SOUTHEAST ASIA OFFERS BIG EXITS (Just Not Through IPOs)November 10, 2016
In the United States, the ideal exit for technology companies is immortalized in one iconic image: a CEO ringing the bell on the floor of the NASDAQ on the day of the company’s IPO. With the explosion of startup cultures in China and India, that image has gone international, though with a slight change of scene to Shanghai, Mumbai, and Hong Kong.
But an IPO isn’t necessarily the greatest fairytale ending for tech companies on that side of the globe. In Southeast Asia, which investors look to more and more as a potential asset, the question of how tech startups will exit is more pressing than ever.
In this paper, we will analyze data on the past fifteen years of M&As and IPOs to identify growth trends for each. By projecting these trends into the future, we estimate the number of M&As and IPOs that are likely to take place in 2020, and identify which type of exit will be dominant. We will also review the context for these predictions in terms of general economic and investment trends for SEA.
The Changing Exit Landscape
Whereas a publicly listed company might be the ideal in China, India, or the West, such an opportunity rarely appears here. Acquisitions are the bread and butter of both investor and founder alike in Southeast Asia. The most notable exits here have all been acquisitions: Rakuten’s earth-shaking purchase of Viki for US$200M in 2012, Zendesk’s US$30M acquisition of Zopim in 2014, and even McAfee’s landmark acquisition of Darius Cheung’s tenCube back in 2009. In fact, there have only been 11 tech IPOs in SEA since 2005, while there have been 127 acquisitions during the same time period. (See Appendices 1 and 2).
Vincent Lauria, managing partner at Golden Gate Ventures, explains, “In the United States, a successful exit involves going public. The financial returns generated from listing on NASDAQ or the LSE usually mean that both investors and entrepreneurs alike have generated a pretty healthy return on their investment. In Southeast Asia, it’s the opposite: a trade sale will often result in larger financial returns than going public, especially if the acquirer has a strong strategic interest in the region.”
It’s always possible, however, that old patterns will change. Like China a decade ago, Southeast Asia is now an emerging market on the brink of something big. Five of the ten member countries of the Association of Southeast Asian Nations (ASEAN) are among the top 25 countries globally in terms of GDP growth. The ASEAN Economic Community (AEC) had a nominal GDP of $2.4 trillion in 2013, placing it seventh overall in the world. Given current growth patterns, the AEC is predicted to rise to the fourth spot by 2050. The region has already passed an inflection point in terms of digital growth; more people are consuming digital content, more people are paying for goods and shopping online, and more people are buying mobile phones.
The creation of the AEC and a more cohesive economic environment in SEA also represents a collective shift towards facilitating access to SEA markets that is only now getting underway. The aforementioned effects are compounded by the fact that China’s economic growth has been slowing over the years, leading foreign companies and investors to look towards SEA as a region of economic interest.
And as the markets become larger and more mature, so too do the number of high-value startups. An explosion of new funds in the region has given startups the ability to scale up. In 2015 alone, firms including Golden Gate Ventures, Northstar Group, Venturra Capital, Sequoia, and KKR have launched or backed SEA-focused new funds, with a total capitalization of as much as US$2 billion. Overall, capital invested in emerging Asia has increased by 47% since 2013, according to a recent EMPEA Data report. To compound this growth, funding rounds are increasing in size and frequency, driving an increase in startup valuations. Though valuations are not officially disclosed, as of March 2015, thirteen companies in SEA had raised US$20 million or more in funding (See Figure 1), implying valuations in the hundreds of millions. In another positive sign, private equity firms are increasingly making smaller early-stage investments in SEA startups instead of writing larger growth-stage checks — a sure sign that they expect to make Uber- or Facebook-level returns on such deals. With all this in mind, it seems possible that SEA could be on the cusp of a China-like explosion of IPO exits.
Figure 1: 15 Most Well-Funded Startups in Southeast Asia
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To IPO, or Not To IPO?
Historically, Southeast Asian stock exchanges are not known for their track record of listing tech startups. Many turn to the Australian Stock Exchange (ASX) instead: out of eleven ASEAN tech IPOs in the last fifteen years, five have listed on ASX (See Appendix 1). According to James Posnett, the Manager of Listings Business Development at ASX, this growth has been spurred largely by Australia’s own burgeoning domestic tech market.
“The IPO market in Australia has been open since mid-2013, since then we have seen the largest number of tech companies listing and raising capital on ASX in over fifteen years,” Posnett says. “ASX is unique in offering smaller growth companies a main board listing on a globally recognised exchange. As the peer group of domestic tech listings has grown, ASX has increasingly attracted companies from New Zealand, Southeast Asia and USA.”
But this is slowly changing. The Singapore Exchange (SGX) has launched several initiatives to help tech startups list more easily. One notable example is a junior board called The Catalist, which replaced the SESDAQ.
Whether on the SGX or any other exchange in the region, however, startups in Southeast Asia still have to consider the pros and cons of an IPO. The biggest drawback may be that the tech market itself is immature. Only 7% of the 170 companies listed on Catalist are in the information technology sector, as are less than 1% of the companies in the S&P/ASX 200, Australia’s main stock market index. Institutional investors that are looking for growth investments on the exchange don’t have experience dealing with technology startups and may have difficulty understanding their business models and growth trajectories. These factors combine to make IPOs less attractive for startups even as programs like Catalist make inroads.
A Strong Market for M&As
Despite the incredible profitability of SEA markets, foreign companies find them very difficult to establish a firm foothold in. Protectionist legislation is at least partly to blame. All the ASEAN countries except Singapore have foreign ownership restrictions; the difficulty of navigating the various regulations, which can vary widely from industry to industry, is a great disincentive against foreign companies expanding into SEA on their own. Economic nationalism can also take more direct forms. In 2014, Indonesia enacted a law that prohibits exports of mineral ores by the country’s largely foreign-owned mining firms; the result was as much as a 60% cut in production by some firms.
However, the greatest obstacle to foreign companies entering SEA markets is the difficulty of understanding the markets themselves. Business in SEA is conducted via a web of interpersonal connections that can be hard for outsiders to understand, much less thrive in. As of 2015, half of ASEAN member countries were in the lower 50th percentile in the World Bank’s “Ease of Business” rankings (though it must also be noted that another ASEAN nation, Singapore, was ranked at #1). As a U.S. Commercial Service report on Indonesia states, “a local joint venture partner is often essential for success in this market,” as local partners “provide foreign entities with access to local management and also the advantage of providing immediate access to valuable local networks and connections.” It comes as no surprise that in the decade since 2005, about 43% of M&As in the region have been made by foreign (non-SEA) companies (See Appendix 2).
In many cases, market access is a major aim of these acquisitions. For instance, the conglomerate LVMH Moët Hennessy Louis Vuitton SE (LVHM) neatly sidestepped foreign ownership restrictions by purchasing Singapore-based Luxola, which owned subsidiaries in other SEA countries including Indonesia. Tech in Asia noted that the deal gave LVHM and Sephora “a ready-made e-commerce solution in the region.”
Luxola’s founder, Alexis Horowitz-Burdick, points out: “[Acquisitions] are extremely useful for international companies looking to expand into Southeast Asia. This is a really difficult region to do business, especially for outsiders that aren’t too familiar with the different markets. By acquiring a company with a strong team, existing customers, and a strong operational foundation, global companies can often expand into Southeast Asia much more efficiently than attempting it themselves.”
Such acquisitions are a win-win for both the startup and its buyer. Not all M&As, of course, are as large and high-profile as the Luxola deal; the list includes many humbler trade sales and consolidations as well. Whatever the scale, however, the conclusion is the same: companies in SEA use M&A to expand and scale across the region.
The rising tide of non-VC investments also bodes well for M&A activity in SEA. Chinese tech firms like Alibaba, Tencent, and JD have already made several large investments in the region. More recently, major Japanese banks such as Credit Saison have begun investing in fintech startups in SEA, looking to increase their customer base. Often, such investments are a prelude to acquisition, as they are an opportunity for the investor to follow the startup closely and learn more about its market for several years or months. ASX-listed large-cap tech companies have also been major players.
Although India has not historically played a large role in the SEA M&A market, Indian companies in recent years have been strengthening ties to SEA, particularly Singapore. Around three-fourths of Indian startups that raised early-stage funding in 2015 will redomicile to Singapore, seeking a more amenable regulatory climate, according to the Financial Times. Indian FDI in Singapore also reached $25 billion in 2014. This could point to an increasing trend towards M&A by Indian companies in the next three to five years.
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To gauge the potential for exits in both categories, we analyzed the growth trend for IPOs and M&As in SEA for the period 2005-2015.
M&As in SEA
A scatterplot of number of M&As per year suggest an exponential growth pattern. (See Figure 2).
To characterize this non-linear time trend, we used the following exponential regression model to fit the data:
y = ea+bx
where y = deal count and x = year. Once we estimate the values of a and b from the existing data, we can predict the number of tech IPOs and M&As in SEA from 2016 to 2020. We found the line of best fit with the coefficients a = -762.3415 and b = 0.3801281, with the coefficient of determination R-squared = 0.9231 (See Figure 3). This model yields a projection of 249 M&A deals in 2020.
IPOs in SEA
Identifying growth trends for IPOs was more difficult because of the high variability of IPO numbers year-to-year. 2014 was a particular outlier, with 5 IPOs, whereas all other years had 1 or fewer IPOs (See Figure 4).
No model resulted in a high correlation coefficient; a simple linear growth model y = -419.273 + 0.209091x with R-squared = 0.240455 yields a prediction of 3 IPOs in 2020 (See Figure 5).
Assuming that other factors remain constant and current trends continue, M&A will still be the predominant exit strategy for tech startups in SEA in 2020.
The Next China?
For the last decade, Southeast Asia has often been overshadowed by the tremendous outlays of capital and exit activity in India and China. But as these regions start to approach a hard ceiling on attainable returns on investment, investors will need to look to emerging markets for growth. Regional and global acquirers are just now fully realising Southeast Asia’s potential as a real growth market, which is marked in part by an unprecedented rise in startup formation.
Juha Paanen, founder of Nonstop Games, weighs in: “Global Internet and mobile companies recognize the talent in Singapore startups and the opportunity in South East Asia. We’re only in the beginning — I expect the M&A activity to vastly increase in next 3 years.” Nonstop Games was a local Singaporean-Finnish mobile company before being acquired by King for nearly US$100 million in August 2014, one of the largest to date.
When these two trends ultimately intersect in the next five years, exit activity in the region is going to explode. Our analysis shows that this explosion will be led not by IPOs, as China’s was, but almost entirely by strategic acquisitions.
It is still possible that SEA has surprises in store. In the early days of its economic boom, China was already a big IPO player, with five IPOs in 2000 on NASDAQ alone (See Appendix 3). But growth was uneven in the years following, leaving little indication of growing into the robust IPO market it has today. It could be that the linear growth trends in IPOs found here are similarly deceptive. ASX continues to be an attractive option for startups in the region that seek an IPO exit, and local SEA exchanges will continue to develop their offerings in the coming years.
These, however, are likely to be longer-term trends. For now, the burgeoning market for M&A in SEA is a unique opportunity for VCs and investors. To provide attractive exits, the region doesn’t seek to match India and China in number of IPOs. A restrictive regulatory climate makes M&A the smarter—and often more lucrative—choice for tech startups in SEA, and there is no shortage of international companies looking to acquire. Japan, China, Korea, Australia, and the US will continue to originate most acquisitions by non-SEA companies in the next five years, as they have in the past fifteen. Based on these trends, early-stage investors can expect to make impressive returns, even without a stock-floor bell to ring.
Appendix 1: Tech IPOs in SEA from 2001 – 2015
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Appendix 2: Tech M&As in SEA from 2005 – 2015
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Appendix 3: Tech IPOs by Chinese Companies on the NASDAQ & NYSE from 2000 – 2005
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Appendix 4: Top 10 M&As in SEA by Value
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