Singapore: Private equity (PE) funds in India continue to attract significant investments from limited partners as their overall return on the portfolio is good, even if they have not seen success on exits for every portfolio firm, said Srividya Gopalakrishnan, managing director, Duff and Phelps Singapore Pte. Ltd.

Since India was among the few markets which continued to grow, and also had very strong demographics driving demand, these factors would sustain investments into the country, she said.

With South-East Asia and Singapore seeing a surge in tech investments, Gopalakrishnan said there were several learnings that this region can take from China and India, including on valuations.

Edited excerpts:

India saw robust PE investments in the past two years. But when it comes to exits, it has a poor record. Why is that so? Can India continue to attract record PE investments when its track record of exits continues to be poor?

Exits for PE/VC (venture capital) funds traditionally came from either IPOs (initial public offers) or trade sale—M&As (mergers and acquisitions). Every year, the number of PE/VC investments in India have far exceeded the number of IPOs. That is the reason for the poor exit record. However, the exits through trade sales have been fairly successful and have given good returns on several investments. In the past few years, more funds are also pursuing the secondary sale route—sale to other funds—as an exit option, even if the return on some such transactions have not been very high. Funds are continuing to attract significant LP (limited partnership) investments as their overall return on the portfolio is good even if they have not seen successful exits for every portfolio firm. In addition, India is one of the few markets which continues to grow and has very strong demographics driving demand. These factors will continue to drive investments into India.

Singapore and South-East Asia have been witnessing robust funding for start-ups over the past 12-24 months, a phase that India and China went through a couple of years ago. What are the learnings start-ups and VCs in this region can take from India and China as they navigate this phase?

There are several such learnings that South-East Asia can take from China and India. The first learning is to understand that tech firm valuations are not always based on non-financial parameters such as MAU (monthly active users), GMV (gross merchandise value), subscriber base, etc. While such measures set thumb rules for tech company valuations, the real basis of valuation goes deeper to look at financial parameters, business plan and concept viability. For example, firms such as Amazon and Alibaba could differ significantly on GMV multiples, but will converge on Ebitda (earnings before interest, taxes, depreciation and amortization) multiple. The company’s objective should be to make profits and positive cash flows sooner than later. Else, we will start seeing a correction in valuations and down-rounds.

Secondly, a related belief among some start-ups is that any tech start-up is valuable. Entrepreneurs should understand that the business should be commercially viable and perceptibly unique enough to be valuable.

Thirdly, we should remember that for those few successful unicorns that we see in China and India, there have been many more which have failed. Statistics show 25% of start-ups fail in the first year, 55% by the fifth year and 71% by the 10th year. If we embed this learning into our thinking and planning, the probability of failure can be reduced.

Last but not the least, while technology and Internet start-ups may be a new phenomenon in South-East Asia, we must understand that investors have significant experience and maturity of investing in similar firms in the US, China and India. They are more seasoned and have the hindsight experience of what works and what does not. It will be important for start-ups to leverage on that learning.

Asia boasts of over 50% of the world’s population, but when it comes to start-ups and VC investments, both in terms of deal value and volumes, the continent is still behind North America. When do you see the situation turning?

Asia constitutes 55% of the world population, compared with Europe which comprises of 11% and North America at 5%. However, the VC investments in value terms for Asia is only half of North America, though higher than Europe. This is because Internet penetration in Asia is under 44%, while the same is 90% for North America and 74% for Europe. This untapped potential makes Asia a key focus market for technology companies going forward. While it may take quite some time for Asia to overtake North America, we can certainly expect to see a substantial growth in tech investments in Asia over the next few years. Further, in recent times, we are seeing an increasing culture of innovation and entrepreneurship coming up in Asia. This traditionally has been more prevalent in North America and Europe. The increase in such culture and mindset in Asia will spur opportunities for VC investments in the region.

China has been a huge driver of global M&As this year. Will this become the new normal? How do you see outbound deals from China in 2017?

China has been on an acquisition spree this year. A significant part of these acquisitions have been outbound deals, specifically targeting the western markets such as the US and Europe.

From the earlier days of focusing on resources, in the past few years, we saw a new trend involving a spate of acquisitions stemming from the tech giants including BAT—Baidu, Alibaba and Tencent—acquiring global companies. This year, China has done a record level of outbound acquisitions, which is a significant growth from the previous few years.

The sector focus has got diversified to include consumer-driven industries, chemicals, real estate, hospitality, financial services, etc. Why is China Inc. on an acquisition spree? Clearly, their economy is getting more and more globalized. The maturity of doing business with the rest of the world, the increased confidence, combined with slowing organic growth and opportunities in the local market, has been driving Chinese conglomerates to target global businesses. This is fuelled by rising consumption by a growing middle class and the availability of low-cost funding.

With this recent trend in making global acquisitions, Chinese firms are seeing a mix of experiences. On the one hand, there have been several successful or in-process deals such as ChemChina’s acquisition of Syngenta, HNA Group’s investment in Hilton Worldwide Holdings, Tianjin Tianhai Investment Co.’s acquisition of Ingram Micro, etc.

On the other hand, there have been failed or abandoned transactions such as Anbang’s proposed bid for Starwood Hotels or Zoomlion’s bid for US crane-maker Terex. In several cases, the deals have gone through significant regulatory scrutiny in the target country. Deals such as Anbang’s bid for Fidelity and Guaranty Life or Chinese VC Go Scale’s bid for Philips Lumileds lighting business, fell through due to stringent regulatory reviews. In addition, the Chinese government is bringing about regulatory restrictions on foreign investment in order to curb capital outflows. This is expected to have an impact on billion dollar-plus deals in 2017 and going forward. These regulations are expected to slow down very large outbound deals, but they are unlikely to deter Chinese corporations in their quest for going global.

According to your data, Singapore witnessed a decline in deal activity in 2016, when compared with 2015. What were the reasons? Minus outbound deals by sovereign wealth funds in Singapore, how was deal flow this year, and how do you see 2017?

Singapore has seen 18% lower deal values in 2016 compared with 2015. However, there has been a 16% increase in deal volumes for the same period. The reasons for the reduction in value have been, first, one mega deal—the Avago-Broadcom deal valued at $37 billion—in 2015 that added substantially to the deal values in that year and, second, the average deal size has come down this year with several smaller firms making acquisitions. Sovereign wealth funds have contributed to about 46% of total Singapore M&A value, but only 7% of the volume this year. For 2017, we expect to see a robust level of deal-making from Singapore. Firstly, outbound deals will continue their pace, from both sovereign wealth funds as well as companies. Secondly, there will be increased investments in new-age sectors including technology, healthcare and R&D (research and development) and innovation-based sectors, etc. Thirdly, there will be several transactions driven by restructuring in certain industries, including sale of non-core assets and non-profitable businesses, albeit potentially at lower valuations compared with a typical M&A deal. Finally, we could see more privatizations of listed firms driven by cash availability in the companies as well as increased buyout activity by PEs sitting on a lot of dry powder.

The IPO scene in Singapore, though better in 2016, still compares poorly with other markets. How do you see the prospects for listings?

The IPO scene in Singapore has picked up well in 2016, compared to 2015. However, we have seen exchanges like Hong Kong raising about 10 times the same amount of capital through IPOs this year. Traditionally, some of the significant IPO listings on SGX have come from overseas companies as well as REITs (real estate investment trusts)—domestic and overseas asset based.

Now, Singapore not only faces competition from other global exchanges like Hong Kong, there is also competition from the domestic market exchanges as well as other forms of fund-raising like PE.

Several foreign listers are risk averse to listing overseas—in Singapore or other global exchanges—due to currency volatility. While the Singapore dollar has been fairly stable, some of the regional currencies have depreciated, making the cost of capital higher for such listers.

Having said that, we expect to see some REIT listings on the mainboard as well as more listings on Catalist by the new-economy companies. SGX as well as the Singapore government are taking several initiatives to promote the tech ecosystem. We also expect to see a few listings through RTO (reverse takeover) in 2017. Privatization of listed companies could happen due to various reasons such as—the shares trading at a low price, giving the main shareholder(s) a good opportunity to take it private; acquisition or buyout; and, third, companies facing operational, business or financial issues. We expect to see more privatizations of companies listed in the Singapore exchanges in the near future.

What is your outlook for M&As globally in 2017?

At a global level, 2015 was a historic year for deal-making. While we have not seen deal values in 2016 at the high levels of 2015, I can say that it has come a close second in several regions. With regard to 2017, the outlook for M&A has two sides to it—what the statistics say and what the sentiments say.

The statistics certainly indicate a good pipeline for deals, continued focus on cross-border acquisitions, increased share of Asia in the global deal values, cost of funds remaining relatively cheaper, huge amount of dry powder that can be deployed for buyout deals or PE-backed deals. However, the sentiments are rather negative at the moment. There has been Brexit, an unusual US presidential election, the fundamentals of democracy revisited in several countries, basics questioned, several years of hard work on trade being undone, slow recovery in the energy sector, several liquidations and bankruptcy situations in the marine, offshore or oil and gas sectors and a lot of other uncertainties looming.

Added to this are increasing regulatory requirements and an unfavourable tax-planning environment.

In spite of all the negatives and uncertainties, M&A deals will continue to flow in 2017. On the one hand, companies will continue to look for ways to supplement organic opportunities to help them grow and sustain margins. On the other hand, even restructuring in specific sectors will only increase transactions momentum.

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