Private equity firms based in Asia-Pacific are the most optimistic about deal activity in 2015, according to the fourth edition of the Grant Thornton Private Equity Report, an annual survey of 175 senior industry practitioners around the world.

 

Of those surveyed, 68% of firms in the region expect an increase in the number of deals in the next 12 months, up from 46% in the previous year. Asia-Pacific recorded the biggest change in sentiment when compared with Europe and North America.

 

One reason for higher expectations is exit activity, which is expected to increase in the coming year. Two-thirds (66%) of the firms surveyed around the globe said they expect anticipate exit activity to increase, up from 64% in the previous year. This will largely be driven by higher valuations, more interest in initial public offerings and a positive macro-economic environment. At the same time, firms are seen to buy rather than sell assets as they anticipate a strong recovery in the global economy.

 

“We have China to thank for much of the optimism in the region. Its macro economy has been on an upswing over the past year and the significant growth in industries such as technology, media and telecommunications (TMT), energy and healthcare has led to the strong performance in the private equity markets both in China and Hong Kong,” said Barry Tong, advisory partner at Grant Thornton Hong Kong.

 

“However, as the competition heats up for private equity deals in this region, the real challenge for buyers lies in finding quality deals at good prices in face of increasing competition.”

 

Meanwhile, firms expect average returns and entry multiples in the coming year to remain positive, while transactions in the secondary market will become more prevalent among private equity firms, according to the study.

 

Globally, 79% of private equity firms say they are either “influential” or “very influential” when it comes to how much sway they have over deal prices. A majority of firms surveyed said they were willing to pay a premium for deals. In China and Hong Kong, for example, 86% of private equity firms said they were willing to pay a premium for businesses acquired through the secondary market. “Growth potential” is most often cited as the key factor for paying a premium, according to the study.

 

More than half, or 56%, of private equity firms identify themselves as “growth investors” rather than “value investors”, in a reflection of the increasingly competitive landscape they operate in. In China, 40% of the firms surveyed said they were “growth” investors, while 20% said they were “value investors.” Another 40% said they were a combination of both.

“When selecting a company to invest in, there is a variety of factors to take into consideration but the important questions to ask are ‘which is the right company?’, ‘what is the right price?’ and ‘when is the right time to buy?’” said Eugene Ha, advisory partner at Grant Thornton. “It is also important to note that Asian companies value the opportunity to work with professionals who can ensure the growth of the business rather than sell out to the highest bidder.”

 

The study further shows that deals in secondary market have grown in importance as a source of private equity transactions globally. More than two-thirds, or 68%, of respondents believe the number of these deals will increase in 2015, and 39% of respondents view secondary deals as one of the most important categories of deals, ranking second to family or privately owned businesses.

 

“Historically, Chinese private equity firms have shown a preference for the IPO exit approach, but on the heels of the cooling IPO markets in China and Hong Kong last year, firms turned to channels like secondary transactions as well with increasing maturity of the PE market,” Tong said. “Another factor driving this trend is the view that businesses bought through secondaries are lower-risk assets with better governance, and on top of that are led by management teams that understand how private equity works.”

 

However, acquiring companies through secondary transactions does not come cheap. Fifty-eight percent of firms globally and 86% in China and Hong Kong have a preconception that private equity firms pay higher multiples for businesses acquired via secondary transactions.

 

Even though deals remain a key driver of recovering returns on an investment, the study shows that business performance, while being held in a portfolio, plays an important role as well. Two-thirds of private equity firms surveyed highlight the importance of an improvement in a portfolio company’s performance, while only 2% highlight arbitrage as a key driver of value.  The significance of mergers and acquisitions as a growth driver has fallen, reflecting a shift in focus to organic growth and the realization of high valuations.

 

Firms are most likely to walk away from a deal after due diligence because of management issues, high valuations and a lower-than-expected growth outlook, according to the study.

 

“Much of what defines a good company comes down to the effectiveness of the management team,” Ha explained. “In a competitive environment, being able to accurately assess management’s ability to implement the post-acquisition plan is a vital part of investment decision making.”

 

Globally, the study identifies increased competition and pricing as key issues for private equity firms in the coming year. The markets in China and Hong Kong are also likely to face regulatory challenges.

 

“That said, the growing number of investment and sector-specific opportunities in the region, coupled with higher disposable incomes and an increased level of consumerism in Asia-Pacific, will offset these potential hurdles,” said Tong.

 

“Within the wider region, private equity deals will see strong growth in emerging economies in Southeast Asia, where global investors are now willing to commit greater sums, particularly across industries like construction, infrastructure, and food and beverage, to tap into the region’s fast economic growth,” he added.