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July 2010 Issue
In Brief

A Regulated Future for Private Equity following initial success by US lawmakers in pushing through reforms that seek to prevent a replay of the 2008 financial disaster Feature
Asian Institutions Make Speedy Move for quality assets, as evidenced by recent deals Institutional Investors – Investments
Philippines’ New Political Regime sees return of institutional interest Institutional Investors – Investments
PE in Japan Reflects Nation’s political woes as its fifth prime minister since 2007 takes office General Section – Analysis
Islamic Funds Gaining Stature following a host of such funds being launched recently General Section – Funds
Malaysia-based PE Investors Actively pursuing deals, suggesting private equity is gathering momentum in SE Asia General Section – Investments
Young and Growing Population in India is receiving attention from investors India Corner– Investments
SpiceJet Exit Ends an Investment that spanned a period of six years, during which it was difficult for investors to dodge the headwinds India Corner– Divestments
Content

Analysis

Institutional Corner
News
Investments

General Section
News
Analysis
The Leaderless Years
Funds
Investments

India Corner
News
Funds
Investments
Spending for the Next Generation
Divestments

Subscriber Weekly Summary
Stock Watch
Summary
Index & Exchange Rates

Directions

The writing is on the wall. Private equity will never be the same. On the last day of June, the U.S. House of Representatives (‘House’) approved the most sweeping changes of Wall Street rules since the Great Depression. With 237 votes in favour of the “Dodd-Frank Bill” (‘Bill’), versus 192 that were against it, unless obstructed by the Senate, the Bill’s “Volcker Rule” is set to rewrite private equity. The House’s victory is a statement of inadequate oversight and insufficient transparency for the financial industry as a whole.

Two years after the most devastating financial crisis since the Great Depression, world economies are ready to implement tough measures on private equity and hedge funds to prevent a replay of the 2008 catastrophe. As private equity enters a new phase under the vigilant eyes of regulators, its landscape will change forever.

Gains Taxed

While regulatory impediments have long been a fibre of Asia’s deal making landscape, the global financial crisis has nonetheless led regulators to impose stringent supervision and led to tightening of tax loopholes that private equity investors have previously been able to employ. In May this year, China enforced its Circular 698, which was proclaimed in December last year. The Carlyle Group (‘Carlyle’) became the first global private equity firm that had to abide by the Circular 698 demands. It paid a 10% withholding tax for capital gains it had derived from the sale of Yangzhou Chengde Street Tube Co., Ltd. (‘Chengde Street Tube’) earlier in the year (fig. 1).

Until the 2006 September M&A Regulation that requires transactions using offshore special purpose vehicle (‘SPV’) structure to seek approval from the Ministry of Commerce, SPV had been the standard deal framework employed by virtually all foreign investors in their China deals. For the purposes of tax planning, the SPV, domiciled in a chosen tax haven, would serve as the company that holds foreign investors’ assets in China during its investment tenure and act as an exit vehicle when the China-based assets were sold. Circular 698 is designed to address this loophole, through which foreign investors have been able to enjoy tax-free monetary gains. Circular 698 allows Beijing to levy a 10% withholding tax on capital gained from investment undertaken by non-resident enterprises where the source of such gains were derived from Chinese resident enterprises ....

General Section - Analysis

The Leaderless Years

Japan private equity needs leadership

In a country that extols the virtue of loyalty and advocates a structured society, the political scene in Japan has been unusually turbulent. In early June, following the resignation of Mr Yukio Hatoyama, Mr Naoto Kan, deputy prime minister and Minister of Finance, took office. He is the country’s fifth prime minister since former Prime Minister Mr Junichiro Koizumi stepped down in September 2006. In the four years and nine months that followed the departure of Mr Koizumi, no prime minister in Japan had been able to stay in office for more than 14 months. Even though Mr Hatoyama represented a new political direction and his Democratic Party of Japan broke decades of rule by the Liberal Democratic Party, Mr Hatoyama managed to score only 259 days as prime minister.

The revolving door that ushered in and ushered out Japan’s last four prime ministers is taking a toll on the country’s economic growth and investors’ confidence. In the immediate months after Mr Koizumi left office and was succeeded by Mr Shinzo Abe, investors displayed unwavering confidence and the Nikkei 225 touched 18,000 in July 2007. But two months later, Mr Abe bowed out of the office. Since then, the Nikkei 225 has yet to revisit 18,000 (fig. 10).

The Waiting Years

Two years after Mr Koizumi’s departure, in 2008 the world’s second largest economy registered its first decline in gross domestic product since 2000. Its economy contracted by 1.19% and that percentage widened to 5.2% in 2009 as Japan showed no leadership in lifting itself out of its lengthy economic doldrums (fig. 11).

With the nation waiting for its ideal leader to emerge, coupled with the onslaught of the global financial crisis, the once largest buyout market in Asia has seen investors’ interest decline. In the first six months of the year, private equity investors’ interest in acquiring Japanese assets plunged to an unprecedented low, with 11 deals known to have been consummated that added up to a meagre US$757.7 million in transaction aggregate. This, compared to US$1.1 billion and US$8.7 billion in transaction aggregates for the corresponding periods in 2009 and 2008, respectively, is by far the most depressing statement from private equity investors (fig. 12).

The Administration

Despite that bureaucrats in Tokyo have kept the country’s administrative machinery running without major hiccups during the past few years when virtually all prime ministers could only enjoy a maximum of just over one year in office, investors have been displaying their slipping faith. The capital deployment patterns during the Koizumi period that spanned from early 2002 to late 2006; and those after he had left office are telling statements from investors.

In contrast, the years during which the charismatic Mr Koizumi were in office, from early 2002 to late 2006, coincided with a period of boom in Japan’s private equity market. In 2003, less than two years after taking over the reins as Japan’s 89th prime minister, private equity transactions in Japan towered to US$5.9 billion, compared to US$3 billion in 2002. The figure reached US$10 billion in 2006, the last year of Mr Koizumi’s tenure (fig. 13).

The year after global financial crisis had erupted, 2009 could be described as an annus horribilis in the history of Japanese private equity. Despite private equity investors’ exhausting attempts to resurrect financially beleaguered companies, during those 12 months, investors saw the values of at least eight private equity-backed investments being written down, representing capital commitments that tallied up to US$5.9 billion (fig. 14). In these eight disappointing investments, foreign private equity investors were hard hit as their names appeared in most of them.

Comments

Perhaps no Asian private equity market has had to endure so much as Japan. When the global financial crisis struck Asia’s largest economy, it had not only weathered two decades of economic lethargy, but the nation was also carrying a debt burden that was close to two times of its gross domestic product.

But there are signs that some astute investors now reckon that assets in Japan have reached an enticing low valuation point. In June, Kohlberg Kravis Roberts & Co. (‘KKR’) announced its first investment in Japan since 2007. At that time, KKR committed US$167.4 million and took a stake in the publicly-listed Orient Corporation. In its second investment in Japan, the private equity firm took control of Intelligence Ltd., a recruitment services company. The transaction, at ¥32 billion (US$356 million) is the largest since Bain Capital Partners LLC (‘Bain’) committed US$1.1 billion in Bellsystems24, Inc. late last year. It was also the third private equity transaction by global buyout firms with deal sizes over US$60 million since the beginning of the year. Earlier in the year, Bain took control of Higa Industries Co. Ltd. for US$66.7 million. Hopefully with Mr Kan now taking over the country’s reins, with his background as a finance minister during Mr Hatoyama’s regime, a new dawn is arriving in Japan’s private equity market.

India Corner - Investments

Spending for the Next Generation

Private equity capital goes to India’s young and growing population

The combination of having one of the world’s largest populations under 15 years old as well as a growing middle class has altered India’s investment landscape. Increasingly, private equity investors are directing their capital to the future masters of India. The recent US$86 million undertaking by both Bain Capital, LLC (‘Bain’) and TPG in Lilliput Kidswear Ltd. (‘Lilliput’) points to not only a new direction of capital deployment by private equity investors, but is also a statement on India’s rising wealth.

According to the World Health Organisation, at the end of 2008 over 32% of India’s population of 1.18 billion was below 15 years in age, representing 377.9 million in real numbers, the highest in the world. In the same year, China, which led India by 164 million in population numbers, had 268.6 million who were under 15 years old (fig. 22). The global consulting firm, McKinsey & Co., also reckons that India’s middle class will increase by at least ten-fold, from 50 million in 2007 to 583 million in 2025. India’s youngest pool of consumers represents a gold mine waiting to be explored. It has drawn attention to a new sector that had largely been absent from investors’ radar before.

Since 2008, private equity investors have been directing their capital to companies providing either services or products for those under 15 years old. The trend became most evident during the past few months, with around US$160 million known to have been deployed to this sector (fig. 23).

Dressed Up Kids

So far, it is in the apparel sector for kids that private equity investors have been most readily deploying capital. In April this year, Bain and TPG earmarked close to US$90 million for Lilliput, a children’s apparel manufacturer and retailer based in New Delhi. This is the second round of financing received by Lilliput. Last year, it raised US$7 million from Everstone Capital, formerly known as Indovision Capital Management.

Lilliput is a 4.15 billion rupees company that was established in 1991 with only four sewing machines. It opened its first store in 2003. Since then, the number has grown to 250 covering 150 cities across India, further illustrating India’s domestic demand for kidswear. With the injection of capital from private equity investors, Lilliput plans to launch its “Lilliput World” brand stores, each with an average size of 7,000 square feet.

India’s alluring children’s market has even enticed SAIF Partners, which has largely focused on China. The regional private equity firm is negotiating to buy a 30% stake in Catmoss Retail Ltd. (‘Catmoss’) for around 700 million rupees (US$15.1 million), according to The Economic Times of India.

Compared to Lilliput, Catmoss has a relatively nascent history in India’s children’s retail industry. Established in 2004, Catmoss is headquartered in New Delhi and currently has 150 brand outlets. Its manufacturing facility has the capacity to make 6,000 pieces of apparel per day.

Educated Kids

Children’s education scores top marks in virtually all Asian nations. Since 2008, private equity investors have identified Tree House Education and Accessories Pvt. Ltd. and Pathways World School as investment targets. Earlier in May, the US-based Foundation Capital teamed up with Matrix Partners India (‘Matrix’) in the 400 million rupee Series B financing of Tree House Education and Accessories Pvt. Ltd. The latter is a Mumbai-based education institute that focuses on pre-school to K-12 education.

Separately, Reliance Equity Advisors (India) Ltd., the private equity arm of Reliance Capital Ltd., is another recent investor in this sector. In April, it became known that 1 billion rupees has been earmarked by the investor for Pathways World School. The latter provides education from Pre Nursery to Grade 12 in Aravali, Gurgaon and Noida. It also offers diploma programmes of the International Baccalaureate Organisation of Geneva and the International General Certificate for Secondary Education of the University of Cambridge, England.

Elephant Capital plc, formerly known as Promethean India plc, is also seizing this emerging dynamic in the country. It joined the growing party of investors deploying capital for India’s next generation via a recent £4 million (US$5.9 million) injection to Amar Chitra Katha Pvt. Ltd. The name “Amar Chitra Katha” is a household name in India. The comic series that depicts Indian stories and heritage was founded in 1967. Its products, including children’s books, games and DVDs, are sold through its website and 500 stores across India. In 2007, it came under the control of ACK Media (fig. 24).

Comments

According to The Nielson Company, consumer confidence in India rebounded in the first quarter of 2010 and reached its highest level since the third quarter of 2007, with clothing and home improvements high on the list. They are the natural evolutionary signs of a country that seeks to improve its living standards and that is poised to enter a new era of growth and wealth.