So, companies that can actually achieve this transformation rapidly, and therefore, capture differentiated market share, will do extremely well. What private equity has done, very smartly up to now, is pick the right companies, pick the right entrepreneurs and partner with them to actually help to fulfill their ambitions. And I think that situation will continue to play out. Now, maybe I’ll just touch upon one other point which is relevant in this case, right, which is the way we look at the value that private equity brings, they actually take a very good company and they effectively prepare it to go and to be quite international in terms of their markets, in terms of their practices, in terms of their talent pools, in terms of their systems and all of that; and that is extremely attractive to multinationals. So as a result, if you look at how private equity is actually monetized its investments over the last period of time, most of the companies have been actually trade-sales to strategic investors. That has been the dominant exit piece. Those strategic investors come from the US, they come from Europe, but they also come from China, from Japan and the region. And the reason is that all of these companies, they are looking to try to play in the region, but it’s not easy for them to find the right business model or the right business to partner with. What private equity is done quite nicely is actually prepare these businesses to be able to be owned by multinational companies, and as a result, the moment a business is owned by private equity, it is actually tracked by these multinational companies because they know that when the time comes for exit, they’re able to acquire a very good business. And we transacted one last year, where it was in the middle of the pandemic, it was a very large company, the embassy couldn’t even visit the region. But because it was owned by a very reputable firm, they relied completely on advisors to do all of the work and managed to close the transaction in the middle of the pandemic. So, that’s a great value that private equity brings, I guess, both to potential buyers of companies as well as to entrepreneurs that are looking to get on this journey. We are starting to now see, of course — especially with the tech, with the advent of tech, and PE playing the tech game as well — we’re starting to see the IPO side of exits coming up. So, clearly, SPACs and our big topic and some of the large tech companies in the region, they are exploring SPAC exits, as well as some companies exploring listings on domestic stock exchanges. But by and large, the dominant theme has been exits to strategics, and the reason is that private equity adds a lot of value to these companies.

Brown

One of the areas that you mentioned, and I certainly have been hearing a lot about: ESG and the interest in ESG in ASEAN through my contacts. I’m interested in understanding how you’re seeing in day-to-day companies either, you know, new companies that are ESG-focused bubble up or the focus of private equity on, you know, identifying and valuing ESG-like qualities in traditional companies. Like how are you seeing ESG play out in the region?

Pais

That’s a good question, Winna, because I would probably say that companies in the region are at a fairly nascent stage when it comes to embedding ESG into the operations. Now historically, if you think about it, ESG was viewed as a cost. When you start to implement good environmental practices and all these other practices, it does add some additional points to your cost structure and does decrease your margins. As a result, I think companies historically didn’t really embed too much into their operations. What is happening now is, because investment capital and the available capital pools require that companies check certain ESG boxes, there is now a recognition that this needs to happen. There is a small set of early adopters, and they do recognize that ESG is a value differentiator, and certainly, that’s now being demonstrated in the capital markets, especially in the western markets. So, there’s actually a value differentiation that can be demonstrated. But I would say by and large, it is still in a fairly early stage in this region. It will rapidly snowball. I think that the pandemic has kind of brought additional focus on some of these issues. Certainly, both the equity capital markets and the debt capital markets, there is a clear recognition that this is an important topic. So, we expect to ramp up quite significantly in the next few years, but for now, I would say companies are still at a very early stage of adoption.

Brown

And have you found as you get engaged to do diligence over companies, are you finding that that is becoming more of a topic in the way you approach your diligence? Are you being asked to look at ESG qualities at the outset?

Pais

Yes. It is now an important evaluation criteria. I think the approach that investors take is basically, they will look at the current state. Of course, if there are certain serious issues with the company, sometimes it becomes a deal-breaker, but by and large the approach is that they’ll identify the issues that need to be fixed and then work with the companies to actually put those fixes in place. So, I think that’s the approach that the investment community is taking.

Brown

And so, Luke, if you stand back and you’re, you know, advising or trying to tell the world about ASEAN and the significant opportunities for growth and value creation that exist for private equity, what’s your words of advice to an investor who may be looking to come to the market?

Pais

I would say that southeast Asia is a very vibrant market. There are extremely good group dynamics that are likely to stay for the foreseeable future. There’s always value to be had in one country in the region or the other, and therefore, that makes for a very nice long-term investment story. But of course, when you, from the outside in, it looks like a nice big region of 600 million people and we’ll be getting on 650 million people now. And it certainly is a region that grows between five and seven percent a year. But as you kind of zoom in, there’s a lot of differences in each market, and therefore, having that on-the-ground presence and realizing how those differences play out and understanding the cultural nuances, as you mentioned, and developing the relationships becomes I think super critical to success. So, funds should localize, but when you zoom out and say, how many regions of the world offer these types of dynamics? I would say, very few do. In the regions that do offer these dynamics, some of them have got challenges for to invest in, whether its regulatory or the receptivity to foreign investment and things like that. I think southeast Asia is very, very welcoming. So, we certainly do welcome them. I think Singapore is, frankly, a great place to start from, not just for the region — even getting it to markets like China and India — Singapore is a nice place to base yourself and it’s a great spot from which to discover the region. So, we certainly welcome all of the capital in.

Brown

Well, that’s brilliant, Luke. Thank you so much. Really appreciate you giving us this insight into the region and the opportunities that it offers. It certainly sounds like the region has been on a very exciting growth path, and the future only just feels like it’s going to be extremely exciting and extremely value-adding for the world really, because there are so many opportunities and, like you say, these hidden gems in these countries that are just bursting to go global. Private equity has got some great opportunities here to create value and change the landscape. So, very exciting and thank you again for your time and your insight.

Pais

Thank you. Thank you for having me, Winna.

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