Asia Private Equity Insight Seizing Opportunities Amidst Global Uncertainty

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1 Asia Private Equity Insight 2017 Seizing Opportunities Amidst Global Uncertainty

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3 Foreword Private Equity ( PE ) market overview Ongoing turbulence in global political systems and equity markets has resulted in a significant slowing of Asian Merger and Acquisition ( M&A ) activities from the record highs achieved during 2015 s M&A boom year. In, deal value fell from US$758.2 billion to US$594.7 billion, while the number of deals declined from 3,371 to 3,191 compared to the same 11-month period in the previous financial year. Despite prevailing market uncertainty and the measurable downturn in M&A activities, Asia s PE market remains cautiously optimistic and PE activities are continuing to grow. Interestingly, buyout and exit volumes across the Asia- Pacific region were slightly up, with respective deal values of US$79.2 billion and US$55.2 billion recorded between January and November,. Challenges or opportunities The UK s unexpected decision to leave the EU and the election of Donald Trump as the US president are the two biggest examples of the volatility that affected global markets in. While Asian markets might be less seriously affected by the deep sense of insecurity arising from such monumental political changes, investors in the US, the UK and across Europe were amongst the first to feel the resultant global reverberations. With Asian investors unlikely to remain untouched by the fall-out from such dramatic changes for long, high returns and increasing maturity in markets such as China should continue to attract investors from overseas. The main challenges currently facing PEs when deploying investors capital are growing pressures from existing dry powder plus increasingly fierce competition from insurance companies and sovereign wealth funds. Dry powder held by Asia-based PEs in hit a record high of over US$110 billion an increase of some 15% above the US$96 billion figure recorded in Worryingly, such excessive capital may yet prove to be more toxic than beneficial. This is especially true amongst fund managers who have done everything possible to identify worthwhile deals. It is estimated that competition in the fundraising and exit environment will continue to increase and intensify in the future. Fund managers have always regarded insurance companies as an important source of capital. Recent liberalisation of rules governing investment by insurers/insurance providers involved in PE have given such companies more direct exposure to PE. This has in turn encouraged insurance companies rolling out debut funds to invest in smaller and medium-sized local companies. While sovereign wealth funds are also searching for alternative investments to deploy capital, they have turned to an increased investment in PEs. More tolerant illiquid investments mean sovereign wealth funds are also placing added pressure on the PE market as they seek out more attractive investments. With turbulence likely to continue well into 2017, the obvious question is where best to seek investment opportunities? The past few years showed that Asian PE is the top gateway for those looking to invest in Europe and the US, or who wish to add to their experience in new technology, brands and management expertise. Given the complex interplay of time zones, distances and cultural affinities involved, it is generally far easier to manage one s business closer to home. That said, it appears that PE firms will be given more opportunities under the Belt and Road initiative. The end result should help create massive potential investment opportunities by measurably expanding multilateral ties among more than 65 economies across Asia, Europe and Africa in Despite pervasive economic and political uncertainty and challenges, PE firms that are willing to invest time and resources into driving new and innovative growth and investment strategies throughout their portfolios look set to come out ahead in ASIA PRIVATE EQUITY INSIGHT

4 Major Challenges Facing PE Firms in 2017 Upcoming elections in Europe US presidential election Growing Brexit fear The slowdown of Chinese economy While many of those interviewed in the Liquidity and Capital Raising Forum survey claimed that they viewed PE firms as a primary potential funding source for their companies growth initiatives, PE firms still face significant challenges. In addition to distinguishing themselves from other capital sourcing options, specific examples include the need to identify quality deals. Firms must also investigate ways to operate more effectively and properly integrate new companies into their investment portfolios. Outlook for PE market in 2017 Stepping into 2017, we project the global PE activities to be similar to those of. Despite such an uncertain and challenging macro-environment, the outlook for Asia s PE market remains cautiously optimistic. This is particularly true when it comes to leveraging Hong Kong s role as the region s leading multichannel financing hubs. Ideally placed to benefit from the Belt and Road related infrastructure opportunities, we foresee that investors looking to absorb external capital for their projects will continue to converge in Hong Kong in large numbers. 2 ASIA PRIVATE EQUITY INSIGHT 2017 Trade sale will doubtless retain their position as PE firms preferred exit strategy. With sustained volatility and tighter regulations in public markets reducing attractiveness for IPOs, Secondary buyouts ( SBOs ) will continue to increase and will probably remain PE firms second most favourable exit strategy in The prevailing speculative nature of the public equity market means IPOs are likely to remain a less attractive short-term option for PE firms in the foreseeable future. Given the difficulties involved in fundraising and pinpointing quality deals, portfolio value creation is likely to remain another key initiative for PE firms. This is especially true of those willing to invest time and resources in building up the value of their portfolios and accelerating potential returns.

5 Outlook for the PE Industry in 2017 Global PE Firms WHAT IS YOUR EXPOSURE LEVEL TO PE IN NEXT YEAR Equal 40% Increase 3% % Source: PEI Perspectives 2017 Decrease Invest opportunistically 26% Equal Decrease 37% 5% 8% Invest opportunistically 50% Increase Throughout, both PE deal volume and value have dropped by 20%, while value of PE exits and fundraising are down by 25% and 13% respectively. Coupled with a lack of available quality deals/assets, high purchase price multiples drove down both deal volume and future returns. Experts project 2017 deal flow levels will be similar to those in. Fueled by the high-level of dry powder accumulation and ongoing challenges in capital deployment facing PE managers, the PE fundraising is expected to fall substantially in Interestingly, despite the various challenges faced by each form of PE investment, 32% of those surveyed said they were looking to increase exposure to PE firms in Around half of these respondents said in 2017 would probably see them commit a similar amount of capital to PE as in the previous 12-month period. HOW DID YOUR PE PORTFOLIO PERFORM AGAINST BENCHMARKS IN? As expected Better than expected Short of expectation Not applicable Both PE deal volume and value fell roughly 20% in. Similar performance levels are expected during Source: PEI Perspectives % 33% 10% 8% Over 49% of respondents believed their PE investment performed as per their expectations during. Around 33% of those surveyed felt their portfolios actually out-performed their benchmarks. Ultimately, just 10% of respondents felt their portfolios underperformed. ASIA PRIVATE EQUITY INSIGHT

6 WHAT ARE YOUR PREFERRED PE STRATEGIES? Real estate Mid-market Private debt Venture capital Distressed/ turnaround Secondaries Large buyout Infrastructure Source: PEI Perspectives More than 60% of survey respondents considered real estate to be their most preferred PE strategy for Mid-market buyouts and private debts were other strategies considered by over half of the respondents. An expected rise in interest rates during 2017 is likely to exert downward pressure on property prices. Given ongoing economic volatility, this will probably result in real estate funds becoming more attractive for potential investors. When compared to 2015, investors interest in mid-market buyout strategies has declined from 74% to 58%. The fall is largely due to investors increased long-term caution arising from the continuing political uncertainty, especially from the UK s Brexit vote and the US election outcome. The PE sector s key macro-economic concerns for 2017 are continued global economic slowdown and the prevailing low interest rate environment. Slow economic growth and low interest rates resulting from the global economic downturn have been accompanied by worries about secular stagnation. Given almost fullemployment in the US, investors are also concerned whether the market s business cycle has already peaked. A combination of today s low interest rate environment and extreme market valuations is intensifying uncertainties about expected investment returns. This is especially true for Asian Limited Partners ( LPs ) who are concerned about finding attractive and appropriate potential deals/assets. The market s excess liquidity means the possibility of returns starting to fall is also becoming an issue. WHAT DO SURVEY RESPONDENTS SEE AS THEIR MOST PRESSING MACRO AND STRUCTURAL ISSUES DURING 2017 A global economic slowdown Current low interest rate environment Extreme market valuations Slowdown in China Geopolitical risks Others 0 20% 40% 60% 80% 100% st choice nd choice rd choice 1st choice 2nd choice 3rd choice Sources: PEI Perspectives 2017, GT analysis 4 ASIA PRIVATE EQUITY INSIGHT 2017

7 WHAT DO ASIA-BASED FUND MANAGERS SEE AS BEING THE BIGGEST CHALLENGES FACING THE PE INDUSTRY IN THE NEXT 12 MONTHS Fundraising Exit Environment Volatility/Uncertainly in Global Markets Performance Regulation Deal Pricing Deal Flow 59% respondents concerning about their ability to hit fundraising targets in the coming year represent the largest proportion of Asia-based respondents. This group was followed by the 53% who viewed 2017 s exit environment as their biggest worry. The latter group included many venture capital fund managers in its ranks. 41% of fund managers surveyed said they also considered volatility and global uncertainty to be a major issue when going forward. A further 38% of fund managers indicated that as higher economic and political risks would almost certainly result in increasingly unstable investment returns, fund performance was likely to be another huge obstacle in Fee Pressure 0% 10% 20% 30% 40% 50% 60% 2017 Source: Preqin - Preqin Special Report Asia Private Equity saw deal value in the Energy, Mining & Utilities industry experience a sizeable fall of 40% from US$142.6 billion in 2015 to US$86.6 billion in. The slight increase in the region s technical sector in was largely due to the slowdown of the Chinese economy arising from its ongoing transformation to a more consumption and technology driven economy. In, China has witnessed a rapid growth in outbound M&A, with 262 deals reaching a total sum of US$185.3 billion. Stepping into 2017, the Chinese government s adoption of a policy aiming at abating capital outflow could help boost the country s domestic M&A. As a result, we anticipate an upturn in M&A activities in China particularly within China s TMT and environmental sectors. SECTOR-BY-SECTOR BREAKDOWN OF THE AGGREGATE VALUE OF ASIAN M&A DEALS IN Technology Industrials & Chemicals Energy, Mining & Utilties Financial Services Asia total M&A value (US$bn) 2015 Source: Mergermarket - Monthly M&A activity Jan 2017 ASIA PRIVATE EQUITY INSIGHT

8 Pre-transaction & Target Searches Key Challenges Facing the M&A Activities in 2017 WHAT DO YOU THINK WILL HAPPEN TO M&A ACTIVITIES IN 2017? Remain the same Increase somewhat 48% 12% % Remain the same Increase significantly Decrease somewhat 12% 8% 12% 68% Increase significantly Increase The vast majority (80%) of those interviewed believed that M&A activities will expand in 2017 despite last year s measurable decline in deal making. Such positive sentiment towards M&A also extended to the public equity market. PE firms growing desire to stay innovative and seek technological advancement looks set to continue as a key driver in shaping the global capital market in At the same time, PE firms are eager to grow returns on their own portfolio companies by investing in synergistic acquisitions that will provide strategic technological advancements. A small proportion (20%) of respondents said they foresaw M&A activities to remain constant or even decrease. This 20% figure was an increase over the 8% figure recorded Source: Venue Market Spotlight: 2017 Outlook As many as 52% of respondents considered the biggest obstacle to M&A investors in 2017 to be the sluggish growth across China and in other emerging economies. As a result, many investors are reassessing whether or not to invest in target companies in these markets. Many Chinese investors seemed equally worried about currency controls and uncertainties in their country s geopolitical environment. Such investors are also facing challenges both internally (government restriction of outbound acquisitions) and externally (the West s possible setting up of barriers preventing Chinese investment). Around 40% of respondents said they considered political upheaval in the US, Europe, Latin America and the Middle East to be their biggest areas of concern. WHAT ARE LIKELY TO BE THE BIGGEST IMPEDIMENTS TO GLOBAL M&A ACTIVITIES IN 2017? High valuations/valuation gap between buyers and sellers Sluggish growth in China & emerging markets Government policy chnages in the US Political upheavel in US, Europe, Latin America & Middle East Exchange rate volatility Volatility rate commodity prices 12% 12% 16% 16% 20% 24% 8% 0% 10% 20% 30% 40% 50% 60% 1=most important 16% 8% 24% 4% 40% 2nd Source: Venue Market Spotlight: 2017 Outlook 6 ASIA PRIVATE EQUITY INSIGHT 2017

9 Investment & Integration Key PE-backed Buyout Locations TOTAL VALUE OF PE-BACKED BUYOUT DEALS BY REGION BETWEEN 2012 AND Total Deal Value (US$ billion) High purchase price multiples, growing global political and economic uncertainties and intensified competition from strategic acquirers and insurance companies have caused PE-backed deal volumes to decline globally US Europe Asia Rest of the World Source: Preqin Private Equity-Backed Buyout Deals and Exits saw the global value of PE-backed buyouts fall by 22% to US$319 billion. High purchase price multiples, growing global political and economic uncertainties, and intensified competition from strategic acquirers and insurance companies have all contributed to such decline. Coupled with increased political uncertainty following Donald Trump s election as the 45th US president, the relatively pessimistic outlook for the US economy and the prospect of an appreciation in the exchange rate value of the US dollar have resulted in PE firm managers relative reluctance to invest in the US. Great Britain s Brexit vote has created similar uncertainties in the economies of both the UK and Europe. As both parties are unwilling to compromise, negotiation is likely to be a lengthy process and the full implications of Brexit are yet to be known. This may make Europe and the UK far less attractive investment destinations. This is particularly of investors in Europe and other major markets worldwide where interest levels have already experienced a significant drop. The attractiveness of emerging markets for investors has declined due in part to the slowdown of the Chinese economy. Increasing political and economic risks have also driven down deal volumes across Asia, with risks and potential returns for PE in developing markets becoming less favorable than before. Moving forward to 2017, the US-China relationship the most important driver that investors consider might well become a focal point of the state of global economy as a whole. Major recent developments in Asia that have contributed to these downward trends include: China s introduction of central government policies restricting capital outflow and the depreciation of Chinese yuan might have reduced investor interest in the country s markets. The infamous political scandal in South Korea has seriously harmed investors confidence in the country. ASIA PRIVATE EQUITY INSIGHT

10 Exit PE Exit Trends GLOBAL NUMBER OF PE-BACKED EXITS BY TYPE BETWEEN 2012 AND Total no. of Exit No. of Exits 1, , , , , ,682 PE-backed exits with a total value of US$330 billion were recorded in. The total number of exit in the PE-backed exit market increased by 4% as a whole. Trade sales were ranked the top option from 2012 to and accounted for over 50% of all exits in those periods. SBOs accounted for 32% of all exits in Despite a slight fall in, the number of SBOs has experienced a general rise since 2012 and is expected to continue to rise in Turbulence in equity markets during has caused many IPOs to be postponed. The continued fall-off of IPO exits during was largely due to higher risks and failure levels despite high exit value multiples Trade Sale Secondary Buyout IPO Others Source: Preqin Private Equity-Backed Buyout Deals and Exits GLOBAL PERCENTAGE OF PE-BACKED EXITS BY REGION FOR PROPORTION OF EXIT OPTIONS FOR 8% 4% 32% 55% 48% 30% 12% 40% % North America Europe Asia Rest of World 18% Trade Sale IPO SBO Others Source: Preqin Private Equity-Backed Buyout Deals and Exits Source: Preqin Private Equity-Backed Buyout Deals and Exits 8 ASIA PRIVATE EQUITY INSIGHT 2017

11 Exit Secondary Buyouts GLOBAL NUMBER AND AGGREGATE VALUE OF SECONDARY BUYOUT TRANSACTIONS FROM 2012 TO No. of Deals No. of Deals Aggregate Exit Value ($bn) Aggregate Deal Value (US$ billion) SBOs across Asia and around the world picked up in. The year s total SBO deal value US$79 billion was the highest year-todate value attained since This trend shows no sign of any meaningful slowdown in the near future. According to the 2017 PE Crystal Ball Report published by PitchBook News, the trend for SBOs increase should continue well into Given the world s currently largely speculative public equity market, it seems probable that IPOs will remain less preferable for PE firms. At the same time, trade sales are likely to remain the primary exit route of choice for PE investors. Selling a portfolio company to another PE firm via an SBOs will help the investors realize investments and maintain IRRs with shorter holding periods. Sources: Preqin Preqin Buyout Deals Analyst, GT analysis SBOs look set to increase in 2017 as public market volatility continues to make IPOs less attractive. ASIA PRIVATE EQUITY INSIGHT

12 Exit Major Recent Trends of the Hong Kong IPO Market TOTAL FUNDS RAISED BY HONG KONG IPOS BETWEEN 2014 AND HK$ billion Source: Hong Kong Stock Exchange 2015 NUMBER OF NEWLY LISTED COMPANIES IN THE MAIN BOARD OF HONG KONG STOCK EXCHANGE Funds raised by Hong Kong IPOs during decreased by 25% to HK$195 billion from HK$259 billion in 2015 as a result of the tighter regulations and increased competition from other jurisdictions. The China Securities Regulatory Commission accelerate its IPO approval process by fasttracking listing reviews of A-shares in mainland China. The Shanghai Stock Exchange also start competing with Hong Kong in order to establish itself as Asia s regional IPO centre. The number of IPOs (main board) carried out in Hong Kong during fell by 23%. This was largely due to the sluggish global economy and underpinning uncertainties such as China s economic slowdown, Brexit and the emergence of Trumponomics. This said, saw Hong Kong maintain its top position in global IPO in terms of funds raised for a second successive year. No. of Companies Recent black swan -type events have further increased risk aversion in equity markets. It seems likely that IPO will continue to be difficult as an exit strategy, giving rise to trade sales and SBOs to be investors more preferred primary exit routes Source: Hong Kong Stock Exchange 10 ASIA PRIVATE EQUITY INSIGHT 2017

13 Opportunities and Strategies for 2017 Despite the ongoing uncertainty surrounding the global M&A market, PE firms seem to be offsetting their understandable skepticism with a sense of confidence and optimism about In order to finish ahead in 2017, PE firms must be prepared to invest time and resources into driving new growth strategies across their portfolios. Opportunities for 2017 Hong Kong PE Firms Expanding the number of stocks eligible for trading under the mutual access scheme, the commencement of the Shenzhen-Hong Kong Stock Connect programme on 5 December has inevitably enhanced Hong Kong s position as a global offshore Renminbi business hub. Encouraging progress by the Mutual Recognition of Funds arrangement between Hong Kong and mainland China will also expand the distribution network of Hong Kong s fund industry and pave the way for the territory s emergence as a fully-fledged fund-service centre. New prospects in overseas market the signing of a Memorandum of Understanding with Switzerland regarding mutual funds recognition in December has also enabled Hong Kong public funds to enjoy direct access to European investors for the first time. The establishment of a legal framework for the creation of the open-ended fund company (OFC) structure in June should not only create a more flexible business environment, but also better equip fund managers to meet growing market demand. Designed to expand multilateral ties among more than 65 key economies across Asia, Europe and Africa, the Belt and Road Initiative is sure to leave Hong Kong ideally placed to benefit from opportunities in such areas as infrastructure financing, offshore Renminbi services, asset and risk management. Key strategies for Hong Kong and Asian PE firms in 2017 Emphasise value over valuations PE firms are accustomed to paying high valuations to secure quality assets/deals. To boost both their cash flow and their acquisitions values, as well as offsetting higher than expected purchase prices, PE firms should strive to enhance their abilities in key areas such as operations, technology, sales processes, etc. Specialise to differentiate The identifying and closing of more deals is another way PE firms can accelerate growth. To this end, firms should begin pursuing innovative specialisation strategies in fields such as industry expertise, operational focus and/or market segmentation. They should also do their utmost to differentiate themselves by demonstrating that they are potential investors ideal partners. Drive growth with diligence PE firms should also start to focus on conducting detailed due diligence processes to identify possible inherent risks, enhance value and leverage opportunities to build each acquisition s value. In trying to maximise returns on higher purchase prices, they should also strive to jump-start core planning and integration processes. Leverage company-wide innovation Innovative practices are proven to maximise the effectiveness of acquisition strategies and thus increase the certainty of successful deal closures. Such measures are also likely to reveal previously hidden opportunities for performance enhancement as well as drive value creation. With ever-more sophisticated investors in today s digital world, it has become a new norm to demand a shorter completion cycle with project schedules of 12 to 14 months rather than 3 to 4 years plan. Ultimately, innovation is the engine that is empowering farsighted organisations to transform brilliant ideas into sizable returns. Empower the CFO In placing greater emphasis on financial planning and analysis, forward-thinking PE firms expect their CFOs to contribute meaningful information and growth acceleration strategies across their portfolios. PE firms that embrace a CFO-operating partner model will ultimately be far better placed to maximise operating efficiencies by bundling their needs and harnessing the purchasing power of multiple portfolio companies. ASIA PRIVATE EQUITY INSIGHT

14 For more information regarding this report, please contact us directly. Barry Tong CFE, CPA, MBA, SD (Insolvency) Partner Barry is the partner in charge of both Transaction and Forensic practices at Grant Thornton Hong Kong. As a Certified Public Accountant (CPA) for two decades and the Training Director of the Hong Kong Chapter of the Association of the Certified Fraud Examiner (CFE), the world s largest anti-fraud organisation, Barry has testified as an expert witness in Hong Kong Court and has been involved in Dispute Resolution, Restructuring and Forensic Investigation since T M E Barry.Tong@cn.gt.com Barry helps his clients at all stages of the deal cycle, from pre-deal due diligence and SPA support, to purchase price negotiations and post-deal dispute resolution. Barry s specialist team has extensive experience of advising either party to a transaction and of acting as independent expert to determine matters in dispute. Willis Chan CPA Senior Manager Willis has extensive experience in financial due diligence, forensic accounting, internal control, auditing and financial reporting and equipped with good knowledge on Hong Kong listing rules and business valuation. Willis provided auditing services for various listed companies and initial public offering. T M E Willis.Chan@cn.gt.com Prior to joining Grant Thornton, Willis worked as a manager in the Audit Department and Technical Department in a Big Four firm and specialized to serve clients in manufacturing and real estate industries. Benjamin Fong CPA Manager Benjamin has extensive experience in supporting mergers and acquisitions, financial due diligence, forensic accounting, reviewing business valuation and internal control and monitoring financial forecast and cash flows. T M E Benjamin.Fong@cn.gt.com Benjamin has also provided auditing services for listed companies and multinational corporations in Hong Kong. He has served a variety of clients and industries including trading, manufacturing, retailing, construction, engineering, information technology and software solutions, logistics and service providers. Benjamin has also involved in various transaction support assignments including initial public offerings, and mergers and acquisitions of listed companies. 12 ASIA PRIVATE EQUITY INSIGHT 2017

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