In much the same way that Asia stood as a beacon of strength amid the global financial crisis, even as Western economies took pounding after pounding, the private equity scene on the continent has remained relatively robust compared to the more traditional economic powerhouses. According to a
report by research firm Preqin, as of August 2011, Asia-Pacific fundraising for the year to date stood at 29 percent compared to the pre-downturn year of 2008. In comparison, the figures for North America and Europe were 24 percent and just 16 percent. More tellingly, a greater amount of capital was being sought by Asia-Pacific focused funds than ever before, unlike North America and Europe, where the total amount of capital sought by funds was lower than in 2008.

And yet, this has happened despite the numerous obstacles in its path.Chris Kelly, head of private equity at Linklaters, noted that asset prices in Asia in general have not fallen in line with asset prices in the West, meaning there are fewer assets available for sale at a bargain. “There is relatively less financial distress in Asia and thus sellers are in a position where they don’t really need to sell their assets,” he said. “This has led to a divergence between the price expectations of buyers and sellers.” Another consequence, he said, is the rise in private investment in public equity (PIPE) deals, with PE investors looking to reduce the amount of underlying risk by utilising quasi-equity investment instruments (for example, convertible bonds and warrants) and derivatives (for example,total return swaps). “Stock prices are sometimes seen as a better proxy for value in volatile markets,” he said, “but PE investors are still looking for downside protection and we are seeing a lot more hybrid securities and derivatives in PIPE deals”.

Kelly added that another impediment that private investors face is the regulations targeting PE that are being put in place around the region. “China and India are among the countries that are particularly challenging when it comes to inbound investment and PE/VC houses have not always been seen by
the regulators as the ideal stakeholders in certain highly regulated sectors such as financial institutions group (FIG),telecom/media and natural resources,” he said. Recently, however, restrictions for international PE firms have been relaxed in certain sectors in China,reflecting a more encouraging stance from Chinese regulators. PE firms are also rumoured to be watching the development of the so called “shadow banking” sector very closely, as global financial institutions are being required by regulation to divest FIG assets.

The regulations in certain sectors have spurred PE activity in a number of the other, less regulated sectors. “In particular, there’s been a lot of activity in the consumer space, real estate and IT outsourcing,” Kelly said. He adds that another significant trend has been the rise of local currency funds
across Asia, in particular RMB funds in China, with some $12.3 billion in capital raised in 2010 for funds of that kind. “Investors are looking at functional currencies with a more certain future,” he said. “And for a lot of people, that’s the Chinese yuan and not the U.S. dollar or the euro.” Despite the impediments, the Asia-Pacific continues to remain in rude health, with the region being the primary focus of 22 percent of all funds seeking capital from investors as of August 2011, said Preqin. With Asia accounting for more than 20 percent of all PE activity globally, and now on every PE firm’s strategic agenda, Kelly sees the growth prospects for the Asia PE market as “very strong relative to Europe and the U.S.,” not least because the amount of “dry powder” in PE funds for the region. He adds that agriculture is seen as a major growth sector for investment in the short to medium term, especially with China and India looking to meet their growing demand for food. “We are already seeing interest from both sovereign wealth and PE investors in the agricultural sector in regions such as Asia-Pacific, Africa and South America,” he said.

China: A time of diversity

Perhaps the most compelling story in China’s private equity market today is how local firms are expanding abroad, initially across Asia, but also into certain Western markets. Among them are Hony Capital, which in June announced plans for a fifth U.S. dollar fund with a size of at least $1.4 billion;
Citic Capital, which has a Japan fund and an international co-investment fund, and CDH investments, the private equity arm of which has more than $4 billion of assets under management and has invested in more than 50 of China’s biggest companies. In addition to competing overseas with established
names like Blackstone and Carlyle, these firms are also looking to leverage their local expertise to attract overseas investors into their funds.

These firms have helped ensure that much like the overall Chinese economy,China’s private equity markets has remained one of the most intensely competitive markets in the world. It is also head and shoulders above any other market in the region: 49 percent of Asia-Pacific funds closed in 2009
included an allocation to Greater China,according to Preqin, with the number rising to 55 percent in 2010 and 61 percent in the period of January to August 2011. And just like the nation’s economy – and perhaps the nation itself – the private equity scene is extremely vibrant. “The main trend I see is that of
diversity,” said Anthony Zhao, partner at Zhong Lun Law Firm. “There is diversity in the types of funds operating in China now, and also in terms of the instruments.”

He said that until a few years ago, most of the PE investments were in U.S. dollars, with the aim to list the company overseas, but now that has changed. “There are RMB funds that are purely aiming at the domestic market, with the final aim of an A share IPO,” Zhao added. “Then, there are U.S. dollar funds that not only invest in offshore structures with the aim of an overseas IPO, but also invest cross border with the aim of an A-share IPO, under which the transactions are governed by Chinese law.” He also notes how the instruments have now become more varied and sophisticated in recent times with buyout deals, growth capital deals, venture capital deals, PIPEs and convertible deals among the numerous types of deals that he observes.

The concept of private equity is not new to China; in fact it has been around for at least a decade. Zhao said that the market and entrepreneurs have become a lot more sophisticated now, and with the amount of capital reserves in China,the rise of RMB funds has almost become inevitable. “Many international
fund managers see raising RMB funds as a must for their global strategy, and you can also find local talents becoming successful quickly because of their deep roots in China. Chinese limited partners are gradually becoming more sophisticated and patient. In particular,the business value chain servicing the
RMB funds is also becoming quickly developed and institutionalized, because of which the raising of RMB funds has become more viable,” he noted.The diversity Zhao observes also lies in the industrial sectors in which PE funds invest.

The traditionally popular TMT sector is still among the most attractive, and the e-commerce sector is especially attracting massive interest among VC and PE investors.And this has also led to a lot of funds interested in related industries like logistics and transportation. “You can order something from the Internet,” he said, “but someone has to deliver it to you, right? Thus, popular areas today are sectors like the delivery network, back-office support, and network infrastructure, which have remained backward and fragmented for a long time.” Zhao also sees continued interest in consumer products, brands and services.

Looking ahead, Zhao sees continued growth, with the caveat that much will depend on the performance of capital markets around the world economy. “Lately, the Hong Kong and U.S.markets have not been performing well, and this has affected exits of many PE investments; if the international capital markets do not recover soon and the issuing pace of A-share IPOs slows down and valuation drops, the market confidence in PE funds will be significantly affected,” he said.“More fundamentally, much depends on the state of the global and Chinese economies in the near future.”

Southeast Asia: Exit problems

With markets around the world continuing to be volatile, and in particular, the European debt crisis
continuing to grab the headlines, PE funds in Southeast Asia are facing challenges in when it comes to carrying out exit transactions. “I think we all appreciate that the capital markets are volatile now, and this is seriously affecting sellers trying to take their companies to an IPO,” said Ng Wai King, partner at WongPartnership.

“With the capital market route not available to most, PE funds’ exit options may be limited to a trade sale.” Ng adds that despite the market volatility, and despite there being a difference in the expectations of buyers and sellers, a number of cash-rich funds have a fair amount of dry powder, and are very keen to do deals. “There are a large number of acquisition targets in the region,” he said. “And it is almost inevitable that PE funds will be trying to get in on the action if viableopportunities are presented.” And this, according to him, is a reason why the outlook for the sector remains positive.Ng said that the broader consumer sector has been the most prominent area receiving PE investment.

Meanwhile, in Malaysia, specifically, there has been a great deal of offshore fund interest in renewable and sustainable energy such as photovoltaic and solar energy, and the production of steam energy from the waste of the oil palm industry as well as reforestation programmes in East Malaysia, said Theresa Chong, head of the corporate division at Malaysian law firm Skrine.

“The factors driving this appear to be the need for alternative forms of energy and green technology driven by environment conscious investors,” she said, adding that she expects to continue to see strong interest in the energy, renewable energy, resources and green technology sectors. Another notable trend in the past 12 months has been the emergence of Japanese strategic buyers as a serious competitor to PE funds. “Japanese strategic buyers have become a force to reckon with for M&A opportunities in the Southeast Asian region,” he added.“They are able to offer both price and funding certainty.”

Japan: An ‘M&A boom’

The PE story in Japan in the past for secondary buyouts for funds,” said Ryo Okubo, partner with Japanese firm Nagashima Ohno & Tsunematsu. Okubo adds that there is a lot of cash in Japan at the moment, and coupled with the strengthening yen, is resulting in an “M&A boom.” Cash-rich Japanese
companies are participating in already competitive bidding processes, and that is pushing the bid prices up even higher. The companies are also fanning out across the globe as strategic buyers,investing in companies in Europe and the U.S. and especially in Southeast Asia. “Thailand, Vietnam and India
are among the top destination for a lot of Japanese companies,” said Okubo.

“In particular, they are moving their factories to these destinations as they see this as great investment opportunity.” Despite the seemingly conducive environment, Japanese PE funds still face some challenges. “Private companies in Japan prefer not to sell stakes to PE funds, since these funds
have a negative image,” said Okubo. “So these funds have a much harder time buying into companies in Japan.” The declining economy, however, presents a unique set of opportunities, he adds,noting that he expects to see a lot of companies undergoing restructuring through spin-out transactions and
mergers, which will bring PE funds into play. “With the capital markets performing poorly and due to heavyburden of disclosure, some companies may decide that they do not want to remain listed, and thus we are seeing many management buyout transactions these days,” he said. “In these cases,
they are enlisting the help of PE funds.”

India: Regulatory wrangles

Once a darling of global PE funds, the Indian market has seen its stock plummet of late, even as it is the second-most popular location targeted by funds focused on Asia-Pacific according to Preqin, with 27 percent of the funds closed in the January-August period of 2011. The reasons are numerous. India’s funds have proved no match for Chinese RMB funds in attracting global investment, and as in a number of other jurisdictions, the paucity of exit options is also hampering PE funds. And the attitude of the authorities has not been encouraging either.

The last 12 months in India’s PE space have been marked by changes in regulations that have had a negative impact on the inflow of funds. “Just toname a few: the new takeover code, the changes to the method of valuation for pricing of transfers between residents and non-residents, changes in regulations for investing in real estate projects, the attempts to prevent options, and so on,” said Anand Desai, founder and managing partner at DSK Legal. “This has resulted in a slowdown
in inward investment.” Desai said that he has also seen an aversion to private equity among failing companies, with the promoters of the company actively resisting restructuring that would give a PE fund a larger stake in the organization. All this has resulted in $20 billion lying idle as “dry powder”
with India-focused funds, according to some estimates.

At the same time, consulting firmBain said that there are more than 100 India-focused funds currently seeking to raise $34 billion, which shows the Indian market still has much promise. In particular, real estate has been the recent star, with Desai pointing to a number of deals of late. “This is due to the value of land in India continuing to go up all the time,” he said. “Additionally, we have also seen some activity in healthcare, technology and pharmaceuticals.” But with, in his own words, “too many” regulatory obstacles facing the Indian PE space, Desai does not have a greatly positive outlook for the months ahead. “I expect to see too many changes in applicable regulations,” he said. “This uncertainty in the regulatory environment is possibly the biggest negative.” ALB