The series of fund closings this year was unprecedented in the history of Asian private equity; almost all the applicable fund management houses had to place a ceiling limit on their funds. For Asia's buyout investors, August 2005 left behind an envious and unparalleled fundraising testimony. Two pan-Asian, and one country buyout, funds achieved their final closings, gathering in an additional $2.6 billion to the swelling fund pool. All these three funds - JP Morgan Partners Asia's Asia Opportunity Fund II, Navis Capital Management's Navis Capital Partners IV and CHAMP Private Equity's CHAMP II Funds - followed the same route taken by CVC Capital Partners Asia Pacific II, in achieving close well above their respective original targets through a one-time close.

Since April this year, CVC Asia Pacific Partners closed its second fund at a record $1.975 billion, with a number of prestigious institutional names unable to be enlisted as its limited partners, it is no longer a novelty that limited partners are knocking on Asian private equity fund doors. "For the first time in eight years, institutional investors in the US are picking up the phone and calling us... this is something that we were not accustomed to," said one fund management firm's founding partner, who has just completed his second fundraising but has yet to adjust to the avalanche of attention from his fund investors. His remarks encapsulate the changes that are sweeping across the Asian private equity landscape.

The ringing questions are whether this Asian private equity boom is another irrationally exuberant bubble waiting to burst and whether there is now too much money coming into the rather heterogeneous Asian market. Since May this year, global houses have been hanging up their signs in the Asian private equity scene at lightning speed. The latest is Thomas H Lee's partnership with H&Q Asia Pacific, which came only weeks after Permira appointed its man in Japan, Bain Capital's intention to set up a $1 billion buyout fund and Apax Partners' assembly of its Asian team. There are also reports that Kohlberg Kravis & Roberts is also opening an office quietly in Hong Kong, despite having failed in its bid for South Korea's largest insurance company, Samsung Life. Their entries will further inflate the Asian buyout fund pool, as these global houses will be drawing funds from their US fund pool.

Figure 1: Distribution of top IRR(1) investments (Jul 2003 to Jun 2005)

Source: Asia Private Equity Review

Figure 2: Funds in top IRR(1) by markets (Jun 2003 to Jun 2005)

Source: Asia Private Equity Review

Figure 3: Top IRR(1) profile by markets

Source: Asia Private Equity Review

Brilliant records

Asian private equity began to assert its charm just months after the region was devastated by the visit of Severe Acute Respiratory Syndrome (SARS). In December 2003, the listing of China's online travel booking portal, Ctrip.com, on Nasdaq broke the spell that had long placed Asian private equity among at the lower end of the global private equity performers. Ctrip.com's spectacular success, which returned a multiple-fold of capital to its venture investors (including The Carlyle Group, IDG Technology Ventures and Orchid Asia), ushered in the longest duration of prosperity known in Asian private equity for the past two decades. When Shinsei Bank made its legendary debut on the Tokyo Stock Exchange in February the next year, it was a resounding testament that buyout is a viable investment model in Asian private equity. Since then, Asian buyout's first performance page has been an illustrious list of divestments. For nearly two years, this run has not been interrupted and there are no signs to indicate otherwise, leading the intellectuals to attempt to determine as to when the spell of good fortunes will lose its magic.

Regional or country buyouts

In the two years ending June 2005, the exit results of 56 buyout divestments are known. Of this number, 44 have attained an internal rate return (IRR) of over 25%, a benchmark often sought by institutional investors. Despite Asia's landmass, it has a limited buyout market size. Almost all divestments that achieved over 25% IRR came from three countries: Japan, Australia and South Korea. Together, they account for 89% of the top quartile results. Japan leads in capturing 37%, while Australia is not far behind, taking up 32%, and South Korea clocked up 20% (fig 1).

The performance of these 44 exits has firmly quashed the theory that pan-Asian firms that parachute into identified markets without a long-term operational presence in those markets are in a disadvantaged position. They account for 68% of the most successful results.

In both Japan and South Korea, regional firms command the market. In South Korea, over 89% of the best divestment records are records of foreign houses. The distribution of winners in Japan is not as tilted as its neighbour, but pan-Asian fund management houses took the lion's share in claiming 69% of the top-ranking results (fig 2).

And the figures are unlikely to be reversed any time soon, despite the mushroom of country-focused buyout funds, especially those in South Korea. In the first eight months of this year, eight buyout funds were established with total commitments of $5.6 billion, of which regional houses comprise 68.5%.

Profitable deals

Sceptics of Asian buyouts maintain that the 1997-1998 Asian Financial Crisis accounted for today's buyout results. It is true that the crisis introduced buyout to Asia, but few top investment performers came directly from victim companies of the crisis. In Japan, the largest buyout market, almost all realized investments came from those associated with the country's lengthy industrial overhaul. Likewise, in Australia, it was local corporate reorganizations that gave rise to the buyout transactions. In both of these markets, the crisis factor is conspicuously absent.

In South Korea, one of the three countries that received the IMF-led rescue package, the crisis was a factor leading to buyout opportunities for foreign investors. This category of companies accounted for 55.5% of the top quartile divestment results in South Korea (fig 3). Haitai Confectionery and KorAM Bank are two examples.

The deal profile in these three Asian markets suggests that Asian buyout houses can achieve outstanding results without another financial calamity as long as corporate restructuring or reorganization continues in markets with mature infrastructures, such as Australia and Japan.

Hurdles

When pan-Asian firms first entered Japan and South Korea, no local fund managers could rival their credentials. Their international expertise and large pools of capital were a powerful combination. Over the past 12 months, however, the Asian buyout landscape has changed. They must now revise their past investment formula.

Japan

Japan began to open its buyout market to foreign investors at the turn of the century. However, since 2002, when foreign houses claimed title to 16 transactions, records show that deal consummation has been on a decline. In the first half of 2005 only one foreign buyout house completed a deal.

In recent years, pan-Asian firms have maintained their edge by focusing on mega deal transactions, such as Japan Telecom and DDI Pocket (now known as Willcom), which commanded a transaction total of $2.2 billion and $2.1 billion respectively. But domestic firms have been swift to close the gap. Earlier in the year, Nikko Principal Investments Japan completed the takeover of BellSytem24, which had a price tag of ¥240 billion ($2.2 billion).

Japan's domestic buyout houses are no longer in the shadow of their global counterparts. Although it remains difficult to repeat Ripplewood Holdings' legendary divestment performance of Shinsei Bank, limited partners of some of the country's home grown and seasoned managers are proud of their achievements. Mizuho Capital Partners recorded a 30% return in its investment of Proudfoot Japan, and Unison Capital's recent disposal of Orient Credit to GMO is also a winner, scoring an IRR of 30%.

South Korea

In the period between 1998 and June 2005, pan-Asian buyout houses completed a total of 85 transactions in South Korea, the highest in any market. The first destination for Asian buyout investors after the crisis, its deal consummation rate has been on the decline. Over 72% of the transactions took place before 2001. In the 30 months ending June this year, only 17 were recorded, a far cry from the early days. To foreign buyout investors, South Korea is not only increasingly arid; but there are also formidable challenges from the domestic market.

Since Seoul implemented regulations to fuel the growth of private equity in October last year, seven domestic private equity funds are known to have raised over W1.2 trillion ($1.16 billion). South Korea, which once invited foreign investors to breathe life into its distressed assets, has now endowed its private equity market with generous capital allocations. Its outstanding local talents have also chosen to leave behind the financial cushion afforded by regional firms and point their future career path towards home. The former president of Carlyle Asia's operation, Michael Kim founded MBK Partners, which has attracted at least $750 million from overseas investors so far. Jae-Woo Lee of Vogo Investment gained his experience during his tenure at H&Q Asia Pacific's Korea office. In an interview with the International Herald Tribune in late August, Lee made no secret of his ambition to raise a W1 trillion fund and rival global names such as The Carlyle Group and Newbridge Capital.

Australia

The smallest of three major buyout markets, Australia presents a different set of tests to pan-Asian buyout firms. Although it boasts an excellent infrastructure for buyouts, it is fiercely competitive as it has an existing pool of expert managers who are familiar with international practices. Since the beginning of the millennium, regional houses reached the peak in clinching nine deals in 2001. Since then, deal flow declined to two in 2004 and zero in the first half of 2005. Uniquely different from Japan and South Korea, regional firms are quite ready to partner with local Australian managers in transactions (fig 4).

Figure 4: Foreign houses transactions in selected markets (1998 to Jun 2005)

Source: Asia Private Equity Review

Observation

The success of Asian buyout investors came with a price. Their outstanding performances have transformed the Asian private equity industry landscape, inspiring global players to look to the east and local aspiring managers to adopt this discipline, but they have also drawn the attention of regulators, especially in Japan and South Korea.

In late August, South Korea's Ministry of Finance and Economy revised its tax code. With effect from 2006, foreign-based investment funds will be subject to tax unless they can prove that they have operations in tax havens within a period of three years. In Japan, regulators have tightened loopholes in collecting withholding taxes from foreign investors. From the beginning of the 2006 fiscal year, the local partner of a foreign joint venture has to ensure its foreign associate complies with the country's relevant tax requirements

With some of the earliest pan-Asia buyout investors having successfully raised their second funds, Asian buyouts have entered into a second phase of development. Although the swelling pool of capital has helped to enlarge the market, target companies have multiple choices. In addition both to local and regional investors, corporate investors have shown a willingness to open their wallets and pay high value for strategic assets. They have become one of the most formidable rivals in buyout bids. In this new chapter of development for buyouts, it will take the most astute and responsive mangers to repeat the glorious record in its first chapter.