Private equity funds bet on resilience – Opinion

Usman Akhtar and Soegeng Wibowo

Singapore / Jakarta ●
Wed, July 21, 2021

2021-07-21
01:25
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c78papa32e3af0945bdb46490a823808e
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equity market, COVID-19, Asia-Pacific, resilience, loan, NPL, finance
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The COVID-19 pandemic hit Southeast Asian economies in 2020 and prompted private investors to take shelter. The value of transactions fell 26% year-on-year and contracted 16% from the previous five-year average.

The value of the Indonesian accord in 2020 has fallen 40% from 2019 and 34% from the previous five-year average. In contrast, private equity investors took the value of deals in the Asia-Pacific region to a record $ 185 billion, up 19% from 2019, supported in particular by activity in China, the the only country in the Asia-Pacific region to avoid a decline in 2020 gross domestic product.

The COVID-19 disruption and the economic crisis of 2020 have sounded the alarm bells for investors. Many general partners discovered in the midst of the pandemic that their portfolios were not prepared enough to withstand and recover from sudden shocks. Adding to the dilemma, a decades-long fixation on efficacy has steadily increased the risk. And around the world, trade wars, falling oil prices and financial crises have hit many businesses harder than executives imagined possible.

As decades of relative global stability give way to a new, more turbulent era, major funds are revising their exposure to a range of risks and investing to increase the resilience of the companies in their portfolios. Bain & Company research shows that over 60% of general partners investing in the Asia-Pacific region say they are willing to invest at least 5% of a portfolio company’s short-term profits to build long-term resilience.

A few leading companies that were ahead of the trend highlight the difference resilience can make in dealing with external shocks. Indonesia’s PT BFI Finance, one of the country’s largest independent consumer credit companies, has weathered COVID-19 lockdowns better than many of its peers. The reason: A year earlier, the company’s management, backed by investors TPG Capital and Northstar, embarked on a plan to strengthen the company’s strategic and organizational resilience.

One particularly effective measure improved loan recovery by using a call center collection agency to complement the efforts of field collectors. These “telecollectors” helped the financial group quickly contact creditors who were at risk of default and, in some cases, avoid nonperforming loans. During pandemic shutdowns, the remote collection strategy offered a safe and vital alternative to in-person collection, allowing the company to minimize faults.

Despite widespread economic disruption caused by the lockdowns, the group’s non-performing loans declined during the pandemic. In September 2020, NPLs decreased to 2.7% of total financial assets, down from 3.7% in June and significantly below the market average of 5.2%.

However, many businesses have been caught off guard by COVID-19. The majority of general partners we surveyed (58%) say their portfolios have shown little or no real resiliency during the COVID-19 shock. A third declares that they do not have specific tools to assess the resilience of a target. Almost a third say their portfolio companies are still in the experimental or even earlier stages of integrating resilience capabilities into their strategy and operations.

By their nature, risks are moving targets, so building resilience requires long-term effort and focus. But the benefits are significant: Improving a business’s resilience can almost double its chances of survival and improve profitability over time. Many business leaders make the mistake of assuming that resilience is about building the bottom line. They focus on leverage and liquidity risks, but ignore other potential sources of fragility.

Successful leadership teams take a holistic view of resilience. This means identifying each type of external event that can affect the business. They also take into account simultaneous events across multiple channels that could exacerbate the extent of a shock. A broader and more holistic view of risk and resilience enables management teams to make smarter choices about where to invest limited resources to protect the business from future shocks.

In fact, resilience covers five dimensions: strategic, financial, operational, technological and organizational. Strategic resilience, for example, includes income and profit diversification, relative market share, and elasticity of demand. Operational resilience includes vendor concentration and redundancy.

Companies may be able to address some risk factors quickly and inexpensively, but an effective approach to building resilience typically requires investment and an opportunity cost. The key is to find the right balance between managing risk and creating value. Leaders start by analyzing their exposure. They determine the level of stress the business can absorb and the fund’s willingness to trade short-term profitability for long-term resilience.

GPs in Asia Pacific cite three areas of portfolio risk that are of greatest concern to them: competitive position, balance sheet risk, and organizational agility. Addressing these risks may require more investment. The General Partners believe that other categories of risk, such as portfolio concentration, operational leverage and cybersecurity, are less difficult to manage.

Resilience is a strategic issue. Investors and senior executives need to be involved, as decisions to build resilience involve tough choices. Baring Private Equity Asia has helped HCP Packaging Group, a global leader in the design and manufacture of cosmetics and skin care products, strengthen its resilience by supporting a plan to add new production sites and diversify its customer base . These measures made a big difference when the US-China trade war hit global supply chains and when COVID-19 struck.

HCP began investing in 2018 to expand its international industrial footprint beyond China and North America, with production acquisitions in France and Germany. When the Sino-US trade war broke out, HCP quickly transferred some of its Chinese production to other countries. Likewise, in the early days of COVID-19 lockdowns, HCP was able to make the most of its expanded manufacturing footprint and supply chain flexibility, outperforming the competition.

Leading fund managers and leadership teams looking to build resilience make sure they tackle stocks with no regrets first – those that have minimal impact on profitability. But they also understand that significant risk reduction involves investment and opportunity costs.

Developing the right level and type of resilience for a portfolio company requires a combination of short-term actions and a long-term vision and alignment with the leadership team.

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Usman Akhtar and Soegeng Wibowo are Bain & Company partners based in Singapore and Jakarta respectively.

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