Wilson Wong For The Straits Times

When private equity firms go on the prowl

-- ST ILLUSTRATION: MIEL
-- ST ILLUSTRATION: MIEL

Private equity investments have more than doubled in the first half of the year. PE firms offer local companies capital and expertise to expand their operations but the attention comes at a price.

Singapore's usually staid business landscape has been roused by a series of mergers and acquisitions (M&As) in recent years.

These range from the hotly contested $13.8 billion takeover of Fraser & Neave last year to the recently proposed $1.4 billion buyout of packaging materials supplier Goodpack by leading private equity firm KKR.

The total value of M&As in Singapore has risen significantly over the past few years, more than doubling from US$11.9 billion (about S$15 billion) in 2011 to US$28.1 billion last year.

Fuelled by the ready availability of cheap financing, this M&A trend shows no sign of abating.

Amid ultra-low borrowing costs, tighter anti-trust regulations and declining investment returns in the West, companies are looking to Asia in their search for better growth and profitability.

Hence, firms in politically stable and economically prosperous Singapore - particularly those with considerable local brand equity - have become prime targets.

Some of the keenest acquirers are private equity (PE) funds, whose emergence on the Singapore M&A scene has the potential to significantly alter the corporate landscape.

New players

PE FIRMS have had a limited presence in Singapore since the early 1990s. But they have recently ramped up their activities, as some of the biggest players in the industry open offices here to scout for investment targets in South-east Asia, including Singapore.

For example, KKR opened a Singapore office in 2012 and Blackstone did so last year.

Their modus operandi is to raise funds from third-party investors and use the money, along with a heap of debt, to secure controlling stakes in targeted firms.

They then try to quickly turn around the companies' operations before reselling them or listing them in a few years' time, usually for a significant profit.

PE firms also often use acquired companies as springboards for further purchases. They acquire companies with relatively low debt and strong cash flows, use these companies' cash and assets to settle existing debts, then load up the acquired firms with even more debt and use them as vehicles to acquire other firms.

As of now, PE investment still accounts for only a small proportion of the total M&A market in Singapore - about 2.4 per cent in the first half of this year. But in the past year, PE investment in Singapore has risen considerably. It has more than doubled to US$442 million in the first half of this year, from US$182 million in the same period last year.

In Singapore, L Capital Asia - LVMH Moet Hennessy Louis Vuitton's Asian PE arm - is among the most active players. It acquired controlling stakes in upscale club Ku De Ta and restaurant chain Crystal Jade in the last few months, after investing in Singapore footwear fashion label Charles & Keith in 2011. L Capital Asia has indicated its intention to embark on further acquisitions. It is likely to harbour intentions of creating a major lifestyle enterprise with overlapping interests in dining, entertainment and shopping.

Growth benefits

SO FAR, the deals between PE firms and their Singapore targets have been mostly mutually beneficial. Many Singapore business owners seem willing to divest their shareholdings when presented with sufficiently attractive offers. Like Crystal Jade founder Ip Yiu Tung, they often cite their inability to find a suitable successor to continue growing the business.

PE firms can step in with their corporate connections, management expertise and financial strength to develop the brand names of their targets and expand their global footprint.

For instance, L Capital Asia's partial acquisition of Charles & Keith, and its subsequent financial infusion into the firm, has enabled the footwear label to grow from 229 stores in 2011 to nearly 400 boutiques today.

Charles & Keith has also been able to tap on the global branding expertise of LVMH, which owns major brands such as Dior, Givenchy and Louis Vuitton.

Charles & Keith staff were coached by LVMH trainers in marketing and visual branding techniques, boosting their in-store display concepts and marketing campaigns.

Similarly, the 2008 acquisition of Singapore industrial footwear manufacturer King's Safetywear (KSW) by PE firm Navis Capital Partners allowed the firm to rapidly expand its market presence to Australia, India and Korea by 2010.

Had these Singapore firms relied only on traditional organic growth strategies, it is unlikely they would have acquired the capital, cachet and expertise needed to grow at this rapid pace.

For their part, PE firms have also benefited immensely from these investments. After Navis acquired KSW for $97.1 million in 2008, it managed to sell the firm to Honeywell International for $430 million three years later.

Pitfalls

BUT the increasing presence of PE firms in Singapore's corporate landscape may eventually have a downside.

Many PE investors exhibit an intense desire to maximise their return on investment and implement an "exit strategy" - namely reselling their acquired companies - within three to five years of buying them. This strategy is inimical to the long-term growth strategies of most corporations.

Some PE firms also implement aggressive cost-cutting steps, often resulting in large layoffs and lower investment in research and development, while others simply use the assets of acquired firms - known as "cash cows" - to fund further acquisitions.

The recent financial collapse of Energy Future Holdings, which was acquired by KKR, TPG Capital and Goldman Sachs Capital Partners for US$48 billion in 2007, is a searing reminder of the considerable risks involved in accepting PE investment.

The deal loaded Energy Future with over US$40 billion of debt, just before a sharp decline in natural gas prices made the company's coal-fired power plants uncompetitive. Buried in financial woes exacerbated by its crippling debt burden, the firm sought bankruptcy protection in April.

Such risky mega deals are not envisaged in Singapore for the time being, given the relative smallness of our domestic market and the fact that Singapore is a newcomer to the PE scene.

Given the relatively new presence of PE players in Singapore, it may also take some time to effectively evaluate the post-acquisition performance of their acquired firms.

Nonetheless, amid expectations for M&A activity to remain vibrant over the next two years, Singapore businessmen should note the potential risks in accepting PE investment and weigh them against the rosy promises of meteoric expansion in a few short years.

The writer, a senior lecturer at SIM University, has worked as an analyst and consultant in the global automotive and financial services industries.

stopinion@sph.com.sg