Jin Ho Chai, Executive Managing Partner of STIC Investments, shares his views on investment opportunities in the Korean private equity market
Rapidly changing macroeconomic conditions are inflicting hardship on market participants. Challenges include higher costs of financing for business operations, constrained lending by banks, compressed valuation multiples for portfolio companies, and how to create value.
At the same time, rising interest rates will pressure borrower margins due to higher interest expenses. Creditors are leaning toward conservative portfolios, which will result in lower LTV ratios. Lower LTV ratios will in turn result in financing difficulties for businesses that need to sustain their operations through debt financing, and for private equity investors that typically use leverage to fund their buyout transactions and enhance investment returns. Valuations will be impacted, especially for assets that previously showed significant growth through utilizing capital at lower cost.
‘Growth at all costs’ is no longer going to appeal to investors, who need to focus more on value creation rather than multiples expansion. Businesses that burn cash are falling out of favor. Private companies that benefited from high valuations are now facing ‘down-rounds’ in their fundraising series. Companies that went through successful pre-IPO rounds are now waiting it out amid plummeting valuations in public markets.
While rising rates are negatively affecting valuation multiples, within the next three to five years, attractive assets will hold up relatively better, while unattractive assets will be discounted even further, causing a major bifurcation.
Currently, sellers are refusing to lower their valuations as they expect abundant dry powder in the market. However they will have to begin yielding to their buyers in 2023. When valuations of assets with convincing growth stories and profitability drop to reasonable levels, many potential buyers will be willing to bid. Investors need to identify opportunities emerging from paradigm shifts and the latest trends.
Promising sectors in Korea
The focus should be on identifying profitable companies that are leading current growth themes: digital transformation, energy transition, and demographic change.
Korea is one of the most adaptable economies for implementing digital transformation. Many businesses provide new experiences to cater to rapidly changing consumer behaviors. Eventually, the ones that cannot raise capital will fall behind. Particularly, we believe that the semiconductor industry in Korea will benefit from ongoing geopolitical issues.
With regard to the energy transition, global top-tier lithium battery manufacturers, such as Samsung, SK, and LG, have all established solid value chains in Korea. Strong growth is expected in this sector.
The aging population in Korea will facilitate the growth of the Contract Manufacturing Organization (CMO) industry. Plus, its growing group of affluent consumers will accelerate growth in the wellness industry.
Another set of investment opportunities will arise from corporates’ intention to reshuffle businesses’ portfolios and improve corporate governance. In this environment of rising interest rates and macroeconomic uncertainty, deal trends will likely shift; instead of obtaining significant minority stakes, investors will now want a controlling interest to actively perform value creation activities and maximize investment returns.
Although the Korean M&A market slowed down in the second half of 2022 due to current macroeconomic conditions, we expect it to recover in 2023 when the rate hikes stabilize. Businesses with stable and profitable operations will lead to increased competition among financial sponsors and strategic investors. However, only the leverage-free investors that have significant liquidity will be able to take advantage of these opportunities.
About
STIC Investments, Inc. (STIC) is one of the largest and most experienced private equity firms in Korea. Starting its operations as a venture capital firm in 1999, STIC is now renowned as a leading private equity firm in Korea with proven 20-year track record and abundant investment experience in multiple business cycles. STIC’s global investor base includes notable institutional investors from Korea, Southeast Asia, the Middle East, and Europe.