Adopt a long-term view when investing in Asia

ASIA - with immense global trade flow, flourishing economies, and access to a burgeoning talent pool - is now the epicentre of global mergers and acquisitions (M&A) transactions. According to Aon's 2021 Risk in Review report, 68 per cent of investors rank Asia-Pacific (excluding Japan) among the top two most active regions for M&A activity. Investors are setting their sights on Asia to grow their portfolios. However, the many rewards of investing in Asia, like anywhere else, are not without risks.

Asia cannot be viewed as a monolith. The different nations in Asia have varied and challenging national storylines unfolding. Investors interested in the Asian market need to juggle the many demands of a complex stakeholder universe - from consumers to politicians and regulators to society at large.

As such, a thorough understanding of the wide range of domestic and regional political risks is essential. While there are some challenges that are common to many countries in Asia, the level of risk and trend direction vary. As acquisitions have the potential to disrupt a company's internal cultures, as well as founders' operational freedom and control over a company's direction, it is necessary for investors to factor such sensitivities into their strategies.

Large parts of Asia have immense infrastructure development needs. According to the Asian Development Bank, the region needs US$26 trillion in infrastructure investment between 2016 and 2030 to maintain its growth momentum, eradicate poverty and respond to climate change. Inadequate infrastructure increases the cost of business, while bringing additional risks and uncertainty. The Covid-19 pandemic has also further highlighted the importance of infrastructure development in maintaining economic growth and productivity.

Furthermore, political risk and regulatory uncertainty pose serious threats to investment returns. For infrastructure assets, this risk is heightened as an investor needs to commit equity for a longer period and is subject to more volatility when there is a change in political or regulatory regime. Laws that were in place during the tenure of a government could well vanish or change into vastly different regulations when there is political instability, leaving businesses scrambling to deal with the fallout.

Investors need to adopt a long-term view of their investment in Asia. Extensive due diligence is needed to fully understand multiple factors when considering local partners: prior business dealings, technical capability, reputation, financial strength and the personal and business affiliations of these individuals. A progressive approach by staging investments in tranches can mitigate some of these risks.

This starts by gaining a well-rounded understanding of how a relevant industry sector operates in an Asian market. Building relationships with local advisors and partners with on-the-ground experience, knowledge of the law and local language, allows the investor to fully understand the culture, staff and operations of a target company. This also helps in building credibility in an economy that often relies on reputation and affiliations.

Pursuing minority deals and joint ventures is yet another way investors can enter new markets. This will allow investors to participate in the upside of a promising business while retaining the expertise of the founder-operators who know the industry and jurisdiction intimately. Founder-operators usually also want to retain control as they raise funds for expansion, so this approach can be a mutually beneficial approach for both parties.

Risk mitigation tools such as warranty and indemnity (W&I) and tax liability insurance will work well to ring-fence such liabilities.

As of now, there is an increasing competition for assets in Asia due to low interest rates, record amounts of private equity dry powder, competitive bids and higher pricing multiples. These factors are empowering sellers to capitalise on deals by getting the maximum value for their business and receiving a greater proportion of the purchase price on closing.

W&I insurance, when used well, can be a competitive advantage in auctions or acquisitions as it eliminates the need for escrows or holdbacks as part of the bidding process or deal structure. It can help investors cover off unknown risks that may have gone undetected during due diligence while protecting an investor's key relationships.

For example, the investor can claim against the insurers for any losses stemming from breaches of warranties rather than against the sellers, who often remain the target's stakeholders. Keeping claims confidential also allows investors to maintain a positive reputation in the market.

Tax liability insurance, on the other hand, will allow investors to eliminate the exposure of an identified tax risk from successful challenges by a tax authority. It can help deliver value to stakeholders by providing certainty to businesses and eliminate the need for escrows or holdbacks.

And finally, it is critical to look at post-merger integration comprehensively.

All parties in the deal are looking to maximise synergies such that the deal lives up to its predicted value. Businesses can mitigate risks by effectively articulating the post-merger acquisition transition plan with the help of change management experts. Together with experts, investors must ensure that the transition plan spans the entire organisation - from processes (for example, technology, human resources, internal processes and policies) and purchasing to production and sale.

An important part of transition plans is taking into consideration the culture of the organisation. Without proper analysis of post-merger integration strategies, companies with different cultures will find it difficult, if not impossible, to operate effectively and make expeditious decisions. Investors must therefore identify key areas in the integrated company culture and work with employees to adopt solutions to realise the full potential of their investment.

The past year has been a defining period for M&A activities. The macroeconomic outlook is far from certain and this may challenge deal processes, as buyers and sellers struggle to find common ground. Investors and businesses must continue to proceed with caution.