Global Business Guide Indonesia

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Finance | Private Equity in Indonesia: More Deals Await Those Who Dig Deeper

Strong GDP growth and a young population have made Indonesia the focal point for private equity investment in Southeast Asia. The years following the 2009 credit crisis have seen increasing capital commitment from foreign funds seizing M&A opportunities in an economy that relies predominantly on domestic consumption. However, the market is home to a number of sophisticated local players and harsh competition has driven asset prices to levels that some observers consider risky.

Private Equity in Indonesia: More Deals Await Those Who Dig Deeper
Inefficacies at many mid-market companies must be seen as an opportunity for transformational private equity investment

Rising caution in Indonesia’s private equity market might go some way to explain the underwhelming IPO of Saratoga Investama Sedaya in June 2013, when the Indonesian investment firm raised less than half of what it had initially sought. Yet, there is also widespread agreement that private equity is still in its early stages in Indonesia as general partners from around the world are searching for emerging markets that are less explored than China and India.

The single most compelling reason to invest in Indonesia today is the country’s expanding middle class which has supported GDP growth of more than 6% per annum since 2010. This is set to continue in the foreseeable future and as consumption increases, so does business activity, and with it, opportunities for private equity investors.

Macroeconomic strength and a low public debt-to-GDP ratio earned Indonesia investment grade ratings from Fitch Ratings and Moody’s Investors Service in late 2011 and early 2012. Inflation rose markedly in 2013 amid an increase in government-controlled petrol prices, but the central bank expects it to fall back into its target range of 3.5% to 5.5% in 2014.

While competition for assets has clearly intensified, private equity capital in Indonesia is still low in relation to the overall economy and the national stock market. This points to long-term growth potential of the industry.

Inefficacies at many mid-market companies must be seen as an opportunity for transformational private equity investment. Fresh managerial impetus and stronger governance at such companies can boost operational efficiency and unlock upside potential beyond market growth. As management skills are still found wanting in Indonesia, this provides a case specifically for foreign engagement.

Underperforming companies should, in principle, require little convincing that they need to ‘up their game’ to withstand stiffer competition in the planned ASEAN Economic Community (AEC). At the same time, increased regional trade will help portfolio companies export or expand to new markets and cut production costs.

The Indonesian Stock Exchange (IDX) and Bank Indonesia (BI) have undertaken measures to deepen the country’s capital markets, including by luring more local investors (See Capital Markets: Widening the Local Investor Base). These measures should eventually improve options for private equity funds to exit the market through IPOs.

As BI interest rates can be expected to continue their upward trajectory for a while to stave off inflationary pressure, the rising cost of debt capital may make Indonesian companies more receptive to private equity funding in the near future.

The challenges faced by private equity funds in Indonesia are largely congruent with issues often raised by foreign direct investors to the country and logged in the World Bank’s Doing Business survey. Legal certainty remains a prime concern. Indonesian Courts can be susceptible to external influence, which can put foreign funds at a disadvantage when seeking recourse in disputes with well-connected local companies. As a result, legal costs tend to be relatively high and only go so far in mitigating the risks. This makes proper due diligence all the more important. Rigorous background checks on business partners must ensure that the interests of all parties to a deal are aligned. That said, it is important to note that for all the media coverage they receive, prominent cases of ugly disputes remain the exception.

Playing by the rules is challenging at times due to complex regulations affecting most business activity. Powers vested in regional and local governments make licensing procedures cumbersome for business leaders. However, the agency in charge of promoting and handling foreign investment, the Investment Coordinating Board (BKPM), is seeking to ease the bureaucratic burden with a one-stop approach.

While Indonesia has generally welcomed foreign investment over the past decade, it still has numerous restrictions in place. Some sectors are either wholly or partially closed to private foreign and/or domestic investment and placed on the negative investment list (See Understanding the Negative Investment List). The government has also faced accusations of “economic nationalism” in its regulatory policies, particularly in the natural resource sectors, but protectionist tendencies are expected to ease following the 2014 presidential elections.

A shortage of highly skilled labour still afflicts some sectors in Indonesia and can hold businesses back from reaching their full potential. Despite this, government regulations cap the proportion of expatriates in a company’s workforce and impose certain obligations on the employment of foreigners, such as training up local staff. These human resource restrictions must be taken into account with regards to improving operational efficiency at portfolio companies.

For the reasons aforementioned, consumer-related sectors have been particularly attractive to private equity funds in Indonesia. CVC Capital Partners’ partial sale of Matahari Department Store in March 2013 at a multiple of the buyout price stands testament to the fortunes to be made on the retail market (See Indonesia’s FMCG Sector). Other consumer sectors considered attractive include food and beverage, telecommunication, media, pharmaceutical and personal care.

Another sector set to benefit from the growing population and affluence is health care (See An Overview of Indonesia’s Health Insurance Sector). Buyout firms can bring to the table management expertise and technical knowhow to create value at hospitals and suppliers, many of which are still considered to be substandard. Education is another basic need currently underserved by the state, thereby opening up prospects for private engagement (See Indonesia’s Higher Education Act 2012).

Employing a mixture of tax incentives, import duties and other regulations; the government is pushing hard for the development of Indonesia’s industrial sector. Policies are in place to force domestic processing of agricultural produce and mineral resources, while a carrot and stick approach aims at growing the automotive and technological sectors. Going along with this political momentum promises lucrative returns.

The 2013 state budget also allocates more funds for infrastructure development which should bring new opportunities for private equity participation, particularly in transportation and energy. State-owned utility PLN is struggling to meet government targets for electricity generation, which should open up a greater role for independent power producers (See Indonesia’s Electricity and Power Generation Sector). Meanwhile, renewable energy projects are set to benefit from higher feed-in tariffs and extended tax holidays.

Unlike in the banking sector, where ownership is generally capped at 40%, Indonesian insurance companies can be up to 80% foreign owned. The market has seen rapid growth in recent years, yet remains under-penetrated. Private equity financing should be welcome to help insurers meet rising minimum capital requirements. At the same time the stricter requirements should prompt some consolidation in the market, which increases M&A opportunities and exit options for private equity (See Opportunities in Indonesia’s Banking Industry).

Global economic sentiment in mid-2013 was marred by a slowdown in Chinese manufacturing and on-going debt woes in Europe provided a less than ideal set of circumstances for emerging market private equity. This would naturally lead to a degree of caution among funds looking to acquire assets in Indonesia, as would the upcoming elections.

None of these factors, however, should distract from the fact that the country continues to hold value for private equity in the medium and long term. Deals based solely on income and population growth will be harder to come by, since much of the low-hanging fruit has been harvested. Digging deeper into the mid-market segment will be key to success in Indonesia, where small and medium-sized enterprises account for almost 60% of GDP (Statistics Indonesia).

Foreign funds need to maintain a strong local partnership or presence and keep their ear to the ground. Accumulating local market intelligence in Indonesia relies heavily on personal relations. Formal private equity participation is still an alien concept to many owners of small-scale or family-run enterprises in Indonesia. Familiarity with the local business culture will prove crucial to capitalize on the sort of deals that need to be created rather than discovered.

Global Business Guide Indonesia - 2013

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Indonesia Finance Snapshot - Capital Markets

Bourse Name: Bursa Efek Indonesia (IDX)
Main Index: Jakarta Composite Index
Market Capitalisation: 5.6 trillion IDR July, 2016)
Annual Performance: 11.97% (2016)
Record High: 5,523.29 (April 2015)
Number of Issuers: 523 (2015)
Top Stocks by Market Capitalisation: HM Sampoerna, BCA, Telkom, Unilever, BRI, Astra International, Bank Mandiri, Gudang Garam, BNI.