Managers of private equity funds are buying companies in Asia at prices that are making their own investors worried, industry practitioners said at a conference in Hong Kong.
As the valuations paid for companies climbs, the likelihood is private equity managers will see the internal rate of return (IRR) they can deliver fall in lock-step if they do not compensate by adjusting their investment strategy.
“We’re in a very hot vintage year and returns are going to suffer. At least, we’re paying valuations that we weren’t paying five to seven years ago,” said Omar Lodhi, partner and regional head in Asia for emerging markers private equity firm Abraaj Capital.
The top concern in Asia among private equity fund managers, known in the industry as general partners, is high entry valuations, according to a survey by data provider Preqin.
Purchase prices in Asia were lower in 2005 than in Western Europe or North America, but now they are roughly on par at about 10.4 times enterprise value/Ebitda, according to data compiled by alternative investment management services firm Hamilton Lane.
“There’s a lot more competition out there, the consumer is a lot more discerning and there are exogenous factors that impact your businesses which mean you have to be on top of your game,” Lodhi said during the HKVCA Asia Private Equity Forum 2018 on January 17.
Prices have also been driven higher by private equity managers struggling to put their burgeoning funds to work in the region. Their investors, global money managers known as limited partners, have been allocating a growing proportion of their assets under management to alternative products in search of higher yielding assets at a time of record low interest rates.
In South Korea, pensions funds and mutual funds are almost forced to invest in domestic private equity firms, said Yong Hak Huh, founder and CEO at First Bridge Strategy, an alternative investments portfolio adviser.
This has led to a boom in the number of private equity funds in South Korea looking to do deals, from 110 in 2009 to 383 funds in 2016.
“It’s no wonder that these commitments to private equity are leading to high valuations,” said Huh.
In 2014, average private equity entry multiples in South Korea were around 9.5 times enterprise multiple/Ebitda; in 2015 that went up to 10.5 times; in 2016 prices climbed further to about 11.5 times; and in 2017 it seems like it will be close to 2016 levels, said Michael Hwey-Hoon Chung, head of Korea at Morgan Stanley Private Equity Asia.
The average private equity entry multiple over the past five years is 10 times, said Chung. If you take out the largest billion-dollar-plus deals then the multiple comes down to around 8.5 times. Chung said the last three deals done by Morgan Stanley Private Equity Asia in South Korea were struck at 6.4 times.
Some large investors that have relatively flexible investment mandates are turning more cautious as a result.
“This year, if the market stays as frothy as it has been then we may shrink [our exposure] but we don’t look at it year over year but in a longer term period,” said Suyi Kim head of Asia Pacific at the Canada Pension Plan Investment Board, more commonly known as CPPIB.
However, others are still piling in as they expect private markets to outperform public markets even during difficult times.
“Even as LPs tell us absolute returns will be lower in the next five years than the last five years they are going to commit more [capital]” said Mark O’Hare the founder and chief executive of Preqin. That's partly due to the fact private equity outperformed public markets during the 2007 global financial crisis.
In another comparatively mature Asian private equity markets, Japan, practitioners are also getting nervous.
“Pricing surely has been going up” since 2012, said Tatsuo Kawasaki, a founding partner at Japanese private equity firm Unison Capital. He noted that many deals are benchmarked off comparable companies trading on the Nikkei 225 index, which hit a 26-year peak earlier in January.
Prices have moved to around eigh to 10 times earnings multiples in Japan he said.
“We need to be very cautious on pricing and need to recognise that there is no easy nominal growth taking place in Japan,” Kawasaki said. As a result Unison Capital is focusing on subsectors in Japan such as healthcare growth which are growing due to the country’s ageing population.