Reaching for the exit

As we enter a more challenging environment for the world’s economies, how are LPs viewing exit prospects in their emerging markets exposures? And where will liquidity come from?

With private capital exit options still more limited in emerging markets (EMs) than in developed ones, gaining liquidity has long been among top LP concerns. There are notable bright spots in some markets – India’s private equity and venture capital community had one of its most active years for realisations in 2021, for example, reaching 281 in 2021, versus just 157 immediately pre-pandemic in 2019, according to Statista. But many of the structural barriers to exits remain.

Bonnie Lo, Partner and COO at TPG NewQuest, outlines the situation in Asia. “Every year, we have seen record amounts of capital raised and deployed by private markets. In comparison, there are few exits,” she says. “LPs continue to commit; growth and TVPI is promising, but the numbers for DPI are more challenging. For every $4 invested across Asia each year, only $1 comes back to investors – in the US and Europe, that figure is more like $2-$1 or even $1-$1. The paths to exit are still challenged.”

As a result, many LPs are now asking their current and potential GPs more – and more urgent – questions about how their investments will be realised. “Liquidity is a big issue for LPs,” says Julien Kinic, Managing Partner at idi EM Partners. “I would encourage GPs to work as much on exits as they do on entry due diligence when they invest. They also need to improve communications and provide LPs with visibility on when and how exits will be achieved.”

The arrival of the pandemic and the disruptions it caused has heightened LP concerns. “We’ve seen a lot of exits delayed over the past two years because of COVID-19,” says Yee Hean Teo, Principal Investment Specialist, Asian Development Bank.

"GPs need to engage on a more intensive basis with LPs to communicate what is going on in the portfolio.”

That doesn’t necessarily mean investors are clamouring for a mass amount of additional information; rather they are requesting that communications include exit prospects as a matter of course. “LPs need to know when an asset will be sold and what kind of return they will get,” says Kinic. “What figure should I be reporting to my boss? It’s not about more transparency; it’s about formalising exit communications.”

This kind of approach could also help GPs spot exit opportunities at an earlier point in time. “If there is a win on the table, consider strategically taking it earlier than anticipated,” says Teo. “That way you can deliver DPI to investors faster.”

Where’s the DPI?

LPs don’t want to be the last to hear the bad news, especially from a third party.

New buyers

But where will exits come from during a turbulent time for the world’s economies? In some markets, the answer may well lie in the more traditional routes as investors and strategic buyers seek out new growth opportunities away from more recession-prone economies. Sameer Mehta, Director of Atlas Family Office, says there are new buyers looking at Indian portfolio companies. “We’ve recently seen a lot of strategic acquirers looking here,” he says. “These are the market-makers across geographies. We’ve not seen this before now.”

Lo agrees. “Trade sales are becoming more popular,” she says. “But you do need to be sure that management are on board with this. That means discussing this at the outset of the investment.”

And, with relatively high levels of dry powder in the private capital market, secondary buyouts may become more important, although the continued predominance of minority stakes in many emerging markets makes this a less popular path than elsewhere.

IPOs, however, are likely to remain more challenging, at least in the short to medium term. Of all emerging markets, China has clearly had most success at IPO exits abroad, yet new government regulations and the geopolitical situation between the US and China will dampen the prospects for IPOs as an exit route.

“Dollar-denominated funds in China may face some exit challenges,” says Manjia Guan, Managing Director at Capital Dynamics. “Many US dollar funds used to exit tech-related companies through US IPOs but global turmoil, the data security review from China and the tougher audit regulation from the US SEC will stem this tide.” She is, however, more optimistic for listings within the region.

“Companies that had planned a US listing will need to rethink their listing destination and redesign their structures and that will take a year or so,” says Guan. “Asian stock markets have digested some regulatory shocks and are now starting to stabilise. I see local listings on either China A-share or Hong Kong exchange being strong over the medium term.”

Where we are likely to see more activity, however, is in the secondaries market. Some LPs may well wish to sell fund positions to achieve liquidity and reposition their exposure. However, the growing GP-led market is also offering a new option when it comes to DPI for LPs. “GP-led deals have really taken off globally,” says Lo. “And they now tend to be the best assets of the best GPs; this is the case in Asia as well. They give GPs more runway to create value while also offering LPs the chance to crystallise returns or roll over. They are increasingly seen as an exit alternative.”