Q&A: How EQT finds value in Asia's mid-market

The Swedish alternative investment firm tells FinanceAsia how it finds high-growth companies and manages risk in Asia’s under-researched middle market.

Early-stage private companies are getting more attention than ever from the international investment community, meaning private equity and venture capital funds could face stiffer competition for assets in the years ahead.

Specialist asset manager EQT's plan is to continue harvesting the region's middle market. 

Having already deployed more than $1.2 billion through investments in 18 companies after a decade investing in Asia, the Sweden-headquartered alternative investment firm recently closed its third Asia-focused mid-market fund.

EQT’s Mid Market Asia III fund will target mid-market companies in Greater China and Southeast Asia with clear growth and development potential. With total commitments of $800 million, it aims to invest two-thirds of its capital in Greater China and one-third across the countries of Southeast Asia.

FinanceAsia talks to Martin Mok, partner and head of the EQT Mid Market Asia advisory team.

The following transcript of the interview has been edited for clarity.

Q How does EQT define mid-market?

A For our Mid Market Asia funds we target companies with an enterprise value between $30 million and $250 million.

We also carve out about 20% of our capital to invest in non-Asian companies that have significant business exposure in Asia. For this segment, we place a higher cap of up to $500 million.

For example, we paid A$560 million ($425 million) for Australia’s I-MED Radiology Network about four years ago and subsequently sold it to Permira for about $1.3 billion earlier this year, generating a capital return of over three times.

Q This is already EQT’s third Asia-focused mid-market fund. As a specialist in this segment, how do you pick your target companies?

A We don’t compete on price. We do not participate in investment bank-led M&A auctions that much, compared to other private equity funds in the region, because these companies are usually offered at a premium to the sector’s average valuation.

Instead, we focus a lot on researching the sectors we are interested in and find target companies with the help of our industry advisors. We take a sector-based approach.

As a result, we are generally able to invest in our portfolio companies at an EV/Ebitda of about 1-2 times lower than the sector average.

By passing on some M&A auctions, we may not be able to buy the country’s top firm in any specific sector. But we are capable of finding a regional/provincial leader with strong growth potential, and one that we can create value in.

Q You talked about value creation. What exactly can private equity firms like EQT bring to their portfolio companies?

A Our portfolio companies pick us as their investor because we are able to bring managerial expertise, extra investment and potential M&A opportunities for them.

One example is our investment in Long-Spring Education, the largest privately owned education group in China’s Yunnan province. Long-Spring Education values us because we have experience in managing education-related firms and taking them public, which is the ultimate goal for the firm.

We were an early investor in Europe’s largest private education provider, AcadeMedia, and helped it with its initial public offering in 2016. Our mid-market funds also invested in Finnish day-care centre operator Touhula and Norwegian cloud-based learning company itslearning.

We also brought in Mason Lee, an education veteran with experience in China and Taiwan, as a co-investor in Long-Spring Education. These are all examples of how we can create value for the firm instead of purely being a financial investor.

Q Asia’s middle market is relatively under-researched and, thus, investment involves a lot of risks. How do you alleviate such risks?

First, we generally seek a controlling stake of over 50% in order to make sure we have our say in major corporate decisions. Of our 18 investments in Asia since our inception, we acquired controlling stakes in 12 of them.

We require board seats and the right to decide key corporate issues such as budgets and business models, as well as the appointment of key management personnel.

We also seek the right to dismiss or replace the CEO when business results fall out of our expectations for a certain period.

If we are a minority shareholder, we will seek to include the so-called trigger exit clause in the agreement to ensure we can monetise our investment after a certain period. This clause is meant to ensure our investment remains independent to that of the major shareholder and will not be locked up in case the major shareholder does not make an exit over a long period of time.

Q What are the sectors you see value in the long-term?

A We see value in Asia's services, education, healthcare and consumer sectors.

So far, we have invested in four companies. Apart from Long-Spring Education, we acquired ILA Vietnam, a leading premium English language training service provider.

We also acquired GPA Global, a Chinese one-stop-shop premium packaging and display solutions provider, and Clinical Innovations, a US-based provider of medical devices for mothers and babies.

Q Do you invest jointly with other general partners (GP)?

A We seldom co-invest with other parties because it will mean less control for us. There are now many startups with multiple rounds of funding from a long list of investors, but they are not on our radar.

For us, the issue with this type of investment is that we need to spend a lot of time and resources communicating with other GPs. Also, the split ownership structure means no one will feel completely responsible when the company runs into trouble.

Normally we only split our stake with the founder, who on some occasions keeps 20% to 40% of the company after our investment. But in many cases we purchased our portfolio companies in full.

Q Do you have any IRR (internal rate of return) targets for the new fund?

A We tell our limited partners (LP) that we target a 25% increase in IRR per year and an overall MOIC (multiple on invested capital) of 2.5 times. But, internally, we aim to achieve [a capital return of] 3 to 3.5 times.

For individual companies, we generally seek 10% to 15% organic growth in equity value per year. Our companies also grow through acquisitions and we generally expect their value to double by adding new businesses throughout our typical holding period of five years.

Q Could you share more on EQT’s due diligence and risk-management process and how it differs between middle and large markets?

A It is clear that the middle market is less transparent compared to other mature markets. As a result, we place more effort and resources in due diligence, particularly in emerging markets.

It is very important to engage third parties for due diligence checks in order to prevent any bias we might have throughout the bidding process. [So] we appoint third parties to help us perform a number of checks.

For commercial due diligence we collect third party opinions on industry-wide information including estimated growth rate, competition, entry barrier and size of overall profit pool, etc.

Commercial due diligence also entails financial checks including quality of earnings and cash flow. We also engage in forensic due diligence with a bottom-up approach to investigate operational data in detail.

Legal due diligence is equally important. For example, we need to check whether the company is properly registered or whether it has breached any regulations on tax, social benefit or labour, etc.

As a foreign entity, we need to pay extra attention when we invest in China to make sure we are eligible in controlling the company under its corporate structure.

For sector due diligence, we focus less on the hard numbers but the company’s reputation, credit, vision and style of work. We get such information from the company’s competitors, which in turn gives us a softer view of whether the management is credible and reliable.

Q Is there any new form of due diligence you will consider?

A In recent years we [have added] a new category known as social compliance. We look at corporate governance issues and make sure the company does not run into major labour or environmental problems. 

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