Private Equity: Implications for Economic Growth in Asia ...

Private Equity:Implications for Economic Growth in Asia Pacific

advisory

private equity

introduction 2

executive summary 4

inside private equity in asia pacific 8

Criticisms of private equity and regulatory responses 14Excessive leverage

Lack of transparency

Potential conflicts of interest

Tax leakage

Negative impact on employment

Other issues

the growing reach of sovereign Wealth Funds 29

private equity performance analysis 30Case studies

Little Sheep in China

Austar in Australia

the way forward 40

Contents

© 2007 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.

The lure of Asia Pacific for private equity houses has increased dramatically over

the last few years and showed no signs of abating during the first six months

of 2007. Last year, private equity (PE) companies in Asia Pacific raised USD

32.9 billion in new capital, up 39 percent from 2005 and five times the total just

four years ago. Deal volumes jumped 79 percent in 2006, with a total of 1,495

transactions completed and average deal size up by 8 percent to USD 41.3

million.1 According to the Asian Venture Capital Journal, private equity houses

invested USD 61.8 billion of new funds during the year and total private equity

funds under management across the region rose by almost 30 percent to USD

158.5 billion, from USD 122 billion in 2005.Initial figures for the first six months

on 2007 indicated that these trends have all continued.2

This sudden growth has caused excitement, but also some alarm. To a degree,

this reflects a lack of understanding about this industry and its somewhat brash

image when seen against the quiet dedication of Asian businesses and financial

institutions. Media opinion pieces have cautioned against the PE houses’

excessive and lightly-taxed profits and their use of high levels of debt to fund

buyouts. In turn, this is influencing a wider political and regulatory debate.

In Australia, these sentiments have been voiced by several prominent politicians.

“If private equity funds broaden their market activity substantially they can

affect our whole economy,” Senator Andrew Murray recently warned. “If as a

consequence the market as a whole is exposed to too much higher risk, then so

is Australia exposed to much higher risk.”3 Although a Senate inquiry found no

case for further regulation at present, it did note and recommend the ongoing

vigilance of the corporate and taxation authorities.

The anxiety is by no means confined to Asia Pacific. In the United States,

congressional hearings are being held to examine the risks of hedge funds and

private equity funds, and whether the tax rates these funds pay should be sharply

raised. The US Securities and Exchange Commission recently adopted a new

anti-fraud rule for hedge funds and private equity funds, which are technically

not covered by the Investment Advisers Act of 1940.4 In the United Kingdom,

the Walker Commission into private equity has now handed down its report,

recommending a variety of measures designed to enhance the transparency of

private equity funds to their stakeholders and the community at large.

1 “Asian Venture Capital Database, 24 September 2007

2 Data provided by AVCJ Research show that private equity houses made new investments of USD 37.4 billion in the first half of 2007, up 24.7 percent from the same period in 2006, while total private equity funds under management across Asia Pacific topped USD 171 billion, from USD 138.5 billion in the first half of 2006.

3 “Private Equity: Higher risk, higher return, higher danger,” online opinion by Senator Andrew Murray in Australian Democrats, 6 February 2007 www.democrats.org.au.

4 On 11 July 2007 commissioners of the US Securities and Exchange Commission (SEC) voted 5-0 to adopt a new rule that “will make it a fraudulent, deceptive, or manipulative act, practice, or course of business for an investment adviser to a pooled investment vehicle to make false or misleading statements to, or otherwise defraud, investors or prospective investors in that pool.” In a media statement, SEC Chairman Christopher Cox said the rule “applies to investment advisers not only of hedge funds, but also of private equity funds, venture capital funds, and mutual funds.” Source: “SEC Votes to Adopt Antifraud Rule Under Investment Advisers Act,” media release by the US Securities and Exchange Commission, 11 July 2007.

Introduction

Private Equity: Implications for Economic Growth in Asia Pacific2


Private equity investments in Asia Pacific are quite modest by international

standards. In Australia, a major destination for private equity investment, the

value of all businesses purchased by private equity funds in 2006 amounted to

less than 1.4 percent of the market capitalisation of all companies listed on the

Australian Securities Exchange.5 At the regional level, USD 61.8 billion of private

equity deals were announced in 2006,6 coming to a minuscule 0.5 percent of

market capitalisation.7

Nevertheless, these complaints and criticism have swayed opinion among the

wider public, many of whom would have barely heard of private equity more than

a year ago. Private equity has now been made very public. The turmoil in the debt

and equity markets over July and August 2007 has further focused the spotlight

on private equity, particularly the large leveraged buy-outs with their substantial

covenant-lite debt packages. While it is still too early to call just how markets in

the region will react over the next year as the debt crisis in the sub-prime US

home loan market works it way through the global financial system, it is fair to

say that, at least over July and August 2007, there seems to have been minimal

impact on announced deals in this region where the focus is on growth capital

rather than leveraged buy-outs.

The speculation about how the industry may fare in this new world where risk

has been re-priced has illustrated how little is known about private equity’s core

investment rationale. This report presents some basic facts about private equity

funds in the region, including their size, their deals, their investment approach,

exit strategies and plans for the future. By assembling information directly from

the ground, we hope to inject a measure of objectivity into the emotional debate

on private equity in Asia.

5 “Private Equity in Australia,” submission by the Australian Private Equity & Venture Capital Association Limited (AVCAL) to the Senate Standing Committee on Economics, May 2007.

6 Asian Venture Capital Journal database. According to the World Federation of Exchanges, the combined market capitalisation of 17 Asian stock markets, including those in Japan, Hong Kong, Australia, China, India and South Korea, topped USD 12 trillion as of the end of 2006.

7 “WFE Annual Report and Statistics 2006,” annual report by the World Federation of Exchanges.

David NottRegional Leader

KPMG's Private Equity Group

Private Equity: Implications for Economic Growth in Asia Pacific 3


In March 2007, KPMG member firms in Asia Pacific commissioned a survey of

119 private equity funds across the region. The following are the key findings:

• Generalist, venture and growth capital are likely to remain as private equity’s bread

and butter. Only one-tenth of respondents describe their fund as a buyout fund, meaning

that their strategy is to acquire other businesses, usually by borrowing against the target

company’s assets (10 percent). The vast majority of those polled describe their fund as

generalist, meaning it invests in all stages of a company’s development (44 percent),

provides venture capital to start-up enterprises (27 percent), acts as a fund-of-funds that

finances other private equity funds (11 percent), or injects growth capital into later-stage

companies in need of expansion support (8 percent). This indicates that while high profile

buyouts may dominate the headlines, most private equity funds will continue to take

stakes in private companies and work with existing management to build more profitable

and competitive enterprises.

• While public to private (P2P) transactions are comparatively rare in the region,

they look set to become more of a focus. Only 39 percent of the respondents say

they conduct P2P deals. Looking forward, another 47 percent say that, while their

fund currently does not engage in P2P, they may consider doing so in the future. A key

determinant of the reluctance to participate in P2P deals is the high execution risk, as

Australian PE funds have found in recent times. There also needs to be a degree of

maturity in the capital markets and a regulatory acceptance of this type of takeover

activity.

• Whatever the investment approach, the respondents describe their company as an

active participant in the task of growing businesses. The vast majority, 90 percent,

say their company is a hands-on investor. They agree strongly with statements that

say private equity companies supply the capital needed to expand businesses, provide

management guidance at the board level and improve corporate governance. In terms of

their impact on economies, the respondents say their main contributions lie in improving

the ability of regional businesses to compete globally (India, Korea, Japan and Oceania),

helping a country attract external investment (China, India), and growing small businesses

(Southeast Asia). This reflects the core thesis of private equity funds that, while they

may bring some debt to a deal, there must be a core growth of earnings proposition. At

the very least this should increase value based on a current multiples and it should also

create the possibility for a multiple shift as the underlying quality of earnings is raised.

• Mezzanine finance will increasingly be used to help structure private equity

investments. Slightly more than half of respondents expect increased borrowings from

Asia Pacific banks (55 percent), local banks (53 percent) and international banks (48

percent). In addition, the majority (70 percent) see increased levels of borrowing from

mezzanine funds or providers.

Executive summary



• Future investments are likely to diversify risks because they will be pan-regional

rather than focused on a single country. Six out of ten respondents (66 percent) say

the next fund they raise will have a pan-regional focus, with only 34 percent saying their

next fund will concentrate on a single market. This investment mandate gives the fund

managers flexibility in applying the funds to work, reduces overall fund risk and reflects

a view of the region, or segments of it, as an integrated economic whole rather than as

a collection of disparate countries. The one exception to this is likely to be Japan. Most

likely due to the size of its economy and M&A market, it is expected that pure Japan

focussed funds will continue to attract much interest.

• Going forward, private equity investment is likely to continue growing strongly

across the region. Asked the primary reason for investing in the Asia Pacific, the

overwhelming majority (94 percent) cite economic growth, a trend that looks set to

continue particularly in China and India in the foreseeable future; 83 percent expect

to see deal sizes increase in the next two years, with only 15 percent forecasting no

change. In the next five years, the top two target markets will be China – 74 percent of

respondents say their company will remain or put in new money there – and India (63

percent). More than one-third each say they will be in Taiwan (38 percent), Australia (37

percent) and Vietnam (36 percent). They expect to be investing in consumer markets,

healthcare, environment, services and renewable/alternative energy.

The growth of private equity in Asia appears to be having a positive effect in

driving economic gains across the region. The findings of this report suggest

that private equity is fulfilling an important development function in mentoring

entrepreneurs and mid- and late-stage managements about operational best

practices, transparency and corporate governance, and achieving regional

and global competitiveness. Private equity houses have also pursued "roll-up"

strategies, building economies of scale and creating companies that have the

potential to expand out of their Asian roots and become more serious global

players.

Both advocates and antagonists have noted, however, that the industry can do

more to communicate its contributions. To do this, it has been suggested that

the industry needs to engage with the media and the investment community,

and disclose its results not only to its shareholders but also to the larger market.

Some proponents suggest that at the very least it needs to clearly explain to

outsiders why and when certain information cannot be shared publicly. Private

equity firms could also consider adopting a code of practice and code of ethics,

and pursue more self-regulation to pre-empt more heavy-handed regulatory

oversight.

Private Equity: Implications for Economic Growth in Asia Pacific �


About the study

This report is based on a survey of 119 general partners (65 percent), investment

directors (19 percent), investment executives (13 percent), and fundraising/investment

relations executives (3 percent) in the Asia Pacific’s private equity industry. The

respondents were based in Greater China (29 percent), Oceania (19 percent), Southeast

Asia (18 percent), India/Pakistan (11 percent), and Japan/Korea (10 percent). The 13

percent who came from the rest of the world were making investments in the region.

The anonymous online survey was conducted in March 2007 by i.e. consulting on behalf

of KPMG.

Respondent Job Function

n Partner/equivalent

n Investment Director

n Investment Executive

n Fundraising/Investor Relations

65%

3%

13%

19%

n Greater China

n Oceania

n Southeast Asia

Respondent Location

29%

10%

11%

13%

19%18%

n Rest of World

n India/Pakistan

n Japan/Korea

ChinaIndia

AustraliaSingapore

TaiwanKoreaJapan

MalaysiaNew Zealand

ThailandIndonesia

VietnamPhilippines

61%37%

29%

29%

28%

26%21%

18%

18%18%

14%10%

8%

Current Investment Profile

0% 10% 20% 30% 40% 50% 60% 70% 80%

We would like to thank all the executives from private equity houses and private equity

organisations that were interviewed in the course of this research.

Private Equity: Implications for Economic Growth in Asia Pacific�


Private Equity 101

Private equity is long-term, committed share capital that helps companies to grow and

succeed. Whereas debt financing entails a legal right to interest on a loan and repayment

of the capital, irrespective of success or failure, private equity is invested in exchange for

a stake in the company and, as shareholders, the investors’ returns are dependent on the

growth and profitability of the business.

The entity that makes the investments is usually structured as a limited partnership and

is known as a private equity fund. The investors in this fund, known as limited partners,

primarily include pension funds, insurance companies and wealthy individuals. A private

equity fund is managed by a general partner, who is tasked with deciding where and how

to invest the fund’s money, in accordance with the focus defined in the fund’s terms of

reference.

Different private equity funds have different objectives, such as backing start-up

companies (venture capital funds) or investing in mid-stage/mature enterprises that

need expansion support (growth capital funds). A third focus of many international funds

is the buy-out of existing equity holders, in a public to private deal, a privatisation of

government owned assets, a takeover of a division of a larger company or the acquisition

of a private company from retiring shareholders. Whatever the objective, they have a

medium to long-term investment horizon, typically three to five years, during which

they provide management with guidance, experience and expertise on the board and

operations levels. Private equity funds make money (or cut their losses) by exiting their

investments through an initial public offering or sale of their stake to another company

(a ‘trade’ or ‘secondary’ sale, where the latter is a sale to another private equity fund). In

the emerging markets of Asia, private equity investment has predominantly been growth

capital, even when conducted by the larger buyout private equity houses.

Private equity funds are often mistaken for hedge funds, but these two investment

classes are fundamentally different. While private equity funds have a long-term

investment horizon and add value to their holdings by playing an active role in strategy

and operations, hedge funds concentrate on company and industry hedging strategies,

short-term performance and returns. Whereas private equity funds typically focus on

long-term valuation methodologies, hedge funds frequently mark their investment to

market (or model), and utilise this valuation methodology in decisions concerning exit

strategies.

While the differences in approach are significant, a convergence between private equity

funds and hedge funds may occur in one of three ways:

• Hedge funds have been involved in private equity deals, such as building stakes in

potential public-to-private deals (for example, Airline Partners’ failed USD 10.95 billion

bid in 2006 for Qantas Airways), buying leveraged loans in the debt markets or co-

investing with private equity funds in target companies.

• Hedge funds have participated in private equity-type investing, as illustrated by the rise

of activist hedge funds in the US.

• Private equity funds and hedge funds are sometimes owned and managed by the

same entity, as is the case with Blackstone, the US global alternative investment

company.

Private Equity: Implications for Economic Growth in Asia Pacific �


exhibit 1Value, volume and new fund-raising by private equity funds

Source: Asian Venture Capital Journal database

Private equity funds are rapidly growing in size in the Asia Pacific. As tracked by

the Asian Venture Capital Journal, total private equity funds under management

across the region were valued at USD 158 billion last year, up nearly 30 percent

from 2005.8

70

60

50

40

30

20

10

0

1600

1400

1200

1000

800

600

400

200

0

Value of deals

2002 2003 2004 2005 2006

Funds Raised Volume of deals

The region’s private equity funds have large volumes of capital to invest. Last

year, they raised USD 32.9 billion in new money, an increase of 39 percent from

2005 and five times new fund-raising in 2002. They are now aggressively putting

that money to work. The number of private equity deals last year jumped 79

percent to 1,495 transactions, from 834 in 2005 and just 532 in 2002. The value

of the 2006 deals topped USD 61 billion, up 94 percent from 2005 and over five

times the value of 2002 transactions.

A key driver in this growth has been a move up the transaction value chain

– between 2003 and 2005 there were on average eight deals a year in excess of

USD 500 million; in 2006, there were 24 completed deals. Similarly, the average

deal size has grown from just USD 18.5 million in 2002 to USD 41.3 million

in 2006. Asked about deal size in the next two years, the vast majority of our

respondents (83 percent) expect this trend to continue.

Inside private equity in Asia Pacific

8 These figures and other data in this section were extracted from the database of the Asian Venture Capital Journal, on 24 September 2007, unless otherwise stated.

Valu

e of

dea

ls a

nd fu

nds

rais

ed, U

SDbn

Volume of deals



exhibit 2How do you expect deal sizes to change over the next two years?

Source: KPMG survey of 119 private equity firms in Asia Pacific, 2007

n Increase

n Decrease

n Stay the same

83%

15%

2%

exhibit 3What are your key reasons to invest in Asia Pacific?


Economic growthPricing

Dealflow/Investment opportunitiesDemographics

Less competitionMarket size

Quality of management/entrepreneursLocal knowledge/networks

Skilled workforceMarket inefficencies

StabilitySophisticated capital markets

TechnologyRegulation

Labour costsExit opportunities

Manufacturing capabilitiesDebt markets

94%26%

23%15%

13%8%8%

7%7%

6%6%

5%5%

4%4%

3%2%2%

0% 20% 40% 60% 80% 100%

Markets of choiceThe key factor that makes the Asia Pacific region so compelling for private

equity fund managers is the economic growth of the region – 94 percent of our

respondents singled this out (Exhibit 3). It is not surprising, therefore, to find

that the market receiving the most interest from private equity funds is China.

Economic growth eclipsed other considerations such as pricing, deal flow and

competition. The upward pressure on the pricing of deals in Europe and the

US has also made the region more interesting, with very few respondents

mentioning low labour costs as a factor.

Six out of ten respondents say their private equity fund has assets in China. India

is in a distant second (37 percent), followed by Australia (29 percent), Singapore

(29 percent) Taiwan (28 percent) and Japan (21 percent). Of our sample set, the

least penetrated markets are Vietnam (10 percent), the Philippines (8 percent),

and Mongolia (3 percent).



exhibit 5What will the geographical focus of your next fund be?


n Pan-regional

n Single country focus

66%

34%

When asked to project five years out, respondents still choose China as the

prime target market (74 percent, see exhibit 4). India becomes far more popular

(63 percent), however, whilst Taiwan (38 percent), Australia (37 percent) and

Singapore (34 percent) remain attractive. The biggest mover is Vietnam, which

vaults from near bottom to fifth place (36 percent). In terms of growth over

time, the number of funds that expect to invest in Vietnam in the next five years

represents an increase of 258 percent, though admittedly from a low base. Other

big movers include the Philippines (130 percent), Indonesia (100 percent), India

(70 percent), and Malaysia (68 percent).

exhibit 4Which countries do you think you will be targeting in five years’ time?

China 74%

India 63%

Taiwan 38%

Australia 37%

Vietnam 36%

Singapore 34%

Korea 34%

Japan 31%

Malaysia 31%

Indonesia 29%

Thailand 25%

New Zealand 23%

Philippines 19%

Mekong Delta (ex-Vietnam) 17%Source: KPMG survey of 119 private equity firms in Asia Pacific, 2007

The future make-up of private equity investments could be a force for continued

stability. Future investments are likely to diversify risks because they will be

pan-regional rather than focused on a single country (Exhibit 5); 66 percent of

the respondents said the next fund they will raise will have a pan-regional focus,

with only 34 percent saying their next fund will concentrate on a single market.

This should help bring more stability to Asia’s private equity industry, and thus

to financial markets and economies as a whole, since the ability to hold assets

in multiple markets should lower overall risk. A wide investment mandate gives

the fund managers flexibility in putting the funds to work, reduces overall fund

risk and reflects an investors view the region, or segments of it, as an integrated

economic whole rather than as a collection of disparate countries.



exhibit 7Average deal size in selected industries

Source: Asian Venture Capital Journal database

350

300

250

200

150

100

50

0Aver

age

Deal

Size

USD

mill

ion

2002

target sectors

In 2002, private equity funds in Asia most often invested in computer hardware and information technology companies (Exhibit 6). By 2005 and 2006, these remained the most popular sectors, but others were catching up fast. Average deal size has grown steadily from USD 18.5 million in 2002 to USD 41.3 million in 2006, although when looking at individual industries the figures can be skewed by one large deal (Exhibit 7).

exhibit 6Top private equity investment by value, USD million, with volume of deals in brackets

2002 2003 2004 2005 2006

Financial services 2,715 (45) 3,419 (34) 1,867 (40) 8,634 (70) 10,318 (115)

Telecommunications 1,899 (53) 3,637 (33) 2,739 (19) 304 (21) 8,201 (33)

Media 100 (8) 205 (9) 36 (6) 237 (7) 7,059 (24)

Travel/Hospitality 77 (11) 1,185 (10) 571 (8) 2,130 (26) 4,295 (48)

Retail/Wholesale 388 (20) 338 (20) 1,229 (26) 2,328 (37) 4,095 (74)

Consumer products/services 393 (21) 250 (20) 383 (21) 1,078 (28) 3,888 (69)

Medical 250 (45) 960 (42) 943 (64) 2,044 (93) 3,687 (127)

Transportation/Distribution 502 (15) 928 (37) 3,314 (36) 2,368 (47) 3,306 (75)

Manufacturing - Heavy 505 (25) 1,055 (36) 480 (57) 1,089 (61) 2,771 (116)

Computer related 663 (107) 1,199 (72) 2,061 (89) 3,730 (99) 2,265 (158)

Electronics 255 (41) 547 (35) 443 (56) 2,801 (42) 2,033 (89)

Information technology 272 (57) 585 (37) 262 (79) 890 (116) 1,874 (221)

Ecology 14 (3) 61 (5) 17 (3) 103 (6) 1,709 (7)

Mining and metals 146 (8) 176 (15) 125 (18) 708 (26) 1,645 (43)

Non-Financial Services 232 (23) 243 (31) 456 (38) 293 (36) 1,469 (97)

Construction 1 (5) 311 (8) 158 (8) 1034 (7) 849 (30)

Infrastructure 449 (1) 263 (3) 283 (7) 177 (3) 748 (23)

Utilities 27 (5) 1544 (18) 764 (18) 200 (19) 472 (34)

Manufacturing - Light 345 (17) 132 (19) 276 (19) 491 (40) 460 (36)

Textiles and clothing 19 (3) 138 (4) 81 (10) 841 (24) 307 (27)

Agriculture/Fisheries 310 (4) 30 (6) 0 (1) 7 (5) 220 (15)

Leisure/Entertainment 273 (15) 754 (11) 58 (17) 374 (21) 110 (34)

Total 9,836 (532) 17,960 (505) 18,919 (640) 31,800 (834) 61,782 (1,495) Source: Asian Venture Capital Journal database

2003 2004 2005 2006

Average Transaction Size - All Industries

Telecommunications

Financial services

Media

Computer related



exhibit 8In five years’ time, which sectors will you be investing in?

Consumer/Retail/Services 25%

Environment/Renewable/Alternative/Clean Energy 19%

Healthcare 13%

Telecommunications, Media and Technology 11%

Energy/Resources 9%

Biotech/Life Science 6%

Distribution/Logistics 4%

Financial Services 4%

Infrastructure 3%

Transport 2%

In terms of value, however, financial services (USD 10.3 billion),

telecommunications (USD 8.2 billion) and media (USD 7.1 billion) are actually

the three dominant industries. Computer-related enterprises (USD 2.3 billion)

and information technology (USD 1.9 billion) lag far behind, exceeded in value

by various other diverse sectors. Deals in telecommunications may be fewer

in number, but the individual volumes being invested are larger compared with

deals in IT and computer-related sectors.

Looking ahead, our respondents expect the investment profile to be very

different. Asked which sectors they think their private equity fund will be focusing

on by 2012, the respondents put consumer markets, including the retail sector,

at the top of the list (Exhibit 8). This is an industry that had received relatively

little private equity investment in the past five years. The interest in personal

consumption reflects the growing wealth and personal disposable incomes of

millions of consumers in markets such as China and India, the opening of new

markets in countries like Vietnam with its young population and and the potential

for a consumer revival consumer revival in Japan.

The second most popular sector is environmental technologies, including

renewable energy and waste technologies. This, too, is not among the hot

sectors today, but the respondents evidently see a bright future for it going

forward, reflecting global concerns about sustainable development and global

warming. Healthcare, telecommunications, and media and technology (especially

in areas relating to IT and computer hardware) are projected to remain strong

target sectors over the next five years.

exit strategiesAccording to the Asian Venture Capital Journal, 2006 was a record year for

IPOs in Asian private equity: PE-backed offerings doubled to USD 30.4 billion as

mainland Chinese banks were floated in Shanghai and Hong Kong. Trade sales

were a distant second at USD 11.6 billion, down 48 percent from 2005 as bank

disposals in Korea stalled.9

The executives surveyed were asked how they exit today, and how they think

their equity fund will dispose of their investments in two years’ and five years’

time (Exhibit 9). IPOs emerged as the preferred exit strategy currently (52

percent), ahead of trade sales (42 percent).

9 Extracted from the database of the Asian Venture Capital Journal.



Respondents predicted that the situation could reverse within two years, with

trade sales (46 percent) surpassing IPOs as the preferred exit route (44 percent).

This outlook will however be affected by developments in the debt and equity

markets, as this will determine the extent and the ease with which companies

can leverage their investments and the attractiveness of the stock markets to

new listings.

exhibit 9How do you exit your investments today, in two years, and in five years?


60%

50%

40%

30%

20%

10%

0%

52%

n Now n 2 years n 5 years

IPO Trade sale Secondary buyout Other

44% 43% 42%46%

37%

5%9%

17%

3%1%1%

Interestingly, in five years’ time, respondents see a more significant role for

secondary buyouts (17 percent), which involve selling the investment to another

private equity fund. This may indicate expectations of a continued boom in

private equity funds, with newcomers seen as willing to pay premium prices for

the holdings of older funds in order to get a foothold in the market. While still

substantial, trade sales will account for a lower 37 percent of disposals. IPOs will

remain steady at 43 percent.




Criticisms of private equity and regulatory responsesThe private equity industry has been under sharp attack in the US and the UK,

and to a lesser extent in Australia. In a recent report10 widely picked up by

the media, credit-ratings agency Moody’s challenged some of the benefits PE

houses claim to bring to businesses. Even though PE-backed private companies

in the US are not covered by the strictures of the Sarbanes-Oxley Act and the

requirement to report quarterly earnings, “the current environment does not

suggest that private equity houses are investing over a longer term horizon than

do public companies,” the report asserts. Moody’s also expressed concern about

“the willingness of private equity houses [in the US] to issue special dividends

despite commitments to reduce leverage, sometimes within 12 months of the

transaction’s closing.”

Reports such as this have added to the demands from investors, politicians,

trade unions and other quarters for more regulation of the industry; regulators

and legislative bodies are beginning to respond. In the UK, the Financial Services

Authority is keeping a watching brief on leverage, transparency and conflict-of-

interest issues. In Australia, the Takeovers Panel has circulated a draft Guidance

Note on insider participation in control transactions for private equity companies

and other M&A participants. In Taiwan, the Financial Supervisory Commission is

considering raising the threshold for de-listing of public companies to head off

possible de-equitisation caused by PE buyouts.

PE players say they recognise the need for reasonable regulation, but they

worry that emotionalism, fear-mongering and misunderstanding among

certain stakeholders could force regulators and politicians to impose overly

restrictive requirements. One alarming example is Korea, where prosecutors are

investigating or have indicted at least three international private equity houses for

alleged price manipulation, insider trading and other supposedly illegal practices.

One Korean newspaper publicly accused a US private equity firm of being a

“habitual and wicked” tax evader.11

Controversy is perhaps bound to arise as more and bigger private equity players

enter the arena, larger deals are announced, and iconic listed companies are

targeted. The following sections of this report detail some of the common

criticisms levelled at private equity and the regulatory responses that have arisen

in key markets.

10 “Rating Private Equity Transactions,” special comment by Moody’s Investors Service, July 2007.

11 “Public Scorn for Private Equity,” in BusinessWeek, 4 December 2006.



excessive leverageThere is a growing perception in the public mind that PE firms saddle the

company they have taken over with heavy debts, an impression caused in part

by the massive sums private equity players recently paid to buy out public

companies. In the first half of 2007, for example, private equity groups agreed to

pay USD 8.9 billion for Orica Limited in Australia, USD 976.8 million for Fu Sheng

Industrial in Taiwan, and USD 698.4 million for MMI Holdings in Singapore.12

These transactions followed a USD 8.7 billion bid in 2006 for Australia’s Qantas

Airways, a deal which fell apart despite the airline’s board acceptance of the offer.

Along with the equity component of PE investments, there is usually a significant

component of debt. PE players say they do leverage their portfolio companies’

balance sheet when needed, but they insist that it is in their interest to borrow

prudently. In Australia, David Jones, managing director of CHAMP Private Equity

notes that, “the average ratio of debt to equity in buyouts has been almost

exactly 70 percent debt, 30 percent equity, regardless of the size of the buyout,

which is a reasonable ratio.”13 Jones notes that the Reserve Bank of Australia

(RBA) came to a favourable assessment, which concluded that private equity

exposures currently amount to less than 3 percent of total loans in the Australian

banking system.14

The debt-to-equity ratio may be lower in the rest of Asia, where local banks,

having gone through the crucible of the 1997 Asian financial crisis, generally

follow conservative lending practices. Chris Rowlands, Managing Partner Asia at

3i, estimates the debt-to-equity ratio of PE-backed portfolio companies across

Asia Pacific at 50-50.15 “In Europe in the last few years, we’ve seen debt levels

increasing strongly as the banking industry became aggressive,” Rowlands says.

“In Asia, typically with the cycles and volatility here, we have seen more balance

between equity and debt.”

The global debt market

The unprecedented nature of the global

debt market has helped fuel the recent

PE boom. Its features include:

• Low interest loans – driven by high

levels of liquidity and the reduction in

risk spreads

• High leverage – there is no doubt

that in the larger deals in the US, the

banks have also loosened their lending

requirements, helping to drive the

record volume of leveraged buyouts.

And it is this leverage that changed

significantly over the past four years;

according to Standard and Poor’s

analysis, in 2001 deals were being

done at 4x EBITDA while in the first

half of 2007 they were being done

at over 6x EBITDA (source: “Ratings

Direct Report”, Standard & Poor’s, July

2007)

• Favourable financing structures

– particularly covenant-lite financing

arrangements which lacked the

protective covenants that subject the

borrower to tests to show they are

maintaining financial ratios at agreed

levels. One covenant lite feature was

toggle notes which allowed borrowers

to either make interest payments

in cash or borrow more money to

pay interest on the money already

borrowed.

• Collateral requirement – loosened

where there was no security over

assets/business for the loans

• Bridge loan facilities – typically were

provided by the bank’s capital markets

arm with the understanding that the

buyout firms would find investors to

take over the bank’s stake after the

deal closed.

exhibit 10Sources of new debt in the next two years


Local banks

n Decrease n Stay the same n Increase

100%

60%

80%

40%

20%

0%Regional

(Asia-Pacific) banks

Intemational (North American/European) banks

Mezzanine funds/providers

Hedge funds

12 “Top PE Buyouts in Asia, 1H07,” report by Thomson Financial, 7 July 2007.

13 KPMG interview with David Jones, Managing Director of CHAMP Private Equity and Chairman of the Australian Venture Capital & Private Equity Association, July 12 and 20, 2007.

14 “Financial Stability Review,” report by the Reserve Bank of Australia, March 2007.

15 KPMG interview with Chris Rowlands, Managing Partner Asia, 3i, 13 July 2007.

Private Equity: Implications for Economic Growth in Asia Pacific 1�


Going forward, the respondents to this study say the banking system is not likely

to become more of a source for private equity debt (Exhibit 10). Over the next

two years, just about half of our respondents expect increased borrowings from

Asia Pacific banks (55 percent), local banks (53 percent), and international banks

(48 percent). In contrast, 70 percent expect to see increased levels of sourcing

from mezzanine funds or providers. The worries that Asia’s financial systems

may face higher risks because of increased exposure to private equity buyouts

thus appear to be overblown. Mezzanine funds typically source capital from

sophisticated individual and institutional investors that are hedged and able to

absorb losses.

exhibit 11Types of private equity funds


n Generalist

n Venture

n Fund-of-fund/gatekeeper

n Buyout

n Growth Capital

44%

8%

10%

11%

27%

Moreover, despite their current high profile, buyout specialists are still in the

minority in Asia Pacific’s private equity industry. Asked to describe what type

of private equity firm they are, only 10 percent of our respondents characterise

their fund as a buyout fund (Exhibit 11). A larger share say their fund is generalist,

meaning it invests in all stages of a company’s development (44 percent),

provides venture capital to start-up enterprises (27 percent), acts as a fund-of-

funds that finances other private equity funds (11 percent), or injects growth

capital into later-stage companies in need of expansion support (8 percent).

Private Equity: Implications for Economic Growth in Asia Pacific1�



All that said, however, the indications are that buyouts may become more of an

area of focus in Asia Pacific. Nearly half (47 percent) of respondents say that,

while they are not engaged in P2P today, they may consider doing so in the

future (Exhibit 12). Rowlands, for example, says that 3i is planning to launch a

buyout business in Asia Pacific. To date, 3i’s regional strategy has concentrated

on growth capital, but Rowlands sees opportunities with mid-sized targets in the

USD 2 billion range. These may be public companies that could be taken private,

family corporations with no business successor, or conglomerates looking to sell

off stakes or non-core divisions.

What this means for leverage trends in the region and how regulators will

respond to them is an open question. In a survey of 13 banks in the UK, the

Financial Services Authority (FSA) found a 17 percent increase in bank exposure

to leveraged buyouts, from EUR 58 billion as of June 2005 to EUR 67.9 billion

as of June 2006.16 The FSA judges system-wide exposures to be substantially

greater because “banks are increasingly distributing debt to non-banks such

as managers of Collateralised Loan Obligations (CLOs) and Collateralised Debt

Obligations (CDOs), and hedge funds.” The authority has not taken any action so

far, except to continue monitoring bank lending.

In the US, the spate of mega-buyouts such as the USD 45 billion private equity

deal for electricity generation company TXU and USD 33 billion for hospital chain

HCA have raised concerns about the return of the disastrous junk-bond boom of

the 1980s. US buyouts are typically funded by a mix of bank borrowing, high-yield

bonds and equity. According to the Moody’s report, leveraged buyouts accounted

for 18 percent of new high-yield issuances in the beginning of 2007, compared

with about 5 percent between 2003 and 2004. But the Private Equity Council,

the recently formed industry group in the US, estimates that the average PE

deal since 2002 is in the range of 60 to 66 percent debt, still lower than the 90

percent or more in the 1980s.17

exhibit 12Do you buy public companies to turn them private (P2P)?


n Yes

n No, but would consider it

n No, and would not consider it

39%

47%

14%

16 “Private equity: a discussion of risk and regulatory environment,” Financial Services Authority discussion paper, June 2006.

17 Testimony of Douglas Lowenstein, President of the Private Equity Council, before the House Financial Services Committee of the US Congress, 16 May 2007.



The recent turmoil in global markets caused by problems in the sub-prime

mortgage sector in the US has cooled any excessive leverage in private equity

buyouts. Banks have re-priced risk upwards after the collapse in July of two

hedge funds run by US investment bank Bear Stearns and the decision by

France’s BNP Paribas in August to halt withdrawals from three investment funds.

The five funds held securities and derivatives tied to sub-prime mortgages. The

resulting credit crunch has affected the financing of already agreed private equity

buyouts such as the takeover of US carmaker Chrysler18 and caused market

speculation about the impact on a number of large, unconcluded deals, including

the aforementioned TXU and HCA buyouts.

Some deals have collapsed, such as JC Flowers consortium bid for Sallie Mae,

with others delaying their completion as buyers and sellers wait for more clarity

from the markets or deals are renegotiated. Future deals will almost certainly

be affected, but a slowdown, rather than an implosion, is the most likely

consequence. “There are a handful of transactions that LBO firms could sign in

March that they couldn’t sign today (particularly mega-market deals),” concludes

PE Week Wire, an industry newsletter published by Thomson Financial. “But LBO

firms can do most of them, so long as they are willing to accept less favourable

terms – and buyout firms have proven quite apt at acceding to such requests.

Remember Clear Channel and all those other deals where public shareholders

kept demanding higher prices? Well, now it’s the lenders’ turn.”19

It is also a market where vendors need to be more realistic about asset prices.

Less leverage which is more expensive means that prices should fall. In August

the sale of the Home Depot distribution business was re-priced from USD 10.3

billion to USD 8.7billion as the debt crisis took hold. The markets should expect

lower debt/EBITDA multiples in future. According to Standard & Poor's,20 these

multiples averaged 4x in 2002 but grew to over 6x by 2006.

Finally, this is now a market where trade buyers will be more competitive as the

synergies from a deal they may obtain outweigh the gains no longer available to

PE from higher leverage than a listed corporation typically has.

Private equity houses have consistently brought more than simply leverage to

their investments in Asia Pacific. At this point in the credit cycle, their governance

model, with its unrelenting focus on operational improvement for value

enhancement, is needed more than ever. Private equity must now operate in a

more risk-averse environment, but it is one in which their core propositions and

governance model designed to enhance shareholder wealth should continue to

make a significant contribution to the economy and to those who invest in them.

18 “JPMorgan, Goldman Bond Risk Rises as Chrysler Loan Sale Fails,” Bloomberg, 25 July 2007. The two banks could not sell USD 10 billion in Chrysler loans for a takeover by Cerberus Capital Management, forcing DaimlerChrysler, Chrysler’s European parent, to lend Cerberus part of the money needed to complete the deal.

19 PE Week Wire, 27 July 2007.

20 “Ratings Direct Report”, Standard & Poor’s, July 2007




Rowlands of 3i sees a silver lining. “The recent tightening of credit will bring

greater discipline to current M&A activity,” he argues. “The larger private equity

players will broadly welcome an adjustment. At 3i, with a strong balance sheet,

in-depth sector knowledge and a wide international network, we can work

closely with companies in which we have already invested and take balanced and

informed decisions about new opportunities.” As banks shy away from covenant-

lite lending, there would be less scope for private equity firms to load balance

sheets with excessive debt.

Accusation Country Regulatory/legislative opinion and industry response

Excessive leverage used as part of PE deals

UK The UK’s Financial Services Authority (FSA) noted in 200621 that credit from lenders in

respect of PE-backed buyouts and acquisitions has risen substantially, raising concern

that PE houses are relying on excessive debt. No action has been taken other than

to continue monitoring bank lending. The British Private Equity and Venture Capital

Association (BVCA) maintains that this is not a regulatory issue for PE, as rising credit

levels is a trend that also applies to banks and other areas of the financial sector.22

US In testimony before the US House of Representatives Committee on Financial Services

in May 2007,23 Andrew Stern, president of the Service Employees International Union

(SEIU), complained that “leverage involved in buyout deals can create significant

pressures” that could result in bankruptcy. In response, Douglas Lowenstein, president

of the Private Equity Council, said that PE deals in the US since 2002 “average in

the range of 60 to 66 percent debt,” much lower than the 90 percent or more in the

1980s.24 Both the House of Representatives and the Senate are considering legislation

to address the risks of excessive leverage and other private equity issues.

Australia The Council of Financial Regulators – comprised of the heads of the Australian

Prudential Regulatory Authority (APRA), the Australian Securities and Investments

Commission (ASIC), the Australian Treasury, and the Reserve Bank of Australia (RBA)

– conducted a review and concluded that higher leverage levels due to LBO activity do

not pose “a significant near-term risk” but said the council will monitor developments

closely.25 AVCAL, the Australian Private Equity & Venture Capital Association, endorsed

the comments and findings, in particular the council’s comments on debt, effects on tax

revenue, and broader effects on the capital markets.

China and Southeast

Asia

Leverage is not yet an issue in Asia’s developing markets since the majority of private

equity investments to date has been growth capital and cash investments. There are

also limits on the amount of leverage that can be used in many markets. But leverage

may become an issue as buyouts increase in number and deals become more complex

with the increasing use of mezzanine and other types of debt.

India According to current foreign exchange regulations, foreign owned holding companies

are required to bring in requisite funds from abroad and are not permitted to leverage

funds from domestic market for investments in Indian companies. If debt is taken at

the foreign holding company level with the intention of pushing it down to the Indian

company by merging the foreign holding company into the Indian company, the debt

in the Indian company would qualify as an External Commercial Borrowings (ECB)

and would be subject to the ECB guidelines which are inter alia stringent in terms of

restrictive end use requirements. Tax Deductibility of interest expense in the hands of

the Indian merged company is also a contentious issue.

21 “Private equity: a discussion of risk and regulatory environment,” Financial Services Authority discussion paper, June 2006.

22 “Issue affects non-PE backed companies in the same way,” British Private Equity and Venture Capital Association submission to the Treasury Select Committee, May 2007.

23 Statement of Andrew L. Stern, President of the Service Employees International Union, to the US House of Representatives Committee on Financial Services, 16 May 2007.

24 Testimony of Douglas Lowenstein, President of the Private Equity council, before the House Financial Services Committee, 16 May 2007. The council represents ten of the leading PE firms in the US, including Bain Capital, Blackstone Group, Carlyle Group, Kohlberg Kravis Roberts & Co, and TPG Capital.

25 “March 2007 Financial Stability Review,” report by the Reserve Bank of Australia. The relevant section states: “While the recent increase in LBO activity in Australia has led to some pockets of increased leverage within the corporate sector, it does not appear to represent a significant near-term risk to either the stability of the financial system, or the economy more broadly. The exposure of the Australian banking sector to private equity is well contained, and both the leverage and the debt-servicing ratios for the corporate sector as a whole remain relatively low. Looking forward, however, it is likely that the increase in business leverage that is currently underway has some way to run. Given this, together with the potential implications of LBO activity for the depth and integrity of public capital markets, as well as the importance of investors understanding the risks they are taking on, the agencies that make up the Council of Financial Regulators will continue to monitor developments closely.”



Lack of transparencyThe trend of private equity firms taking over large corporations and turning them

private is also raising questions about transparency. “Unlike publicly traded

companies that are subject to securities laws, it is well known that private equity

buyout firms operate outside of the public eye, with little oversight,” Andrew

Stern, President of the Service Employees International Union, recently told a US

House of Representatives committee.26 “It is critical that the industry provide

more transparency and disclosure so that the people who might be affected by a

given deal – workers, community members, shareholders and others – are aware

of the potential impact on their lives.”

In general, PE funds are transparent with their own stakeholders. “They have to

be,” says a private equity professional in Hong Kong, who requested anonymity.

“The general partner knows everything about the portfolio company he wants

to know; if he doesn’t, he’s unprofessional. The limited partner gets all the

information he needs from the general partner, if he wants it. If he doesn’t get

it, he has picked the wrong GP, but then there are very few of those out there.”

The information then gets passed on to the institutional funds and individual

investors that put money in the limited partnership. As for regulators, they

get the information needed, this interviewee says, because like other private

companies, PE-backed portfolio companies must register and file annual returns

with the companies registry, as well as pay taxes to the revenue authority.

The question, therefore, is how much information should be shared with wider

public and the media. “It’s about journalists who believe they have a right to

this information because they are the ultimate protector of the public,” says the

PE practitioner. “I disagree. If you give me your money to manage and we have

a contract, there is no reason why the world should know about this contract.

It’s not a public company, after all.” In a public to private deal, the situation is

different and stakeholders will need more information.

Commercial and competitiveness issues must also be taken into account in

dealing with the media and other outsiders. The reality, however, is that the

media can wield great influence on public opinion, and thus on the actions of

politicians and regulators.

In the UK, the FSA has noted the “limited” transparency of the PE industry to

the wider market, and said it was monitoring the situation. In response, the

British Private Equity and Venture Capital Association (BVCA) asked Sir David

Walker, former Executive Director of the Bank of England and former Chairman of

the Securities and Investments Board, to head a working group that would draft

a voluntary code of practice to improve private equity’s transparency. In a recent

consultation document,27 the Walker Working Group judged as satisfactory the

reporting arrangements between PE firms and investors, but said the buyout end

of private equity has inadequately informed employees, suppliers and customers

as well as the wider public interest. It should be noted, however, that tends

to be during the buyout process. Once the process is complete, it is usually

in the buyer's interest to ensure that there is a flow of information between

stakeholders to motivate and retain relationships.

26 Testimony of Andrew Stern, President of the Service Employees International Union, before the House Financial Services Committee of the US Congress, 16 May 2007.

27 “Disclosure and Transparency in Private Equity,” a consultative document by the Walker Working Group, July 2007.



Sir David proposed that “portfolio companies that were formerly listed as FTSE

250 companies or where the equity consideration on acquisition exceeded

GBP 300 million or where the company has more than 1,000 employees

and an enterprise value in excess of GBP 500 million should report to an

enhanced standard beyond that required in the 2006 companies legislation.”

The suggested requirements include filing of the annual report on a company

website within four months of the year-end, and financial reporting covering

balance sheet management, including links to the financial statements to

describe the level, structure and conditionality of debt.

General partners are asked to publish an annual review on their website

“that informs their approach to business and the governance of their portfolio

companies.” In addition, private equity firms “will be expected to be more

accessible to specific enquiries from the media and more widely. Confidentiality

concerns will constrain responses that can be given in some situations, but the

line between openness and secretiveness should be drawn with much greater

flexibility than hitherto, especially in respect of large transactions which, in the

listed sector, would attract very full public presentation.”

If adopted by the BVCA, these voluntary guidelines will also cover the Asia

Pacific units of UK private equity firms, such as 3i. But US and other funds,

including local PE houses, are not obligated to follow them, although it is

possible that they will at least adapt some of the standards that they believe

are applicable to the region. “We are studying the report to see what will have

relevance for us here in Australia,” says Katherine Woodthorpe, Chief Executive

of the Australian Private Equity & Venture Capital Association (AVCAL).28


Lack of transparency

UK In its June 2006 discussion paper, the FSA stated that transparency of the PE industry to

the wider market is limited, even though transparency to existing investors is extensive. It

is maintaining a watching brief on this issue. The BVCA has formed a working group that

aims to implement a voluntary code of practice to improve the level of disclosures made

by entities backed by PE houses.

US Public officials and others in the US have called for greater transparency in the US private

equity industry. The Private Equity Council places the issue in the context of PE firms

getting listed. “PE firms that go public will be required to meet the same disclosure as

all other public companies, including Sarbanes-Oxley and other securities laws,” it says.29

But the council warns that moves in the Senate to substantially raise taxes on private

equity funds that seek to become publicly-traded partnerships will discourage such

listings, and therefore negatively affect private equity transparency.

28 KPMG interview with Katherine Woodthorpe, Chief Executive of the Australian Private Equity & Venture Capital Association (AVCAL), 23 July 2007.

29 “Private Equity and Publicly-Traded Partnerships – S. 1624,” response by the Private Equity Council to S.1624, a bill increasing taxes on private equity funds that seek to become listed partnerships introduced by Senator Max Baucus and Senator Charles E. Grassley on 14 June 2007.



potential conflicts of interestThe issue of conflict of interest has been raised mainly in the UK and Australia.

A primary concern is that the fund manager must run the fund both to maximise

the returns to the investors while balancing this with the returns it should make

to itself as the fund manager (under pressure from its owners and staff). While

no regulatory action has so far been taken, in the UK the Financial Services

Authority has been raising awareness of the issue through speeches and

newsletters. In Australia, the Takeovers Panel is asking for submissions on a

proposed Guidance Note and Issues Paper on “Insider Participation in Control

Transactions,” which was driven by PE but covers all public M&A transactions.

The private equity industry participated in the drafting process, and AVCAL has

expressed support for the Guidance Note.


Potential conflicts of interest

UK The FSA sees conflicts of interest since the fund manager must run the fund both to

maximise the returns to the investors and also to balance this with the returns it should

make to itself as the fund manager (under pressure from its owners and staff). The FSA

also believes that conflicts of interest may arise in dealing with the affairs of customers,

investors and companies owned by the fund. It is using speeches and newsletters to

raise awareness of this issue. In response, the BVCA has developed guidelines promoting

an “ethical culture” where conflicts of interest should be addressed and not be taken

lightly.30

Australia On 21 February 2007, the Takeovers Panel published a draft Guidance Note and Issues

Paper on “Insider Participation in Control Transactions,” which was driven by PE but covers

all public M&A transactions. Submissions have been received, but the findings have yet to

be published. The private equity industry was represented on the Takeovers Panel during

the preparation of the draft Guidance Note and issues paper. AVCAL has written to the

Takeovers Panel to express its support for the draft Guidance Note.31

tax leakageA common perception in Asia and elsewhere is that private equity firms are

making such windfall gains that they should be required to share their “bounty”

with the rest of the community. In the US, some in the House of Representatives

want to double the tax on the earnings of PE firms from 15 percent to 30

percent. The Private Equity Council warns that entrepreneurial risk-taking would

suffer and the efficiency of capital markets would be impaired if the measure

were to pass.32

In Korea, some PE firms have been criticised as tax evaders and profiteers. In

the case of the Korea Exchange Bank, for example, the original private equity

investment in 2003 is estimated at KRW 1.4 trillion. When the PE firm asked

for bids for the bank last year, the offers reportedly went as high as five times

30 British Venture Capital Association

31 “Private Equity in Australia,” submission by the Australian Private Equity & Venture Capital Association (AVCAL) to the Senate Standing Committee on Economics, 10 May 2007.

32 “Private Equity and Carried Interest – HR 2834,” position paper by the Private Equity Council, 2007.



the original investment. The sale has been delayed pending resolution of legal

problems. Until the tax authorities introduced a new withholding tax regime on

Korean source income, those gains would have been taxed at a minimal rate.

In Japan, various changes in legislation in recent years provide a mechanism to

tax private equity profits on exit from their investments. The so-called “Shinsei

tax” levies a 20 percent tax on sales of investments by funds, a measure that

was prompted in part by the exit of a consortium of private equity firms from the

former Long Term Credit Bank, which the consortium bought out of receivership

in 2000. Renamed Shinsei Bank, the bank was sold in 2005 for more than four

times the original investment, with no local tax payable. Such exits would now

be subject to tax, although US-based funds may not need to pay because the

Japan-US tax treaty gives them protection in certain situations.

Tax leakage is not an issue in Hong Kong and Singapore, where capital gains

are not taxed. In China, however, the newly approved Enterprise Income Tax

Law could lead to the introduction of a 20 percent withholding tax on dividends

paid out of Chinese portfolio companies. Several funds are in the process of

relocating the intermediate holding company from the British Virgin Islands to

Hong Kong, Mauritius or Barbados to mitigate the adverse impact of a dividend

withholding tax. In India, tax exemptions enjoyed by foreign venture capital

investors (FCVIs) outside of specified sectors such as nanotechnology, bio-

technology and IT hardware and software have been withdrawn.

Some form of taxation is probably inevitable in most jurisdictions, but private

equity firms should at least make their voices heard before new taxes are

imposed.





Tax leakage UK Corporate entities claim that tax relief for shareholder debt given to PE houses is

inequitable. The UK government has responded to this by stating that the Treasury has

no plans to examine the tax-deductible status of interest. The BVCA has denied that there

is special treatment afforded to PE houses, in that tax deductibility of interest on debt is

available to all UK companies; only arm’s length interest is tax deductible for the borrower.

US Senate bill S. 1624 aims to tax publicly-traded partnerships such as the recently listed

Blackstone Group at the standard rate of 35 percent corporate tax, instead of the capital

gains tax rate of 15 percent. In the House of Representatives, House bill HR 2834 aims to

raise taxes on the investment gains of private equity funds (regardless of whether they are

listed or unlisted) to 35 percent from the current 15 percent. The Private Equity Council is

lobbying against both bills, arguing among other things that they will hinder entrepreneurial

risk-taking, hold back PE firms from acquiring and enhancing the competitiveness of

underperforming or undervalued companies, and potentially reduce the returns of pension

funds, foundations and university endowments that provide the bulk of private equity

capital.

Australia The Senate enquiry into the economic impact of private equity, having regard to

submissions from the Australian Taxation Office as well as industry funds, found that there

is no compelling case for leakage from the tax system but did note that this was an area

for continued close monitoring.

China In China, private equity investments have generally been conducted through offshore

special purpose vehicles (SPVs) to minimise tax liabilities, as well as to allow an exit route

via overseas listing. In September 2006, several Chinese regulatory agencies met to revise

and promulgate the Regulations for the Acquisition of Domestic Enterprises by Foreign

Investors. In relation to PE investors, these regulations created additional barriers due to

the difficulty for PRC founders to create offshore SPVs so as to receive PE investments.

In addition, this new regulation further imposes a one-year listing requirement when PRC

founders are permitted to establish offshore SPVs.

A newly approved Enterprise Income Tax Law proposes to introduce a 20 percent

withholding tax on dividends paid out of Chinese portfolio companies. This will have an

impact on PE fund structures using the Cayman Islands and the British Virgin Islands to

hold the Chinese portfolio companies. Several funds are in the process of restructuring

their investments, seeking to mitigate the adverse impact of dividend withholding tax

by relocating the intermediate holding company from BVI to Hong Kong, Mauritius or

Barbados.

India Until recently, a foreign venture capital investor (FVCI) could invest in any Indian sector

and all streams of income earned by them were tax exempt in India. However, in the

2007 tax budget, the exemption was limited to investments in specified sectors (including

nanotechnology, IT hardware and software, bio-technology, dairy and poultry industries,

pharmaceutical R&D sector, and certain hotel/convention facilities). Income earned from

PE investments made in non-specified sectors will now be taxable at both the PE fund

level and the beneficiary level. But as most PE FVCI investment vehicles are housed in tax

favourable jurisdictions (such as Mauritius or the Cayman Islands), the impact has not been

far-reaching.

The 2007 tax budget also amended Employee Stock Ownership Plan (ESOP) regulations,

whereby ESOPs will now be taxable in India as a fringe benefit payable by the employer

company. This amendment could have an impact on actual profitability (and hence the

valuation) of the company in which PE investments have been made




tax leakage (continued)

India Preference share (other than fully convertible) capital will now need to comply with

External Commercial Borrowing (ECB) guidelines on interest/dividend coupon caps and

end-use fund restrictions on the purchase of capital goods, implementation of new

projects, modernisation or expansion of existing units/business facilities, and overseas

direct investment in joint ventures/wholly owned subsidiaries. It is estimated that about

30 percent of Indian PE investments are structured as preference share capital, and so the

new end-use restrictions could negatively affect PE investors. Funds raised via preference

shares can no longer be used for general corporate purposes, funding of working capital,

repayment of existing loans and acquisition of shares and/or real-estate.33

These guidelines also place restrictions on borrowers raising ECB in order to modulate the

capital inflows through ECB by modifying some aspects of the policy34

India has entered into Double Taxation Avoidance Agreements with several countries. It is

interesting to note that the data published by the Government of India suggests that about

37 percent of total FDI into India made during the last 15 years has been routed through

Mauritius to take advantage of the favourable tax treaty between India and Mauritius.

While tax concessions under the India-Mauritius treaty have been a constant matter of

debate within Indian Revenue circles, a recent ruling of the Apex Court in India upheld

the benefits conferred under this treaty. However, there are indications that the Indian

Revenue may consider amending the India-Mauritius Treaty by including anti-treaty abuse

clauses.

Japan There have been various changes in legislation in recent years aimed to provide a

mechanism to tax gains on exit from private equity investments. The so called “Shinsei

tax” was introduced, aimed at grouping the holdings of partnerships in order to calculate

thresholds that would determine whether the transactions are taxable in Japan. There have

also been numerous amendments to the M&A rules (both tax and regulatory) allowing

various mergers that were previously not permitted for either tax or regulatory purposes.

Industry reaction to the Shinsei tax was initially negative, but it is not a particular issue

for US-based firms because the Japan-US tax treaty gives protection to gains in certain

situations.

Korea The Korean tax authorities introduced a new withholding tax regime on Korean source

income such as dividends, interest, royalties and capital gains remitted to a foreign

recipient (for example, foreign funds) located in tax havens designated by the tax

authorities. Such a tax haven would be subject to the Korean withholding tax rate on

dividends, interest, royalties and capital gains, rather than having the withholding tax

reduced under tax treaty between Korea and the tax haven. This new rule applies to

payments made as of July 1, 2006.

To be eligible for the tax treaty benefits, a foreign recipient in the tax haven should obtain

confirmation from Korean tax authorities that the foreign recipient in the tax haven is the

beneficial owner of such income. The tax haven list includes only Labuan in Malaysia at

this time, but the list may be updated at any time.

33 Previously, the ECB policy did not permit utilisation of ECB proceeds in real-estate activities, but “development of integrated township” was kept outside the purview of “real estate,” and hence was considered as a permissible end use utilisation of ECB proceeds. Under the modified ECB guidelines issued in May 2007, the exemption accorded to the “development of integrated township” as a permissible end-use of ECB has been withdrawn.

34 Borrowers raising ECB greater than USD 20 million are required to park ECB proceeds overseas for use as foreign currency expenditure for permissible end-uses. This would be applicable to ECB exceeding USD 20 million per financial year both under the Automatic Route and under the Approval Route.

Borrowers proposing to avail ECB up to USD 20 million for rupee expenditure for permissible end-uses would require prior approval of the Reserve Bank of India under the Approval Route. However, such funds shall be continued to be parked overseas until actual requirement in India.



Negative impact on employmentThe impact of private equity investment on employment levels is not yet a

burning issue in Asia Pacific, where robust economic growth in many countries

is creating more jobs than ever before. Nevertheless, it is worth looking at the

reaction elsewhere for indications of how the issue may arise in the region,

particularly if the anticipated increase in buyouts materialises.

As Exhibit 11 shows, most private equity activity in the region is still focused

on generalist, venture and growth capital, so PE involvement tends to lead to

expansion and more hiring, rather than the opposite. But the situation may

change if buyouts become as popular and as big in the region as in the US and

Europe. “The buyer always cuts costs,” says Kelvin Chan, Senior Vice-President

at Partners Group in Singapore.35 “But in general you cannot look at these

transactions on a short-term basis. The long-term results have shown that private

equity and buyout firms actually make a company more competitive and a bigger

employer.”

Unite, the UK’s largest trade union, is lobbying the House of Commons to

extend protection to workers affected by private equity deals. Its deputy general

secretary, Jack Dromey, says that the experience of his members with private

equity “is all too often job uncertainty, poorer pay, pensions put at risk and even

unemployment.”36 In the US, the Service Employees International Union is

urging Congress to pass legislation that would “ensure that private equity works

for working people and for the rest of the country,” if the industry does not take

steps on its own to protect the interests of employees and the community at

large.37

PE practitioners typically cite research from Europe that credits private equity

with net employment increases. “There have been numerous studies by the

BVCA and EVCA [European Private Equity & Venture Capital Association] that

show companies with private equity participation generate 20 percent more

employment growth than companies that do not have private equity,” says

3i’s Rowlands. In a recently published survey, the BVCA found that companies

backed by private equity and venture capital in the five years to 2006 increased

worldwide staff by an average of 9 percent per annum, faster than employment

increases among FTSE 100 and FTSE Mid-250 companies at 1 percent and 2

percent, respectively.38 In a 2005 survey, the EVCA found that private equity

created 1 million jobs between 2001 and 2004 in the 25 EU member states, a

compound annual growth of 5.5 percent – eight times the 0.7 percent average

growth rate of employment in these economies.39

No region-wide study has yet been conducted in Asia. Last year, AVCAL

commissioned a study that found that 76 percent of the 50 PE-backed Australian

companies polled plan to hire more employees in 2007.40 A region-wide study

along the same lines will provide a more complete picture, and further bolster

private equity’s claim of having a positive effect on Asia Pacific employment in

the long term.

other issuesRegulators and legislators around the world are being asked to respond to

several other issues relating private equity. These include the impact of de-

equitisation arising from buyouts, conflicts of interest involving private equity,

inadequate regulation, and systemic risk to capital markets and the economy.

35 KPMG interview with Kelvin Chan, Senior Vice-President at Partners Group and Chairman of the Singapore Venture Capital & Private Equity Association, 11 July 2007.

36 Jack Dromey, “Protect workers from the private equiteers,” The Financial Times, 2 July 2007.

37 Testimony of Andrew Stern, President of the Service Employees International Union, before the House Financial Services Committee of the US Congress, 16 May 2007.

38 “Statement on trade union comment about private equity industry,” by BVCA Chief Executive Peter Linthwaite at www.bvca.co.uk.

39 “Private equity in the public eye: 2007 global private equity environment rankings,” a report by Apax Partners and the Economist Intelligence Unit, 2007.

40 “Economic Impact of Private Equity and Venture Capital in Australia,” a report by AVCAL 2006.




Negative impact on employment

UK Unite, Britain’s biggest trade union, has called for new legal protection for workers in

private equity deals. Deputy General Secretary Jack Dromey said that the experience of

his members with private equity “is all too often job uncertainty, poorer pay, pensions put

at risk and even unemployment as factories and plants are closed.”41

The BVCA responded by noting that its recent survey entitled The Economic Impact of

Private Equity reveals that PE/VC backed companies in the five years to 2006 increased

worldwide staff by an average of 9 percent per annum, faster than employment increases

among FTSE 100 and FTSE Mid-250 companies at 1 percent and 2 percent, respectively.42

The House of Commons will release its report on employment and other private equity

issues before the end of 2007.43

US In a recent document,44 the Service Employees International Union in the US questioned

the credibility of private equity studies that claim the industry creates jobs “since private

companies do not publicly disclose information about their employees or company

growth,” adding that it was unclear how employees benefit “since industry studies

make little attempt to look behind the numbers at what is happening to workers and

communities.”

The Private Equity Council concedes that private equity employment data have not yet

been developed in the US, but it believes that the increased employment numbers

reported by various surveys done in Britain and the rest of Europe mirror what is

happening in America.45 Congressional hearings on this and other issues are currently

ongoing.

41 Jack Dromey, “Protect workers from the private equiteers,” The Financial Times, 2 July 2007.

42 “Statement on trade union comment about private equity industry,” by BVCA Chief Executive Peter Linthwaite at www.bvca.co.uk.

43 Jean Eaglesham, “Commons private equity report to be delayed,” The Financial Times, 11 July 2007.

44 “Behind the Buyouts: Inside the World of Private Equity,” study prepared by the Service Employees International Union, April 2007.

45 “Public Value: A Primer on Private Equity,” by the Private Equity Council, 2007.

46 “Private equity in Asia,” The Lex Column, The Financial Times, 21 April 2007.

47 “Taiwan regulator debates buyout reforms,” The Financial Times, 4 July 2007.

48 “Australia rethinks value of private equity buyouts,” by Tim Johnston, International Herald Tribune, 16 May 2007.

49 “SEC Votes to Adopt Antifraud Rule Under Investment Advisers Act,” media release by the US Securities and Exchange Commission, 11 July 2007.

50 “Private Equity in Australia,” submission by the Australian Private Equity & Venture Capital Association (AVCAL) to the Senate Standing Committee on Economics, 10 May 2007.

On de-equitisation, Taiwan’s Financial Services Commission is considering a

change in the stock market’s de-listing rules. Whilst the USD 976.8 million Fu

Sheng deal is the island’s first private equity buyout, concerns have been raised

about the effect on the stock market, which is seeing more de-listings than new

public offerings.46 The regulator may raise the threshold for de-listing from the

current 50 percent of shareholders present during the vote (a quorum of two-

thirds of the total shareholders is required).47 Similar concerns have been raised

in Australia, but no regulatory action is imminent there at this time.48

On the adequacy of regulation, the US Securities and Exchange Commission

recently adopted a new rule that explicitly makes it a “fraudulent, deceptive,

or manipulative act, practice or course of business” for investment advisers of

private equity funds, venture capital funds, hedge funds, and mutual funds to

make false or misleading statements to investors or prospective investors in

the pooled investment vehicle.49 The ruling closes a loophole in the Investment

Advisers Act, which was enacted before the rise of private equity funds. Private

equity regulations are also being revised in India as part of the overall fine-tuning

of foreign investment incentives.

Finally, there are fears in Australia about the systemic risk posed by private equity

activities. The Senate has referred an inquiry into private equity to the Standing

Committee on Economics, whose findings have yet to be published. In its

submission to the committee, AVCAL said it recognises as a general principle that

increased debt leads to an increase in risk. But private equity firms in Australia,

it pointed out, conduct extensive due diligence and have extensive experience in

operating businesses with increased debt. “The track record of the private equity

industry shows that it is well equipped to manage businesses throughout the

economic cycle,” AVCAL concluded.50




Lack of or inadequate regulation

UK In its June 2006 discussion paper, the FSA commented with regard to regulation that “current

architecture is effective, proportionate and [the industry is] adequately regulated.” It recently

changed the auditor reporting requirements for certain investment firms for accounting periods

ending on or after 1 January 2007, reducing the regulatory administrative burden.

US On 11 July 2007, commissioners of the US Securities and Exchange Commission (SEC) voted

5-0 to adopt a new rule that “will make it a fraudulent, deceptive, or manipulative act, practice,

or course of business for an investment adviser to a pooled investment vehicle to make

false or misleading statements to, or otherwise defraud, investors or prospective investors

in that pool.” In a media statement, SEC Chairman Christopher Cox said the rule “applies to

investment advisers not only of hedge funds, but also of private equity funds, venture capital

funds, and mutual funds.”51 The Private Equity Council, the first US trade association for private

equity individuals, intends to set out a self-regulatory scheme in the US that is in line with

BVCA schemes.

India PE investments in each Indian sector are governed by the Foreign Direct Investment (FDI)

Guidelines and Foreign Exchange Control Guidelines. Apart from this FDI route, private equity

funds can also register as a Foreign Venture Capital Investor (FVCI), giving them the benefit of

free entry and exit pricing of the Indian investment. However, PE investment (i.e. entry and

exit) in Indian listed companies is governed by the Takeover Code regulations. The Government

of India along with the Foreign Investment Promotion Board are revisiting the foreign

investment caps in each sector and will revise the existing guidelines in the near future. The

revised foreign investment guidelines may also include a change in the definition of “direct and

indirect” foreign holding in Indian companies.

de-equitisation Australia There has been criticism in Australia about the potential of private equity buyouts to narrow the

options available to ordinary investors as they take public companies private.52 David Jones,

chairman of the Australian Private Equity & Venture Capital Association, says buyouts last year

accounted for only a small fraction of the market capitalisation of all companies trading in the

Australian Securities Exchange.53

Taiwan More companies in Taiwan are being de-listed compared with the number of new public

offerings, raising worries about de-equitisation as more and more private equity firms propose

buyouts.54 The Financial Supervisory Commission is considering raising the threshold for de-

listing.55 Under current rules, a company can be de-listed if two-thirds of shareholders are

present at the meeting, and 50 percent of those shareholders vote to de-list.

playing field unlevel

UK In the UK, the existing status of private equity funds, typically via limited partnerships and

Collective Investment Schemes (CISs) offers benefits over listed investment vehicles, since

there is a prohibition in the Listing Rules that stops listed vehicles taking control of the

companies that they invested in. This has led to accusations that private equity funds enjoy

preferential market access. The FSA issued a consultation paper in December 200656 that

outlined changes in listing rules to remove this prohibition.

Listing of private equity funds

US Congressmen Dennis Kucinich and Henry Waxman expressed worry about the implications

of private equity funds going public such as Blackstone’s IPO, which they feared would allow

“public investors to participate in hedge-fund type investments that have previously been

considered unsuitable.”57 Congressional hearings on this and other issues are currently

ongoing.

systemic risk to capital markets and the economy

Australia In August 2007, an inquiry by the Senate’s Standing Committee on Economics published its

findings in relation to an inquiry into private equity investment and its effects on capital markets

and the Australian economy. In their report, the Committee suggested that private equity is not

a threat to the public capital markets and that there are limits to the growth of the sector that

will mitigate against significant equity market risks.58

51 “SEC Votes to Adopt Antifraud Rule Under Investment Advisers Act,” media release by the US Securities and Exchange Commission, 11 July 2007.

52 “Australia rethinks value of private equity buyouts,” by Tim Johnston, International Herald Tribune, 16 May 2007.

53 KPMG interview with David Jones, Chairman of AVCAL and Managing Director of CHAMP Private Equity, July 12 and 20, 2007.

54 “Private equity in Asia,” The Lex Column, The Financial Times, 21 April 2007.

55 “Taiwan regulator debates buyout reforms,” The Financial Times, 4 July 2007.

56 Financial Services Authority: CP06/21 Investment Entities Listing Review

57 Joint letter to Christopher Cox, Chairman of the US Securities and Exchange Commission, by Dennis J. Kucinich, chairman of the Domestic Policy Subcommittee and Henry A. Waxman, Chairman of the Committee on Oversight and Government Reform, both of the US House of Representatives, 21 June 2007.

58 “Private equity investment in Australia,” report to The Senate by the Standing Committee on Economics



The growing reach of Sovereign Wealth Funds

Sovereign Wealth Funds (SWFs) are state-owned funds which invest national wealth into assets such as stocks, bonds, property and infrastructure. Traditionally these funds have been a vehicle for oil-rich nations to diversify their national income. Recent years have seen the establishment of SWFs by East Asian nations with large current account surpluses who are attempting to achieve better returns on their foreign exchange reserves. Morgan Stanley has estimated that total SWF assets globally could be as much as USD 2.5 trillion in 2007, with Asia Pacific accounting for approximately 35 percent of this amount.

The sheer size of these funds means that they will be significant players in global asset markets for the foreseeable future, with private equity likely to be an important part of their asset allocations. SWFs may compete directly with private equity firms for investment opportunities, or indeed invest directly in private equity firms, such as CIC’s USD 3 billion investment in the Blackstone Group.

As with private equity firms, SWFs face scrutiny due to the lack of publicly available information. This has led to concerns by many governments that foreign SWFs are investing for political and strategic reasons rather than solely for financial gain.

Key national players in Asia Pacific are:

Australia: In 2004, the Australian government announced that it would be establishing an SWF into which it would invest budget surpluses to meet its retirement benefit liabilities. The fund aims to hold USD140 billion by 2020 and will be governed by a broad investment mandate. The fund’s chairman has indicated that they are not looking to take controlling interests in companies, only to be more active in publicly-traded securities markets than in private equity.

China: China’s economic performance has led to a dramatic increase in the size of China’s foreign exchange reserves. The creation of SWFs reflects an increased desire to improve the returns on these reserves, which had previously been invested in sovereign debt. With limited public disclosure from the funds, it is not currently clear what mandates and objectives these funds have.

Korea: Korea Investment Corporation was established in 2005 as a government-owned investment management company, specialising in overseas investments. It is mandated to manage part of Korea’s foreign exchange reserves and other public funds. Currently it manages USD 17 billion of foreign exchange reserves from the Bank of Korea and USD 3 billion of foreign exchange stabilisation funds from the Ministry of Finance and Economy.

Malaysia: Established in 1993, Khazanah Nasional is the investment holding arm of the government of Malaysia and is empowered as the government’s strategic investor in new industries and markets. It has stakes in more than 50 companies with assets valued in excess of USD 18 billion.

Singapore: Singapore has long made use of SWFs to manage its national investments, establishing Temasek Holdings in 1974 and GIC in 1981. With an estimated 75 percent of investments being in Singaporean assets, Temasek owns stakes in many of the nation’s largest and landmark companies. Their focus is now being widened with a long-term balanced portfolio target of approximately one-third exposure each to Singapore, rest of Asia (ex-Japan), and OECD (ex-Korea) and other economies. GIC was established to manage Singapore’s foreign reserves, with its investment portfolio managed in turn by GIC Asset Management Pte (responsible for investments in publicly traded securities); GIC Real Estate Pte Ltd (investments in property); and GIC Special Investments Pte Ltd (operating as a private equity investor, taking direct controlling stakes in companies and making direct investments in infrastructure).

SWFs in the Asia Pacific RegionCountry Fund name Acronym Estimated

assets (USD billions)

Inception

Singapore Government of Singapore Investment Corporation

GIC 330 1981

China (PRC) China Investment Company Ltd CIC 200 2007

China (PRC) Central Hujjin Investment Corp n/a 100 2003

Singapore Temasek Holdings n/a 100 1974

Australia Australian Government Future Fund FFMA 51 2004

Brunei Brunei Investment Agency BIA 30 1983

South Korea Korea Investment Corporation KIC 20 2005

Malaysia Khazanah Nasional KN 18 1993

China (ROC) National Stabilisation Fund NSF 15 2000

Total 864 Note: The asset figures listed above are estimates only, as many of the funds do not publish detailed financial information and are subject

to significant flows of capital from central bank reserves.

Source: Morgan Stanley Research:”How Big Could Sovereign Wealth Funds Be by 2015?” 3 May 2007



In Asia Pacific, private equity is helping many companies become regional

and global players, an undertaking that requires not only financial backing but

more importantly, technical expertise, management skills and an international

network of contacts. Satish Deshpande, Head of Private Equity at NV Advisory

Services in India, points to a small Indian auto-parts maker whose acquisition

of two enterprises in the UK and the US has placed it on track to grow by more

than 30 percent annually over the next few years. This was made possible, says

Deshpande, because “one of our founding partners sits on the board of major

auto companies in the US, so we were able to make introductions and help the

company get short-listed in the bidding.”59 The fact that the Indian company had

private equity investment, in his view, was a critical factor given the undeveloped

credit rating system in India.

The two companies we feature as case studies at the end of this chapter

illustrate other ways private equity add value to enterprises. Little Sheep, a

restaurant chain in China known for its hotpot cuisine, became more efficient

and profitable with the injection of international know-how by two non-

executive directors brought in by 3i, Nish Kankiwala, former CEO of Burger

King International, and Yuka Yeung, KFC’s Hong Kong Master Franchisee CEO.

In Australia, pay TV provider Austar was burdened in 2002 by AUD 400 million

in debt, an obligation it was unable to service because its EBITDA was only

AUD 22.6 million. Financial engineering, combined with a focus on business

fundamentals, by CHAMP Private Equity helped turn its fortunes around. Austar’s

stock price, at about AUD 0.25 in 2002, had soared 420 percent to AUD 1.30

when CHAMP exited in 2005.

ipo performanceIn an attempt to quantify the effect of private equity involvement in Asian

companies, KPMG analysed the stock performance of PE-sponsored initial public

offerings versus that of their non-PE sponsored peers that went public in 2005

and 2006. The analysis focused on four markets: Australia, Hong Kong, India

and Japan. The companies were grouped in age-range buckets (meaning that

companies in the 100-200 days bucket have been trading for 100 to 200 days,

those in the 201-300 bucket have been trading for 201 to 300 days and so on).

The comparison days were the IPO offer price and the closing price at the end of

May 18, 2007.

Private equity performance analysis

59 KPMG interview with Satish Deshpande, Head – Private Equity, NV Advisory Services Private Limited, 19 July 2007.



The results for Australia and India were positive. As Exhibit 13 shows, PE-

sponsored companies in Australia which have been trading for 501 to 616 days

were up better than 130 percent on average compared with the 42 percent gain

of their non-PE sponsored peers in the same bucket. In India, the average share

price of PE companies in the 501-616 days bucket had risen 195 percent as of

May 18, while the non-PE companies in the same bucket had an average price

gain of 99 percent.

exhibit 13Stock market performance of Australia’s PE and non-PE companies

Number of PE-sponsored companies: 12

Number of non-PE sponsored companies: 131

Source: Bloomberg, AVCJ database and KPMG Analysis

100-200 days

160

140

120

100

80

60

40

20

0

-20

n PE-sponsored companies -Average Price Gain/Loss

n Non-PE-sponsored companies -Average Price Gain/Loss

201-300 days 301-400 days 401-500 days 501-616 days

exhibit 14Stock market performance of India’s PE and non-PE companies




100-200 days 201-300 days 301-400 days 401-500 days 501-616 days

250

200

150

100

50

0



Gain

/loss

%Ga

in/lo

ss %



Interestingly, there is little difference between the average price performance

of PE and non-PE companies in Hong Kong (Exhibit 15). This may be due to the

growing number of Chinese companies which are listing in Hong Kong in tandem

with the China A-share market. Many of these are outperforming their Hong

Kong peers and therefore distorting overall performance.

exhibit 15Stock market performance of Hong Kong’s PE and non-PE companies




100-200 days



201-300 days 301-400 days 401-500 days 501-616 days

250

200

150

100

50

0

exhibit 16Stock market performance of Japan’s PE and non-PE companies






0

-10

-20

-30

-40

-50

-60

-70100-200 days 201-300 days 301-400 days 401-500 days 501-616 days

Gain

/loss

%Ga

in/lo

ss %

The number of IPOs in the sample period in Japan is larger (24 PE companies and 246 non-PE companies), but the results are the direct opposite of the trends in Australia and India, with most companies in the period showing price losses instead of gains. This can be attributed to some Japanese markets, such as the Tokyo Stock Exchange Second Section and Mothers Index for example, entering into a period of decline starting the first quarter of 2006. Both of these markets have been popular with IPOs. Retail investors, who tend to dominate small cap IPO issues, may also have been weary of entering the market, resulting in reduced funds in the market, and subsequently lower valuations.

The pricing trends in Australia and India represent the potential of private equity firms to add value and rewarded by the market accordingly, while those in Japan may indicate that market conditions, volatile sectors and perhaps individual



failures by PE firms can sour investments in PE-sponsored companies. The picture should become clearer going forward, when more PE companies are listed and longer term trends can be assessed.

Financing, management and processesPrivate equity firms are unequivocal about the benefits they can bring to companies and economies in Asia. The overwhelming majority of this study’s respondents – 90 percent – say they are hands-on investors (Exhibit 17). They are not short-term investors that demand instant results. They are in for the long haul and are not likely to head for the exits during temporary bad times.

exhibit 17What is your involvement in the portfolio company?


n Hands on

n Hands off

90%

10%

The approach of 3i in Asia illustrates the hands-on nature of the private equity business. “Management has to put together a plan for us to buy into,” explains Rowlands. “We test that plan, we look at it from different angles, we get consultants to help us out, we get reactions from experts, and then we come up with what we think is a realistic base case.” Typically, a 180-day action plan is implemented, covering operations, legal, marketing, financial and other matters. In the next three to five years, which is generally how far into the future performance can be realistically measured, 3i takes an active role in strategy-setting at the board level and provides guidance and advice on management and operations issues.

exhibit 18What are the key benefits that you bring to portfolio companies? (degree of commonality on a scale of 1 to 10)


General management guidance at board level

Improved corporate governance

Optimised financing structure

Business process improvement

Links to other financial sponsors

IPO process knowledge

6.7Provision of capital required for investment to grow the business

Accelerated growth through synergies with other portfolio companies

1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0

5.9

5.3

5.3

5.1

5.0

4.8

3.5

3.3

3.0

Ability to recruit the best managers to the business

A greater focus on long-term commercial performance

9.0 10.0



Asia’s private equity funds pride themselves on the value they add to their

investments. Asked to rate the key benefits they bring to their portfolio

companies, the respondents in this study first cite their role in providing capital

needed for growth (Exhibit 18). The second most cited benefit is provision of

general management guidance at the board level, followed by improved corporate

governance, ability to recruit the best managers to the business and ability to

optimise financing structure.

Broken down by fund type, the responses show a remarkable unanimity on

the benefits the private equity firms believe they deliver to portfolio companies

(Exhibit 19). Regardless of whether their fund is in venture capital, growth capital,

generalist or buyout, the respondents single out the provision of capital to grow

the business as their most important contribution. The second most important

benefit is their ability to optimise the portfolio company’s financing structure.

exhibit 19Key benefits by fund type, finance/capital structuring


n Links to other financial sponsors

n IPO process knowledge

n Provision of capital required for investment to grow the business

n Optimised financing structure

Venture

Growth Capital

Generalist

Buyout

Least important Most important

1 2 3 4 5 6 7 8 9 10



exhibit 20Key benefits by fund type, management/processes


n Improved corporate governance

n General management guidance at board level

n Business process improvement

n Abiltiy to recruit the best mangers to the business

Venture

Growth Capital

Generalist

Buyout

Least important Most important

1 2 3 4 5 6 7 8 9 10

There are differences in emphasis in the area of management and processes

(Exhibit 20). Venture capital funds emphasise the provision of general

management guidance at the board level, and their ability to recruit the best

managers to run the business.

Growth capital funds also focus on board-level guidance, but also give equal

importance to their ability to improve corporate governance. Little importance is

given to the recruitment of good managers, implying that growth funds tend to

retain current management.

Generalist funds give equal importance to corporate governance, general

management guidance and recruitment of the best managers.

Buyout funds focus strongly on the improvement of business processes, an

indication of the type of target companies that would most appeal to them,

namely underperforming and complacent enterprises that will benefit from cost-

cutting.




Private equity funds regard their activities as having an impact beyond their own

immediate portfolio companies. The respondents in this survey say their main

contributions relate to helping regional businesses compete globally, helping

countries attract external investment, and helping small businesses survive and

thrive.

It is interesting to see how private equity can deliver different benefits to

different markets (Exhibit 21). Increased ability to attract foreign investment is

seen as the key contribution in Greater China (54 percent) and India (47 percent).

Private equity is also regarded as a contributor to making regional businesses

competitive on the global stage in both countries, as is the case in Korea and

Japan (49 percent) and Oceania (44 percent). In Southeast Asia, private equity’s

main contributions are seen to be helping small businesses grow (49 percent)

and helping local businesses compete on the international stage (49 percent).

exhibit 21Key impact of private equity funds on various economies


n Improved focus on research and development

n Growth of small businesses

n Increased ability for local businesses to compete on the regional stage

n Increased ability for regional businesses to compete on the global stage

n Employment growth

n Increased ability for the country as a whole to attract external investment

60%

50%

40%

30%

20%

10%

0%Greater China India Korea/Japan Oceania Southeast Asia



Case study: Little Sheep

When private equity firm 3i paid USD 20 million60 last year for a minority

stake in Mongolian lamb hotpot chain Little Sheep, it knew exactly what it

was getting. Due diligence had confirmed that the 500-outlet restaurant was

profitable, but the investigation also revealed a number of areas that required

some attention in order for the Chinese enterprise to realise its full potential.

“We saw that there was a lot to do in terms of protecting the brand by sorting

out which were the fake stores and which were the genuine franchises,

improving the overall operational quality and consistency, and ramping up

central support for this part of the business,” recalls Chris Rowlands, Managing

Partner Asia at 3i.

Twelve months later, Little Sheep’s revenues were growing by 40 percent

per annum, far in excess of the 15-20 percent expansion of China’s fast food

sector. The ratio of directly owned to franchised outlets, at 70 to 430 pre-

private equity, is now a more balanced 105 to 221. Most of the 116 outlets that

were closed had been “Little Black Sheeps” – restaurants that were operating

without a full agreement with the company. Next year, Little Sheep plans an

initial public offering in Hong Kong, where it has opened four stores.

One of the first things 3i did was to install two non-executive directors with

extensive fast-food industry experience. They are Nish Kankiwala, a former

president of Burger King International, and Yuka Yeung, KFC’s Hong Kong

Master Franchisee CEO. The two men are part of 3i’s People Programme, a

global network of seasoned senior executives who help the London-listed

group find deals and serve on the boards of 3i investments. “They provided

guidance and external views,” Rowlands says of Kankiwala and Yeung. “Things

like how to motivate staff, what KPIs to focus on, how to increase same-store

growth – all the advanced restaurant management skills that Little Sheep

needed to know.”

They also helped focus Little Sheep’s attention on franchise management

and the protection and enhancement of the brand. Started in Baotou in Inner

Mongolia in 1999, the enterprise had expanded quickly, becoming China’s

largest restaurant chain by the time 3i came in. But there was no centralised

franchising system, allowing copycats to purloin Little Sheep’s signage and

logo, and putting the brand’s reputation at risk with substandard food and

service. The creation of a standards committee and a mandatory training

program for franchisees is helping correct the situation.

Rowlands says Little Sheep is on track to open 45 new outlets a year, creating

more jobs to replace and even exceed the numbers that had been lost. As a

minority shareholder, 3i oversees its investment at the board-level and has not

pushed out the previous management. Founder Zhang Gang remains as board

chairman and a new CEO has been named from within the ranks. “Everyone

is intent on making the company the biggest and the best dining business in

China,” says Rowlands. If they succeed, equal credit should go to the art and

science of private equity investing.

60 Another private equity firm, Prax Capital, invested USD 5 million alongside 3i.



Case Study: Austar

On the face of it, Australia’s CHAMP Private Equity got a bargain in 2002 when

it paid just USD 34.5 million for bonds with a face value of USD 500 million.

The bonds were issued by a US company called UAI, which was going through

Chapter 11 bankruptcy filings after failing to service its obligations. CHAMP

was interested in UAI’s sole asset – a 51 percent indirect stake in Austar, an

Australian subscription TV provider. But Austar was also about to collapse,

having breached covenants with banks that lent it AUD 400 million. Austar’s

EBITDA – earnings before taxes, debt and amortisation – was a paltry AUD

22.6 million a year. Was CHAMP being played for a chump?

As an experienced private equity house, CHAMP had done its homework.

It learned many things about the company by talking to a former Austar

CFO. “We asked him to a case study, and it looked interesting,” recalls

David Jones, CHAMP’s managing director. “We asked him to do more work,

and it still looked interesting.” A commercial due diligence indicated that

there was significant business opportunity. The industry was undergoing

rationalisation, creating an orderly market environment, reducing the cost of

new programming and satellite arrangements, and making possible the shared

development of interactive and near video on demand (NVOD) applications.

CHAMP also examined an internal turnaround plan developed by Austar’s

management. The plan focused on initiatives such as the closure of the

regional office network, outsourcing of field sales and the internet network,

price rises, increasing footprint by 200,000 homes, and reduction of churn

through operational improvements. “The projected EBITDA uplift was

substantial but believable,” says Jones. “What Austar needed to do was to fix

its capital structure to stop the bank distraction and implement the plan.”

Legal thicketCHAMP proceeded to negotiate the legal thicket around Austar. After

coming to terms with the New York bankruptcy court over how much to pay

for UAI’s bonds (a 93 percent discount, at USD 34.5 million), the PE firm

struck an agreement with Liberty Global (LGI), then known as United Global

Communications, for joint control of Austar. LGI owned 31 percent of UAI,

with the US bondholders owning 63 percent. CHAMP’s bond purchase made

it the majority owner of UAI, and thus gave it control of UAI’s 81 percent

stake in Austar (the rest of the 19 percent was in public hands). LGI had

pre-emptive and other rights with regard to UAI, and could have effectively

stopped CHAMP’s deal with the bondholders. Because it had to attend to

other challenges in its other business units, LGI agreed to let CHAMP drive

the Austar turnaround plan.

The partnership with LGI yielded other benefits. “We gained access to their

global pay TV expertise and also some programming,” says Jones. “They had

international experience and we had local experience.” CHAMP knowledge of

the Australian system was important because the deal required a waiver from

ASIC, the local regulator. Under Australia’s Takeovers Code, getting to own



20 percent of a company before making an offer for the rest of the shares

is a criminal offence. “We had to go to ASIC to explain that Austar had big

problems, that the bonds were in a separate market and in bankruptcy court in

New York, that we were doing an arm’s length trade there,” says Jones. In the

end, ASIC granted the new owners relief, with the proviso that they make an

equivalent offer to the rest of Austar’s shareholders after buying the bonds.

Financial engineeringThe “equivalent offer” was AUD 0.16 per share, which is the value of the

USD 34.5 million CHAMP paid for the bonds in Austar equity terms. The PE

firm duly offered AUD 0.16 per share for the 19 percent in public hands, but

virtually no one accepted. CHAMP’s entry boosted the stock price beyond

AUD 0.40 per share, 150 percent higher than the offer price. The new owners

embarked on a new strategy. Austar launched a rights issue priced close to the

strong market price, and got a 93 percent acceptance rate. The offer yielded

AUD 75 million in new capital, which was used for capital expenditures and

debt reduction.

The new owners also had to deal with Austar’s massive bank debts. The rights

offering enabled Austar to pay the banks AUD 45 million, but the amount

was just a tenth of what was owed. Restructuring the borrowings was a

complicated workout because 15 financial institutions were involved and

most of the loans were already in the respective banks’ difficult-to-work with

workout divisions. Seven banks accounted for 9 percent each of the total debt,

with the rest having lower exposure, meaning that there was no one dominant

lender to take the lead. It took CHAMP four months to get the banks on board

in May 2003. The loans were restructured in mid-2004 into senior debt of AUD

290 million and hybrid debt security of AUD 115 million, resulting in improved

flexibility and lower longer term cost for Austar.

Freed from the distraction of the debt, Austar’s management focused on

executing the turnaround plan. “We assessed management carefully, and we

formed the view that they were a capable team, even though they were partly

responsible for getting Austar into its problems,” says Jones. “With some

direction, focus and accountability, we believed we could work with them, and

that turned out to be the case.” To incentivise management, executives who

bought Austar shares at AUD 0.16 had each of those shares matched with

two shares at the prevailing market price, funded by a company-provided loan.

Managers were also vested with shares provided the company met its internal

rate of return targets.

CHAMP exited the investment in 2005 on the back of Austar posting 2005

EBITDA of AUD 125 million. It sold 224 million shares to LGI at AUD 1 per

share and another 298 million shares to Goldman Sachs at AUD1.15. The total

proceeds came to AUD 556.8 million, a six-fold return on the PE firm’s AUD

81.6 million investment (purchase cost of the bonds and the rights offering).

One main beneficiary is Australia’s pension funds, which are major investors in

CHAMP. Private equity had worked its magic once again.



Around Asia Pacific, business management, operations and corporate

governance need to be improved and this is something that private equity

has proved it is equipped to help with. Private equity can help create deals in

emerging markets, where industries are fragmented, companies are sprawling

and due diligence is tough. It also fills an important need as deals get bigger and

the focus shifts to larger companies. As ‘roll-ups’ are carried out, private equity’s

established network of contacts, ability to attract world-class management

teams and put together financing on attractive terms become even more

important.

There are many avenues available to Asian companies as they seek to improve

their management, including M&A, partnerships and internal transformation.

However, the PE industry is in a position to help many of these “local

champions” as they seek to compete on a more international footing. Private

equity participation or buyouts are certainly options they can consider.

However, this is where private equity in Asia can become vulnerable to negative

public and media opinion. Takeovers can ruffle local feathers, especially when

national assets are at stake. Emotional and nationalistic feelings can complicate

already complex commercial considerations. Isolated instances of excessive

profit-making and overzealous deal-making can also tar the rest of the industry.

The challenge for private equity funds in Asia is to remain sensitive to Asian

business ways, which emphasise partnership rather than confrontation,

moderation rather than excess.

Private equity is now in the public domain. This means PE companies should

engage more actively with the wider community, including the media. As non-

public entities, private equity funds are obliged to disclose their financial results

and activities only to their shareholders. As the Walker Working Group in the

UK suggests, however, they should consider being more transparent to the

larger market and all community stakeholders, particularly when they embark on

buyouts involving state assets or well-known companies. The companies they

invest in should also improve their level of transparency, including activities that

affect employee numbers.

One truth is fairly self-evident. The self-regulatory and voluntary approach is to be

preferred to possibly heavy-handed regulatory edicts, and the civil and criminal

penalties that they may prescribe. Towards this end, Asia’s private equity players

should arm themselves with on-the-ground knowledge of exactly what is going

on not only in their own businesses but also in their local market and the rest of

the region. How well the industry communicates to the media and the general

public these facts about what they do and the benefits they deliver to their host

countries could influence how regulators and legislators will act in resolving

various issues involving private equity in Asia.

As noted, there are moves in several countries to develop reporting standards

among private equity funds and the portfolio companies operating in their

market. In addition, some national associations want to develop a code of

ethics and a code of behaviour as part of a system of self-regulation of the

industry. These moves should be across Asia Pacific, both individually by national

associations and also by co-oordinating and co-operating with each other.

The way forward



The structures are already in place. Private equity and venture capital associations

have been formed in Australia, China, Hong Kong, India, Indonesia, Japan,

Malaysia, Singapore, South Korea, Taiwan and Thailand. Seven of these

associations are founding members of the Asia Pacific Venture Capital Alliance

(APVCA), which was established in 2001 and has its secretariat in Kuala Lumpur.

The APVCA aims to strengthen communications and networking among national

associations, their members and institutional investors, provide an effective

platform to jointly evaluate issues, threats and opportunities, and engage in

dialogue and cooperation with government agencies and multilateral institutions.

In our view, APVCA and the national associations should also add to their mission

the conduct of national and regional studies on the impact of private equity on

businesses and economies, and the role of interfacing with the media in an open

and professional manner. These two aims complement each other, since the

associations will not have much to tell the press if they have little data about the

latest trends and developments across the region.

Bringing this about will require financial resources and political will. Most

associations, including the APVCA, will need more support and funding to

shoulder this responsibility. Kelvin Chan, of the Partner’s Group wants to set

up an Asia Private Equity Institute that will harmonise standards and valuation

methodologies across the region, as well as conduct studies about the industry.

With seven full-time staff, AVCAL in Australia is probably the best equipped

among the Asia Pacific associations. “Every association is always looking for

more funding,” says Dr. Woodthorpe, its chief executive. “But we manage,

and we have many professional practitioners who assist us. Our membership is

strong in supporting our work in more than just the purely financial way.” AVCAL

patterned its 2006 study on the impact of private equity in Australia on research

by the British Private Equity and Venture Capital Association. “At the moment,

we are trying to make sure that our research is as rigorous as possible,” says

Dr. Woodthorpe. “Then we’d certainly be looking at how we can enable others

[in Asia Pacific] to carry out surveys with similar questions so they can all be

correlated.”

Jamie Paton, former chairman of the Hong Kong Venture Capital and Private

Equity Association and currently a member of its executive committee, says “We

have appointed this year a PR firm to be involved with the association. In addition

we are holding a conference around the theme of what the industry is doing

for companies and the added value being put in to try and counter people being

negative about the industry.” Paton agrees that PE firms need to be more media

savvy. “But there are other people in our industry, and we should be hearing

from them too. We all have a responsibility to spread the positive impact our

industry has on economies,” he says, pointing to investment bankers, lawyers,

accountants, limited partners and pension funds.

KPMG member firms are responding with this study, the findings of which we

believe put the private equity industry in better perspective. In Asia, as in the

rest of the world, private equity companies must communicate to the media and

the public what they already know: that what they are and what they do, while

pragmatic, can ultimately drive efficiency and prosperity. By providing options

in the financing and nurturing of businesses, private equity companies advance

both their own interests and those of the larger community.



Asia Pacific PE Group Leadership

david Nott

Tel: +61 (2) 9335 8265

e-Mail: [email protected]

Australia

Jonathan dunlop

Tel: +61 (2) 9335 7633


China and Hong Kong SAR

Honson to

Tel: +86 (21) 2212 2708


India

vikram utamsingh

Tel: +91 (22) 3983 5302


Indonesia

david east

Tel: +62 (21) 574 0877


Japan

Masami Hashimoto

Tel: +81 (3) 5218 8815


Korea

edward Kim

Tel: +82 (2) 2112 0770


Malaysia

Hock eng Lim

Tel: +60 (3) 2095 3388


For more information on KpMG’s private equity Group in asia pacific, contact:

Asia Pacific Regional Coordinator

robert stoneley

Tel: +852 3121 9850

e-Mail: robert.stoneley @kpmg.com.hk

New Zealand

ian thursfield

Tel: +64 (9) 367 5858


Philippines

vicente J. sarza

Tel +63 (2) 885 7000 ext: 220


Singapore

diana Koh

Tel: +65 6213 2519


Taiwan

Jay Cheng

Tel: +886 (2) 2715 9716


Thailand

tanate Kasemsarn

Tel: +66 (2) 677 2750


Vietnam

rupert Chamberlain

+84 (8) 946 1600

[email protected]





The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation.

© 2007 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved. Printed in Hong Kong.

KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative.

Publication date: November 2007

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