Investing in Asia: Why Challenging Does Not Mean Impossible

Investing in Challenging Markets like Asia

The global economy is tied in large part to growth in Asia, where nearly two-thirds of the world lives. But picking the right investments in that often volatile, multifaceted region can be unusually challenging for capitalists more used to a Western business model. However, challenging doesn’t have to mean impossible.

Ravi Chidambaram, president and cofounder of Asian boutique investment bank TC Capital, uses what he calls a “book value” strategy to invest in more opaque markets like Asia. He spoke on the Knowledge@Wharton show on Wharton Business Radio, which airs on SiriusXM channel 111.

An edited transcript of the interview appears below.

Knowledge@Wharton: Ravi, explain what it is that TC Capital does, and what you look for specifically within the Asian market.

Chidambaram: We’re a full-service investment bank, so we do have an investment arm, but we also have a capital market and M&A arm, so we really see Asia from a 360-degree perspective, from a financial services point of view. Investing in Asia is really difficult. If you go all the way across the chain from sourcing deals through to executing deals at reasonable valuations to managing your portfolio to exit, it’s very, very difficult compared to the U.S. or Europe.

Let’s just take each piece of the chain. If you take sourcing deals, frankly, in Asia, it’s very hard to find deals. If you’re in the buyout business, it’s very hard to find entrepreneurs and families who are willing to let go of their businesses. Generally, it’s not considered good practice to broadcast that companies are for sale. There are usually no formal sale processes. It’s very hard to unlock deals from a buyout point of view.

Knowledge@Wharton: Hard to find them, even?

Chidambaram: Very hard to find. Harder to unlock, and when you do, you might find that four or five others are circling around the same deal. On the venture capital side, the real problem is it’s hard to find enough of a critical mass of startups that are investment-worthy. That’s the real problem. You will, from time to time, in some select areas, but nothing compared to the intensity you’d find here. There’s no ecosystem for that, so it’s a lot more ad hoc. So that end of the chain is hard.

“Investing in Asia is really difficult. … It’s very, very difficult compared to the U.S. or Europe.”

Knowledge@Wharton: Is that level of entrepreneurship not being cultivated enough in Asia?

Chidambaram: It’s not structured. I think as a venture capitalist, you are willing to invest in exciting startups and add some structure to it, but in Asia, to be honest, a lot of what’s being done is probably not even investment-worthy in the venture capital stage. It just takes a lot more work to get it to that stage.

Knowledge@Wharton: Then how do you try and grow that out?

Chidambaram: That’s right. We’re taking a slightly more radical approach, we call it the “book value” approach. Instead of investing in existing companies, we actually are creating our own. What we do is, we get together with a group of managers who are qualified and capable to run a certain business, we back them with money, we back them with our network, and we try to get the business off the ground that way. For example, we started a data analytics business where we’re collecting a lot of data on private companies operating in Asia, because as you know, information in Asia, it’s hard to come by.

And you know, the information is opaque, often incorrect and hard to make sense of. So a good data analytics business, I think, has a high demand in Asia. Now that’s a business that you’ll be hard pressed to find in the market, so we just created one from scratch with a management team that had worked for some of the big database companies, and had a lot of knowledge, had some technical capabilities, and we just put it together. That is doing very, very well.

We’re doing something very similar in the infrastructure area in renewable energy in Indonesia where, again, we’re backing a team that’s capable of sourcing and executing various small wind and solar projects. This is the approach we’re increasingly taking because coming in at book value with a good team, you have no competition. It takes much longer to build, but it’s far more rewarding. I think you’re going to find more and more private equity funds and VCs switching to this model or some version of this model.

Knowledge@Wharton: For each Asian country, probably certain areas need to be developed out more so than others. Needs in Singapore, for example, may be totally different than in Indonesia.

Chidambaram: Absolutely. The biggest demand will be in the biggest emerging markets, which are probably the least developed. So in our region — Southeast Asia — Indonesia is that market. Vietnam is probably the other market. We’re active in both countries, and in both, we see a lot of potential in almost every area of the economy. But good luck finding entrepreneurs or established businesses that are handling that very, very well.

Knowledge@Wharton: China has had an incredible growth rate for quite some time, and now that it’s dipping down, it’s almost like the global economy is walking on hot coals. Are the concerns valid where China is concerned in terms of its economy, or is this a bit of a new normal for them?

Chidambaram: I think it’s a little bit overdone. Personally, I still think there are a lot of great opportunities in China. In my opinion, some sectors suffer from overcapacity and overinvestment, and there will be a natural slowdown and rationalization in manufacturing, especially low-end manufacturing. Tech may be reaching that stage, to be honest. I think there’s just too much money at ridiculous valuations going into the sector.

I’m not sure there’s enough of a revenue model to back that up, but take a sector like financial services — which is my area. We are looking actively at the book value model for that, in terms of getting some businesses started from scratch with Chinese partners, because that’s a sector that a) is a relatively unregulated sector, which means it will become more regulated in the future; b) has tremendous potential in terms of the model, because so many things don’t work at all or they don’t exist.

“We call it the ‘book value’ approach. Instead of investing in existing companies, we actually are creating our own.”

There is no asset management business in China. There’s no proper investment banking business in China. A lot of the things we take for granted here — compliance, back office, all that kind of stuff — does not exist today in China. Now, that cannot last. Over the next 20, 30 years, we actually forecast the financial services sector to be probably the best performing sector in China. It’s the one part of the service economy that will really develop, in our opinion.

Knowledge@Wharton: Obviously, this is a changing time for China in terms of the relationship between the government and business. There are many questions about how their business model is going to play out, but the government controls of a lot of different sectors in China right now.

Chidambaram: That’s right. The state plays too big of a role in a bunch of sectors. I think they will retreat from that, or at least create national champions and leave the rest to the private sector, but I don’t think that will happen in the financial services sector. There are some big state-owned banks, but I think they’ll control a relatively small part of the pie and I think you’ll see a lot of smaller companies come up and do really well in this area.

Knowledge@Wharton: Maybe the concerns about China are a little overbaked at this point …?

Chidambaram: We have to go sector by sector. China’s a huge place. I think to write off all of it would be a mistake. I think some areas are very underinvested and will grow. I gave you one example; there are others. Other sectors are overinvested, [have] overcapacity, and they won’t do well. Unfortunately, those sectors probably do represent a bigger part of the GDP in China today. So that will have a net cumulative slowdown effect, but that does not mean that some sectors in China will not perform above average.

Knowledge@Wharton: Are you seeing those companies that are involved in sectors that may be overdone a little bit realizing that they need to adjust and move into some of the areas that are undervalued at this point?

Chidambaram: That’s correct. I think you will see some of that. I think you’ll see some of the existing guys refocus into those areas.

But as I said, we also see the potential for a lot of new players to emerge. The entrepreneurial spirit in China is still undimmed. There’s still a fair amount of liquidity in the market. I think you will see a new generation of entrepreneurs enter completely underpenetrated areas. The ones that are most talked about are health care — another area with tremendous growth potential — and financial services. But you could take other parts of the service economy; I think that all of those sectors are underrepresented in China today.

Knowledge@Wharton: China is a country with a very large aging population, contrasted with its millennials and Gen Xers, who are really involved in a lot of these ideas that we’re talking about. How much will that shift in the types of people involved in these sectors really benefit China?

“Over the next 20, 30 years, we actually forecast the financial services sector to be probably the best performing sector in China.”

Chidambaram: I think that you will see a new dynamic generation of entrepreneurs who are far better trained than their predecessors. Arguably, you could definitely say that from the first 20 years of China’s development, really, very few businesses will last. That’s a fairly controversial statement, but probably a lot of those guys have gotten rich, they’ve gotten big, but they’re not necessarily good or sustainable.

This next generation of entrepreneurs that we’re seeing is much more sophisticated, a lot more switched on. They understand the market realities much better. They also understand corporate governance better. They understand the realities of operating in more regulated markets, and they will be built to last. They will sustain more than the previous generation.

Knowledge@Wharton: When you think about China, it’s a massive country, and it does have opportunities. But in some respects, it seems like that some of the opportunities that you’re seeing in Indonesia or Vietnam may have equal if not greater growth potential, perhaps just because those nations are smaller entities than China.

Chidambaram: That’s right. It’s sometimes easier to operate in markets like Indonesia than China. It’s relative, but Indonesia is probably a slightly more developed market. It’s been open to outside investment for a long time and it’s a little bit more predictable. Vietnam is somewhere in the middle. Vietnam is also a very opaque market. It has a little bit more of a frontier quality, but smaller, more discreet, more easily understood in some ways. You could attack the country more easily, especially from a distribution point of view, if it’s a distribution-related business.

The biggest problem in China is the ever-changing nature of the government, its priorities, how that may impact you. There’s no such thing as truly private enterprise in China, because even a private enterprise — privately owned and privately funded — is somehow at the whim of some government, whether it be the provincial government or the federal government.

And one never knows, because what we’ve noticed in China in our years of doing business there is that there are periods of time when there’s a kind of détente, and everything is open and you can do everything. Then there are periods when suddenly it goes the other way and it’s not clear really what is allowed, what is doable, and there’s kind of this gridlock situation. That is probably a unique feature of China.

Vietnam has some of that, because their model is not that different than China. Indonesia does not have that. In Indonesia, a private business can function like a private business. It is far more vulnerable to macro changes in the economy. For example, the rupiah has depreciated tremendously this year. So if you are a dollar-cost business earning money in rupiah, that’s very problematic. The infrastructure sector where capital equipment is bought in dollars but tariffs are paid in rupiah, it’s been badly affected.

But that’s more normal. Those are the kind of risks that someone at Wharton can understand — currency risk and stuff like that. But how do you factor in something like the whims of a government?

Knowledge@Wharton: How much do you think the development of trade relationships with China and various other entities will open the doors even more for operations like yours?

“There’s really no such thing as truly private, private enterprise in China, because even a private enterprise is somehow at the whim of some government.”

Chidambaram: Well, to be honest, I think selectively, in some areas, where you can add value, I think the Chinese will welcome you. But overall, to be honest, I’m not very sanguine about China being a very “open trading” sort of place.

I think certain industries will be almost off limits to foreigners. We’re seeing that in tech. The U.S. firms pretty much have been shut out of that market. There will only be Chinese national champions. By and large, in the larger sectors, which they view as mission critical to their economic success, like the environmental sector, certain big banks, things like that, I doubt there will be a whole lot of foreign market penetration.

The auto sector is another, and we’ve seen some similar developments in pharma — including intimidation, espionage charges and stuff like that. Resources is probably another protected industry. So I think large areas of the economy probably will be controlled primarily by Chinese, state-owned companies and a few private companies in favor with the government. I don’t see foreign companies picking up much market share in China, and I think that is exactly how it’s going to play out.

Knowledge@Wharton: Even in an area like infrastructure? Because we hear stories of how there needs to be a large amount of infrastructure change in China over the next decade or so, if you truly want to connect the western and eastern parts of that country.

Chidambaram: What I’m seeing is that they’re mostly domestic and national champions building the infrastructure now. It’s true, they may have their designs from the U.S., or engineering expertise from Germany, and certain products probably were designed in the U.S. or Europe once upon a time. But that is now effectively Chinese IP. It’s been nationalized, and these are the guys that we’re seeing in the local markets doing most of the big infrastructure. Take environmental services. As you know, China’s an environmental disaster and the government wants to clean up the place.
They are relying heavily on foreign technology now to do that, but even here [the situation is changing].

We do a lot of work in the water sector, and the water treatment sector 10 years ago was dominated by a lot of foreign players — the likes of Veolia, Suez, companies like that. Now, we’re seeing more and more national champions, and a lot of the foreign companies are retreating from China.

They’re not winning new projects, they are not in favor at all with the provincial or national authorities, although they have cutting-edge technologies in air pollution, water treatment, waste management, you name it. But they’re not the guys in the ascendency in China today.

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