Asia Private Equity, April 2012

Sovereign debt has once again become a key risk indicator for private equity investors, but this time around Asia is good shape Someone unable to make credit card payments tries to work out a plan to pay it off. He can ask the card issuer for lower monthly payments, sell things in the garage to get some quick cash, even declare personal bankruptcy and walk away. Sovereign debt is the country-level equivalent, and it has roared back as a key investment risk indicator.

"For more than a decade, sovereign debt didn't matter and it now matters again:' says Mark Delaney chief investment officer of Australian Super Fund. "Sovereign risk translates through to currency risk and market pricing risk and can have a substantial impact on returns."

Sovereign debt can have multiple effects that impact on private equity as the European crisis demonstrates. Credit markets have tightened and economic growth has been stifled. Unemployment increases and people spend less. On the ground, banks are skittish about lending, hampering private equity investments.

"There's a direct correlation between healthy sovereign debt and the investment climate for private equity," says Frank-Jurgen Richter, founder of research group Horasis and former director of the World Economic Forum. "A good rating brings some security to long-term investors like private equity."

In developing countries, governments tend to borrow to build infrastructure and invest in technologies. But the debt can become dangerous depending on multiple factors, including the size and diversification of the economy, whether the debt is the result of prudent investments that will bring returns, size of payments required and the type of currency the debt is denominated in, according to Richter.

That said, concerns over default have moved away from Asia, which was worrisome in 1997 during the Asian contagion, to the West, primarily Europe.

As of Q4 2011, no major Asian countries were in the top ten for sovereign debt risk, according to data from CMA Datavision.

"On average, the debt ratios in Asia look much better than in North America or Europe, the opposite of what it was 15 years ago," Delaney says.

On the opportunity side, sovereign debt issues can create interesting situations for bargain hunters. States may sell off their assets at discount prices to raise cash while companies facing slowing growth at home may do likewise.

China has been discount shopping. Chinese company investments in Europe last year were up about 250 percent to $10.4 billion, compared to $4 billion in 2010, according to data from A Capital, a private equity fund focused on outbound Chinese investments.

Richter says Chinese investors today are shrewd. They work with leading investment banks, accounting firms and law firms and are well advised on due diligence when they buy. Indian films at are also acquiring European companies. Tata, he points out, is today the largest industrial employer in the UK.

He sees a strong trend toward investment in mid-sized German machinery equipment companies. "Many first generation entrepreneurs want to sell their assets and it's quite a fashion to sell to the Chinese and Indians."

That was something unthinkable a few years ago, Richter says.

"At the time it was an insult even to consider selling it to them. People thought those companies only buy the brand and, layoff workers and move industrial assets back to China or India. But actually that's not happening Usually when those companies invest in Germany's industrial sector, they keep the manufacturing and employees and further integrate the operation globally with assets back home."

Horasis is a global visions community committed to enact visions for a sustainable future. (http://www.horasis.org)