July 6, 2015
Interviewed by: David Snow
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Indonesia’s Value Proposition

With a population of more than 200 million and an underdeveloped infrastructure, Indonesia is an attractive opportunity, according to experts from FLAG Capital Management, Headland Capital Partners, and EY.

With a population of more than 200 million and an underdeveloped infrastructure, Indonesia is an attractive opportunity, according to experts from FLAG Capital Management, Headland Capital Partners, and EY.

Indonesia’s Value Proposition
Investing in Southeast Asia

David Snow, Privcap: We’re talking about private equity in Southeast Asia. It is a very large region. There’s a lot of different economies and cultures there. But let’s focus on one very large economy, Indonesia, which has seen its private equity market develop along with many other aspects of its economy. Paul, your firm, Headland, has done several investments in Indonesia. Can you paint for us a picture of what are the most important features about Indonesia that make it a distinct private equity opportunity?

Paul Kang, Headland Capital Partners: If you look at the macro drivers, it’s over 200 million population and it’s the largest core—if you like—of the Asian region. The population is relatively young and infrastructure is somewhat underdeveloped. Again, all of those elements would tend to lead to the proposition that inward investment should be able to earn a pretty good return. So, from a 30,000-foot perspective, I think those are the opportunities.

The issue is that you’ve now got actually a lot of liquidity within the private equity market. Debt capital is expensive, but it is a competitor in respect of actually funding a lot of the expansion opportunities out there. Then, on the other hand, you’ve probably got a corporate governance structure that has come a long way but is probably lagging behind the more advanced parts of the Asian region—Singapore and Malaysia, as examples. I think those are the pros and cons—high valuations, weaker corporate governance. But you’ve got very good, positive drivers in respect of growth.

Snow: Wen, your firm invests around the world and also around Southeast Asia. What’s distinct about the GPs you’re backing and the way they’re doing business in Indonesia?

Wen Tan, FLAG Capital Management: Just setting the scene there actually, the important thing to bear in mind about Indonesia is that, unlike many of the other markets within the region, there’s a very shallow pool of investable GPs. This, from a LP perspective, does actually make it attractive given the relative lack of competition. Having said that, if you look at the themes and the approaches GPs have used to generate returns, I think one of the exciting things—coming back to Paul’s comment on the opportunity set—is that, in Indonesia, market leaders in various segments have yet to emerge. And I think that’s part of the play there, to be able to back one of the multiple players to become one of the end-market leaders. Certainly, the opportunity set is quite substantial.

Snow: Mike, as someone who’s a student of private equity developing in different emerging markets, what are some important milestones you look for in a private equity industry as it develops? And what does that say about the state of Indonesia?

Michael Rogers, EY: I think the interesting thing that private equity looks at when they see Indonesia is something—as Paul mentioned—that I think is close to 250 million people and population which is a huge market, for one. Secondly, I think they’ve developed some expertise in the consumer-product space, and the food and beverage arena is something they’re known for and has been an attractive entrance point for a lot of private equity into that market. Also, geographically, it’s very strategically positioned in the market there as well and they’re known to be good traders, international traders. Those are concepts or ideas that private equity looks for. Because one thing they do like to do is (not only when they buy entities, of course) to invest in their home country, but also have the interest to grow that geographic footprint. And I think that folks in Indonesia are known for having that skill set and that trading mindset.

Snow: What are the most important sectors that you think hold promise for private equity investors in Indonesia?

Kang: FMCG, education, healthcare—we think these are some of the sectors where you’ll see above-average growth over the next few years and which could represent interesting opportunities.

Snow: Without sounding like I’m shilling for the private equity asset class, it is the case that many of these sectors you mention, tied to the consumer, are not necessarily reflected in the stock market? So an investor couldn’t necessarily say, “I would like to capture the growth of the rising consumer in Indonesia. I’ll just buy an index fund on the local stock exchange.” Do you agree with that, Wen?

Tan: I think there is certainly truth in that. It’s less pronounced in Southeast Asia than, for example, in China, where (just because of the structural nature of the Chinese market) it’s overwhelmingly SOEs, utilities, financial services, etc. [It’s] very underweighted in terms of consumer and that’s actually pushed up the valuations of the listed consumer companies. In Southeast Asia, it is an issue. It’s not quite as pronounced, but certainly if you look at the public markets, there is a significant exposure to what we would call the GLC (government-linked companies) in Singapore and Malaysia, as well as some of the publicly-owned utilities across the region.

Snow: Indonesia is known, among other things, for having a robust energy sector. Are there any opportunities for private equity investors in Indonesia’s energy sector?

Kang: I think the energy sector within Indonesia has some interesting dynamics. But if you layer in the fact that there are ownership restrictions and that it tends to be quite a politically linked, that would be something that a firm like us at Headland Capital would try and steer clear of.

Snow: What does it say about the Indonesian opportunity that there are so few backable GP groups in Indonesia? Why is that the case? Is it simply not enough time to mature? Or are there structural issues that prevent the formation of new, credible GPs?

Tan: Sure. I think, to a large extent, it’s a chickenandegg situation. There are obviously significant opportunities within the Indonesian private equity set. However, from most LP’s point of view, you wouldn’t necessarily back a new startup manager. That manager needs to have a verifiable track record within an Indonesia context. So, really, the LP community is dependent to some extent on spinouts or individuals or subteams out of some of the more established, either local Indonesian GPs orpan-regional GP’s Indonesia teams. And we’ll begin to see a bit of that, but the pace at which that’s occurring is relatively slow.

Rogers: Paul, you mentioned the healthcare side and that’s the first time we’ve talked about that today. With that size of population—and it’s a younger population, of course—what sort of trends are there in the healthcare space and what opportunities do you see in the future there?

Kang: We’re talking about Indonesia specifically, so I think healthcare—again, as a macro opportunity—is very interesting. But I think you’ve also got to put into context the fact that Indonesia is an economy that’s grown very quickly over the course of the last 10 years. And the healthcare space isn’t all that deep. So if you are looking for investable businesses of scale (and anyone and everyone has tried to look at that space for all the obvious reasons we’ve talked about), there aren’t that many opportunities. Those guys understand that they’re of interest to financial investors and value themselves accordingly. You layer on to that the fact that healthcare, again—and this is one of the issues within Indonesia—has some restrictions about foreign ownership. Then, you start to layer on some of the complexity about actually getting invested in Indonesia.

Snow: It sounds like the Indonesia regulatory regime does have some roadblocks left in place that make life a bit more challenging, at least for a non-domestic private equity investor.

Kang: It absolutely does. I think you’ve got certain restrictions in place, depending on the sectors in respect of the extent of foreign ownership that’s allowed. But even beyond that, the other issue that arises is the lack of clarity around some of those restrictions. Yes, if you were to go back seven or eight years ago, it would seem clear that foreign ownership of financial institutions was allowed. And three or four years back, that kind of situation all reversed, so anyone that had a controlling position in an Indonesian bank had to think about how to unwind that position. So the lack of clarity and volatility in the regulatory regime does create some issues. But, against that, you’ve got to bounce the macro positives that we’ve talked about as well.

Rogers: At EY, we’ve been focusing on emerging markets private equity for some time now and it really comes in three different buckets, if you will. What we like to do, of course, is support those funds that are in these markets directly that are growing and thriving and raising capital. There’s a whole suite of skills and support we can provide those funds.

Then, of course, we like to support the pan-regional funds as well. There’s more and more of those. We’re seeing those bucketed in Southeast Asia, in Latin America and in Eastern Europe. Some folks are just focused on those markets, so we will reach across borders and help those funds make—support those investments that might touch multiple jurisdictions, multiple countries.

Lastly, we try and follow our large global clients around the world. Even though some of these funds might be based in London or New York or San Francisco or Singapore, they might have an interest in doing deals in any market that we could name around the world. We would bring the firm’s full scope of resources to bear from a tax perspective, an advisory perspective and a transactions perspective. And ultimately, in many cases, we might provide the assurance relationship as well. It’s really our job to follow the footprint of our bigger clients, all the way down to the smallest local funds where we can add significant value.

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