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Private Equity:Implications for Economic Growth inAsia Pacific
advisory
private equity
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Excessive leverage
Lack of transparency
Potential conflicts of interest
Tax leakage
Negative impact on employment
Other issues
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30Case studies
Little Sheep in China
Austar in Australia
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Contents
2007 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMGInternational provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis--vis third parties, nor does KPMGInternational have any such authority to obligate or bind any member firm. All rights reserved.
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The lure of Asia Pacific for private equity houses has increased dramatically overthe 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 n ew 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 USD138.5 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
2007 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMGInternational provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis--vis third parties, nor does KPMGInternational have any such authority to obligate or bind any member firm. All rights reserved.
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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 equitys 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 Nott
Regional Leader
KPMG's Private Equity Group
Private Equity: Implications for Economic Growth in Asia Pacific 3
2007 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMGInternational provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis--vis third parties, nor does KPMGInternational have any such authority to obligate or bind any member firm. All r ights reserved.
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In March 2007, KPMG member firms in Asia Pacific commissioned a survey of119 private equity funds across the region. The following are the key findings:
Generalist, venture and growth capital are likely to remain as private equitys 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
companys assets (10 percent). The vast majority of those polled describe their fund as
generalist, meaning it invests in all stages of a companys 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
Private Equity: Implications for Economic Growth in Asia Pacific4
2007 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMGInternational provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis--vis third parties, nor does KPMGInternational have any such authority to obligate or bind any member firm. All rights reserved.
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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 globalplayers.
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
2007 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMGInternational provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis--vis third parties, nor does KPMGInternational have any such authority to obligate or bind any member firm. All r ights reserved.
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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 Pacifics 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
nInvestment Executive
n Fundraising/Investor Relations
65%
3%
13%
19%
n Greater China
nOceania
n Southeast Asia
Respondent Location
29%
10%
11%
13%
19%18%
n Rest of World
n India/Pakistan
n Japan/Korea
China
India
Australia
Singapore
Taiwan
Korea
Japan
Malaysia
New Zealand
ThailandIndonesia
Vietnam
Philippines
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
2007 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMGInternational provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis--vis third parties, nor does KPMGInternational have any such authority to obligate or bind any member firm. All rights reserved.
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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 funds money, in accordance with the focus defined in the funds 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 inpotential 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 r ise
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
2007 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMGInternational provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis--vis third parties, nor does KPMGInternational have any such authority to obligate or bind any member firm. All r ights reserved.
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exhb 1
Value, 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 regions 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.
Valueofdealsandfundsraised,
USDbn
Volumeofdeals
Private Equity: Implications for Economic Growth in Asia Pacific8
2007 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMGInternational provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis--vis third parties, nor does KPMGInternational have any such authority to obligate or bind any member firm. All rights reserved.
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exhb 2
How 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
nDecrease
n Stay the same
83%
15%
2%
exhb 3
What are your key reasons to invest in Asia Pacific?
Source: KPMG survey of 119 private equity firms in Asia Pacific, 2007
Economic growth
Pricing
Dealflow/Investment opportunities
Demographics
Less competition
Market size
Quality of management/entrepreneurs
Local knowledge/networks
Skilled workforce
Market inefficencies
Stability
Sophisticated capital markets
Technology
Regulation
Labour costs
Exit opportunities
Manufacturing capabilities
Debt 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%
Mk f chcThe 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).
Private Equity: Implications for Economic Growth in Asia Pacific 9
2007 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMGInternational provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis--vis third parties, nor does KPMGInternational have any such authority to obligate or bind any member firm. All r ights reserved.
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exhb 5
What will the geographical focus of your next fund be?
Source: KPMG survey of 119 private equity firms in Asia Pacific, 2007
n Pan-regional
nSingle 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).
exhb 4
Which 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 Asias 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.
Private Equity: Implications for Economic Growth in Asia Pacific0
2007 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMGInternational provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis--vis third parties, nor does KPMGInternational have any such authority to obligate or bind any member firm. All rights reserved.
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exhb 7
Average deal size in selected industries
Source: Asian Venture Capital Journal database
350
300
250
200
150
100
50
0AverageDealSizeUSDmillion
2002
tg c
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).
exhb 6
Top private equity investment by value, USD million, with
volume of deals in brackets2002 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
Private Equity: Implications for Economic Growth in Asia Pacific 11
2007 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMGInternational provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis--vis third parties, nor does KPMGInternational have any such authority to obligate or bind any member firm. All r ights reserved.
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exhb 8
In 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.
ex gAccording 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.
Private Equity: Implications for Economic Growth in Asia Pacific2
2007 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMGInternational provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis--vis third parties, nor does KPMGInternational have any such authority to obligate or bind any member firm. All rights reserved.
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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.
exhb 9
How do you exit your investments today, in two years, and in five years?
Source: KPMG survey of 119 private equity firms in Asia Pacific, 2007
60%
50%
40%
30%
20%
10%
0%
52%
n Now n2 years n5 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 inprivate 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.
Private Equity: Implications for Economic Growth in Asia Pacific 13
2007 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMGInternational provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis--vis third parties, nor does KPMGInternational have any such authority to obligate or bind any member firm. All r ights reserved.
2007 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMGInternational provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis--vis third parties, nor does KPMGInternational have any such authority to obligate or bind any member firm. All r ights reserved.
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Criticisms of
private equityand regulatoryresponsesThe 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 Moodys 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. Moodys 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
transactions 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 ServicesAuthority 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 foralleged 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.
10Rating Private Equity Transactions, special comment by Moodys Investors Service, July 2007.
11Public Scorn for Private Equity, in BusinessWeek, 4 December 2006.
Private Equity: Implications for Economic Growth in Asia Pacific4
2007 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMGInternational provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis--vis third parties, nor does KPMGInternational have any such authority to obligate or bind any member firm. All rights reserved.
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exc lgThere 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 topay 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 Australias Qantas
Airways, a deal which fell apart despite the airlines 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, weve 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 Poors
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 & Poors, July
2007)
Favourable financing structures
particularly covenant-lite financing
arrangements which lacked the
protective covenants that subject theborrower 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 banks capital markets
arm with the understanding that the
buyout firms would find investors to
take over the banks stake after the
deal closed.
exhb 10
Sources of new debt in the next two years
Source: KPMG survey of 119 private equity firms in Asia Pacific, 2007
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
12Top PE Buyouts in Asia, 1H07, report by Thomson Financial, 7 July 2007.
13KPMG 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.
14Financial Stability Review, report by the Reserve Bank of Australia, March 2007.
15KPMG interview with Chris Rowlands, Managing Partner Asia, 3i, 13 July 2007.
Private Equity: Implications for Economic Growth in Asia Pacific 1
2007 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMGInternational provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis--vis third parties, nor does KPMGInternational have any such authority to obligate or bind any member firm. All r ights reserved.
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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 Asias 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.
exhb 11
Types of private equity funds
Source: KPMG survey of 119 private equity firms in Asia Pacific, 2007
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 Pacifics 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 companys 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 Pacific
2007 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMGInternational provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis--vis third parties, nor does KPMGInternational have any such authority to obligate or bind any member firm. All rights reserved.
2007 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMGInternational provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis--vis third parties, nor does KPMGInternational have any such authority to obligate or bind any member firm. All rights reserved.
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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, 3is 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 billionas 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 Moodys report, leveraged buyouts accounted
for 18 percent of new high-yield issuances in the beginning of 2007, comparedwith 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
exhb 12
Do you buy public companies to turn them private (P2P)?
Source: KPMG survey of 119 private equity firms in Asia Pacific, 2007
n Yes
n No, but would consider it
n No, and would not consider it
39%
47%
14%
16Private equity: a discussion of risk and regulatory environment, Financial Services Authority discussion paper, June 2006.
17Testimony of Douglas Lowenstein, President of the Private Equity Council, before the House Financial Services Committee of the US Congress,
16 May 2007.
Private Equity: Implications for Economic Growth in Asia Pacific 1
2007 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMGInternational provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis--vis third parties, nor does KPMGInternational have any such authority to obligate or bind any member firm. All r ights reserved.
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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
Frances 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 couldnt 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 its 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.
18JPMorgan, 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, Chryslers European parent, to lend Cerberus part of
the money needed to complete the deal.
19PE Week Wire, 27 July 2007.
20Ratings Direct Report, Standard & Poors, July 2007
Private Equity: Implications for Economic Growth in Asia Pacific8
2007 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMGInternational provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis--vis third parties, nor does KPMGInternational have any such authority to obligate or bind any member firm. All rights reserved.
2007 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMGInternational provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis--vis third parties, nor does KPMGInternational have any such authority to obligate or bind any member firm. All rights reserved.
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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 UKs 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.
Austral ia The Counci l 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 councils 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 Asias 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.
21Private equity: a discussion of risk and regulatory environment, Financial Services Authority discussion paper, June 2006.
22Issue affects non-PE backed companies in the same way, British Private Equity and Venture Capital Association submission to the Treasury Select Committee, May 2007.
23Statement of Andrew L. Stern, President of the Service Employees International Union, to the US House of Representatives Committee on Financial Services, 16 May 2007.
24Testimony 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.
25March 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 b usiness leverage that is currently
underway has some way to run. Given this, together with the potential implications of LBO activity for the d epth 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.
Private Equity: Implications for Economic Growth in Asia Pacific 19
2007 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMGInternational provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis--vis third parties, nor does KPMGInternational have any such authority to obligate or bind any member firm. All r ights reserved.
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Lck f nncThe 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, AndrewStern, 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 doesnt, hes unprofessional. The limited partner gets all the
information he needs from the general partner, if he wants it. If he doesnt 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. Its 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.
Its 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 equitys 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.
26Testimony of Andrew Stern, President of the Service Employees International Union, before the House Financial Services Committee of the US
Congress, 16 May 2007.
27Disclosure and Transparency in Private Equity, a consultative document by the Walker Working Group, July 2007.
Private Equity: Implications for Economic Growth in Asia Pacific20
2007 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMGInternational provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis--vis third parties, nor does KPMGInternational have any such authority to obligate or bind any member firm. All rights reserved.
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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
Accusation Country Regulatory/legislative opinion and industry response
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.
28KPMG interview with Katherine Woodthorpe, Chief Executive of the Australian Private Equity & Venture Capital Association (AVCAL), 23 July 2007.
29Private 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 be come listed partnerships introduced by Senator
Max Baucus and Senator Charles E. Grassley on 14 June 2007.
Private Equity: Implications for Economic Growth in Asia Pacific 21
2007 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMGInternational provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis--vis third parties, nor does KPMGInternational have any such authority to obligate or bind any member firm. All r ights reserved.
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pnl cnflc f nThe 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). Whileno 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.
Accusation Country Regulatory/legislative opinion and industry response
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
Austral ia 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
tx lkgA 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
30British Venture Capital Association
31Private Equity in Australia, submission by the Australian Private Equity & Venture Capital Association (AVCAL) to the Senate Standing
Committee on Economics, 10 May 2007.
32Private Equity and Carried Interest HR 2834, position paper by the Private Equity Council, 2007.
Private Equity: Implications for Economic Growth in Asia Pacific22
2007 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMGInternational provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis--vis third parties, nor does KPMGInternational have any such authority to obligate or bind any member firm. All rights reserved.
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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 Shinseitax 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.
Private Equity: Implications for Economic Growth in Asia Pacific 23
2007 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMGInternational provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis--vis third parties, nor does KPMGInternational have any such authority to obligate or bind any member firm. All r ights reserved.
2007 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMGInternational provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis--vis third parties, nor does KPMGInternational have any such authority to obligate or bind any member firm. All rights reserved.
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Accusation Country Regulatory/legislative opinion and industry response
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 isavailable to all UK companies; only arms 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.
Austral ia 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
Private Equity: Implications for Economic Growth in Asia Pacific24
2007 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMGInternational provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis--vis third parties, nor does KPMGInternational have any such authority to obligate or bind any member firm. All rights reserved.
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Accusation Country Regulatory/legislative opinion and industry response
tx lkg
(cnn)
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 overseasdirect 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 p