In a region experiencing such a high degree of corporate restructuring, it should be no surprise to learn that opportunities for private equity investment are plentiful. Which is just as well because 2006 promises to be another boom year for the amount of capital deployed in private equity transactions.

The Asian region has its own way of making well-intentioned investors seem like fools and there is no shortage of war stories for anyone who wants to know how tough it is to do the deals at all. But there is no doubt the Asian region has come a long way since the late 90s Asian crisis, a point brought home by private equity specialists who testify that the interest is not just focused on the large scale buy-outs but is particularly active in the middle market and at the VC level.

The strong bounce back from the Asian crisis has convinced US investors in particular that the boom bust days are over and that this is a good source of buy-out opportunities in the next five to 10 years. But as Grant Fleming at Wilshire Private Capital says, you have to put it in perspective. The sums being committed to Asia are only a fraction of the size of the deal book of the major global private equity players. And while international capital is flowing to Asia from the US, Japan and Australia, European institutions have yet to reflect Asia's resurgence in their asset allocation. European investors may take some convincing that it is a viable alternative for them. As Donald Peck, managing partner for Actis in India comments, "Europe is the last great unconquered area for Asian PE. My colleagues are having some success with European family offices, but I have seen no significant breakthrough with a European institution into Asian private equity."

Signs of a heightened interest in Asia were evident in 2005 when Kohlberg Kravis Roberts established offices in Hong Kong and Tokyo. A number of landmark events occurred during the year, including Carlyle's $375 million investment in Xugong, the biggest private equity investment in China and the country's first LBO. For the first time, three Asian mega funds, each at $1.5 billion or above, closed within a year, adding $5 billion to the capital pool. Several single country funds raised more than $500 million, indicating a new level of maturity.

With Bain, Newbridge, Carlyle and Apax all raising substantial sums specifically for Asia, the challenge is to bring the deals to the market. At the middle market level, the banks and consultants are working to educate Asian companies about private equity. While they are having some success in educating management to the advantages of the buy-out idea, it is a drawn out process because Asian business are still wary of taking on too much debt.

Essential data on Asia

• In 2005, over $17.6 billion of fresh capital came into the market, compared to $5.6 billion in 2004
• India led all other markets in attracting over $2.3 billion of fresh capital
• $15.2 billion of capital was deployed, a 29% increase over 2004
• Although there was no increase in the number of deals (271) the average deal size increased by over 30%, to $63 million
• Buy-out situations accounted for less than 50% of transactions, with growth/expansion forming the majority, indicating the return of growth capital investment in Asia
• Services companies were the most-favoured sector, raising $5.3 billion
• 188 exits were recorded, a rise of 25% from 2004
• $20 billion has been returned to investors, from an invested capital of $6 billion
• Japan accounted for 46% of that total, followed by China and India
• IPOs were the most preferred exit route, taking up 50% of the divestment route
• Trade sale remains the dominant exit route in Japan, where it accounted for 85% of divestments.

Source: The Centre for Asian Private Equity Research

Many of Australia's superannuation funds have included private equity within their investment mix in the last five years. Leading the charge was Perth-based Westscheme. Chief executive Howard Rosario explains that Westscheme had a clear idea of what they needed to achieve within their target return portfolio, so it was a straightforward decision to use private equity managers: " Private equity investing seeks a reward for the manager's skill. Westscheme decided to try and benefit from this skill by agreeing to co-invest. We will co-invest where one of our existing private equity managers is already invested and identifies a good opportunity that it is unable to access because it is precluded by the investment guidelines it has committed to. The arrangement has the advantage of giving Westscheme's private equity managers a relatively more amenable alternative source of capital (they avoid having to share opportunities with competitors) and allows Westscheme to get invested more rapidly."

To put this in perspective of Westsheme's overall allocations within its target return portfolio, in 2005 the portfolio had a 3.5% exposure to private equity compared with a 16% allocation to subordinated debt/infrastructure, a further 16% in direct property and only 1% in hedge funds. The actual strategic allocation to private equity is in the range of 5 to 10%. Rosario says the investments are made on the basis of suitable opportunities, suggesting that Westscheme has not found sufficient private equity deals that suit it.

The Australia Venture Capital Association reports that $3.1 billion of private equity was raised by 20 funds in the year ended 30 June 2005, with buy-out funds the dominant category. Of the 209 financings in the year, half were companies in the expansion stage of development. There were 25 acquisition/buyout financings (18 buyouts and seven acquisitions) and 20 start-up deals. Over 30% of the amount invested was in the industrial/energy category, 23% in consumer related and 11% in medical/health.

Other super funds, notably CSS, Vision and Military Super have allocated to private equity as part of the expansion of their long term asset allocation policy. M ilitary Super made its first private equity investment in 2000. Chairman Charles Kiefel says, " As the Fund's initial investments are maturing, we are now starting to see the benefits with significant returns starting to flow back to the fund. At the portfolio level our private equity investments provided a return of 11.1% for the year 2004-5 with one of our domestic P/E investments achieving an impressive 56% net internal rate of return since the inception of the investment in December 2003.

Overall, Australian private equity funds have a 10.6% annualised pooled return over the last 8 years. Buyouts, later stage, and generalist funds also had an upper quartile IRR of 42.3% while expansion stage companies had a 10.8% upper quartile return. Buyouts, later stage, and generalist funds had returned 99% of what had been historically paid in as of June 30, 2005 while investors for all private equity funds had received back 73%.

The focus for 2006 is likely to remain on China and India, but market watchers are quick to note that leveraged buyouts there will be relatively small and at the mercy of the bureaucrats. For the pension fund type investor, the core markets will remain Japan, Hong Kong, Singapore, Taiwan and Korea, where the more substantial buy-out action will be focused. According to Heath Snyder of PWC in Singapore, "the next wave of PE deals will not be through industry restructuring, but from government-related company sell-offs and conglomerate sell-offs similar to those seen in Europe."

First published in Investment & Pensions Europe, March 2006