Driven by the need to deploy capital and realise existing positions, private equity firms may pursue buyouts more aggressively in Asia in 2024. Financing will be the least of their concerns if they do.

The prospect of an interest rate hike in the US in the second half of 2024 may influence how Asia-based buyout managers think about refinancing existing investments next year, but industry participants anticipate minimal impact on new deal activity.

“I don’t think financing has impeded getting deals done. In some cases, the cost of borrowing is a factor in the ability to support leverage, but the bigger issue is the gap in valuation expectations between buyers and sellers,” said Nicholas Macksey, a managing director at BPEA EQT.

“Maybe asset owners will hold for longer or take money out in other ways, like non-core asset disposals or dividend recaps. That’s what I would expect to see in 2024. At the same time, those with mature portfolios must start thinking about liquidity and this could narrow the valuation gap.”

Buyout volume in Asia has slipped from its 2021 peak of USD 145.5bn to USD 74.9bn in 2022 and the running total for this year is USD 63.4bn. Deal count is down by one-quarter year-on-year. Investment has moderated to pre-pandemic levels, but any notion of back-to-normal is undermined by the quantum of capital raised in the interim and the highly concentrated nature of deal activity in 2023.

For the first time in six years, Japan is Asia’s largest buyout market, accounting for nearly half of capital committed region-wide. Yet three deals make up 81% of the Japanese total, led by Toshiba, Asia’s largest announced buyout on record at USD 15.9bn (it has yet to close). There are three of only 13 investments to surpass USD 1bn: four in Japan, three in Australia, and two each in South Korea, India, and China.

There is a flakiness to investor behaviour, according to industry participants. Work begins on a deal and then often fizzles because managers not only have to build an underwriting case with a premium sufficient to counterbalance the attractive risk-return available in credit markets, but also factor in a higher cost of capital, macroeconomic uncertainty, and geopolitical tensions.

“Even if there is a pickup, conviction is still low. They might ask us to do two weeks of work, then it’s pencils down and they have a think about it,” said Xuong Liu, a Hong Kong-based managing director in the transaction advisory group at Alvarez & Marsal. “The investment committee bar is very high, especially for China.”

Leverage levels

Availability of financing is not a sticking point. Peter Graf, a managing director and head of direct lending for Australia and New Zealand at Ares Management, describes a market that has shifted from rising base rates, high margin spreads on debt, and wary lenders in the first half of the year to greater certainty on the interest rate outlook at greater willing to participate in deals in the second half.

“The problem is a lack of deals. There’s plenty of liquidity and all our deals have been comfortably syndicated,” added John Corrin, head of international corporate finance at ANZ. He also plays down the rate-cut effect, pointing to energy prices and supply chain cost inflation as bigger deal-breaking factors.

While there is greater certainty that the cost of debt will not go up, the increase in base rates over the past 18 months from near zero to 5.5% has made GPs cautious about leverage. BPEA EQT maintained the existing capital structure on completing the acquisition of corporate services provider Tricor Global in January 2022. When Tricor merged with Vistra, another portfolio company, earlier this year, the leverage multiple went down.

“We took a view on leverage when we made the Tricor acquisition and then we adjusted it downwards because we recognised the market had changed,” said BPEA EQT’s Macksey. “Our returns primarily come through growing the topline through revenue growth and margin expansion, but we are being more disciplined in our approach to leverage and the sectors in which we operate.”

BPEA EQT broke new ground in June by using an Asian bank debt package to support the acquisition of a US-based asset, sport education operation IMG Academy. On Asia-based businesses, Macksey observed that non-bank or institutional markets in the US and Europe – which typically offer more aggressive and flexible financing solutions – are still open to issuers that are well-known to lenders.

In some cases, investors opt for lower leverage at the outset in the knowledge that they can introduce more debt when making bolt-on acquisitions. In others, there is simply a reluctance to overload companies in industries that are more cyclical and more susceptible to covenant breaches.

For term loan A financing provided by Asian and international banks, leverage multiples are in the 4x range, rising to 5x or more for companies in areas like IT services which are cash-generative and operate under long-term contracts. “Leverage can be lower, it depends on what the sponsor feels is sustainable for a business through a cycle,” said Manas Chandrashekar, a partner at Kirkland & Ellis.

This corresponds to accounts of term loan A and unitranche deals in Australia. There has been a sizeable drop-off in that market with deal volume and deal count down 58% and 42% year-on-year, respectively. Lightly leveraged middle-market deals account for the bulk of activity. For the handful of larger transactions, 5.5x represents the upper end of the leverage spectrum; 18 months ago, it was 6.5x.

Both InvoCare, an AUD 2.2bn (USD 1.4bn) funeral services take-private led by TPG Capital, and Ticketek, which Silver Lake is refinancing after abandoning a sale process, fit this profile. Buyouts of around USD 1bn involving fashion brand Zimmerman and hospitality business Australian Venue featured more conservative leverage of 3x-4x, largely because of sectoral or business model nuances.

Time to act?

There is general optimism about the prospects for Australia, India, Japan, and China-relevant deals that happen outside of China. There is also a sense that managers need to be active – accelerating deployment after a couple of slower years and looking for exits so they can make distributions to LPs. However, this isn’t necessarily going to be easy in 2024.

On the investment side, Liu of Alvarez & Marsal noted that if China is off-limits to many investors, opportunities to write USD 300m cheques in Asia are relatively limited, which suggests more competition for assets. As for exits, there are questions about business quality. Much of the Asian pipeline comprises companies that were primed for exit over a year ago and have yet to get there.

“These are businesses that have been held for a long time, they’re not great, and sponsors need to sell,” Liu said. “When it comes to the stronger assets, often they want to wait longer in the hope of getting a better price. However, we have seen situations where they need to sell because they are raising a new fund. Good assets, whatever the point in the cycle, command interest.”

Graf of Ares expects some difficult conversations between financial sponsors and lenders as more portfolio companies feel the delayed economic impact of COVID-19. These tend to be businesses that are over-levered and beleaguered by poor operating models. They have been able to grind along thus far, but in the absence of a viable exit route or a refinancing, points of reckoning loom.

“The next 12 months will be the key test,” Graf said. “I do expect more activity in 2024, but from a lower base. Some of this will be out of necessity because a capital structure isn’t right for a business. Pick the right one, pay a lower multiple, and make some smart decisions on the equity side over the next 12 months, and you could end up with a good outcome in three to four years.”

The argument is that, with time, interest rates will fall, and investors will have a more positive outlook on the broader economy, so that a deal underwritten to a 2.5x return under current conditions will blossom into a 3x-4x windfall. Comparisons are readily drawn with the post-global financial crisis period, which saw the emergence of numerous battle-tested companies that outperformed in the upcycle.

This view is endorsed by Andrew Thompson, head of Asia Pacific private equity and head of deal advisory at KPMG, who refers to 2009-2010 as the high watermark in terms of private equity vintages.

“Buyouts will remain tough unless you have a strong value creation thesis and have the credentials and capability to follow through and execute on that. But with deal volumes, deal values, exits, and fundraising all down, it’s a great time to start thinking about investing,” he said.

“While it might not really get going until the second half, we think some of the deals done in 2024 and 2025 are going to be very interesting on a look-back basis.”