Japan and Southeast Asia are picking up the slack in the Asia-Pacific private equity (PE) market, amid the pullback in China, according to a new report.

Dealmaking in the region took a tumble this year amid uncertainties in the Chinese market, which traditionally dominates PE activity given the size of its economy.

The value of PE transactions in the first three quarters of 2022 slumped 60% year-on-year to around US$100 billion, with the volume dropping 17% to 707 deals during the period, global law firm Dechert says in its latest report, Global Private Equity Outlook 2023.

Globally, PE deals almost halved from US$1.2 trillion to US$685 billion over the same period, although the decline was not as steep as in the APAC region.

Dechert attributes the slump to rising leverage costs and volatile valuations amid the economic downturn and rising interest rates. In Asia-Pacific, it is largely due to China.

China headwinds

“There’s been a lot of happenings in China, which has really skewed the numbers so far this year,” says Siew Kam Boon, co-head of Dechert’s private equity group. “Traditionally, the country’s taken the lion’s share of deal value. However, people have been concerned about the geopolitical situation in China, the uncertainties around the regulatory policy affecting the tech sector and the extensive lockdowns.”

The credit stress on the country’s property market is a major factor. Evergrande’s default in December 2021 triggered a contagion that has since spread across the sector.

Foreign investors, in a bid to reduce their exposure to the risks in the China market, have been looking for alternatives.

Amid the uncertainties in the Chinese market, Japan has become more attractive to foreign investors, helped by the weakness of the local currency against the US dollar and the country’s political stability. As a result, the value of PE deals in the market reached US$19.9 billion in the first three quarters of this year, exceeding the total for the whole of 2021.

The top two PE deals in APAC this year showcase the dominance of US-based PE in Japan, with both involving US investment manager KKR. The largest is its US$6 billion bid for Japanese third-party logistics provider Hitachi Transport System.

Asean’s gain

Meanwhile, the Asean region is benefiting from the supply chain shift from China as it expands its manufacturing activity and dismantles its Covid restrictions.

The region’s digitalization initiatives, which are aligned with its young and tech-savvy population, have further attracted interest from global investors, as technology continues to underpin business activity and growth.

“We see that with a lot of the travel restrictions being lifted this year, our clients are returning to in-person deal sourcing and it’s the Southeast Asian region where they’re going to tap opportunities,” Boon notes. “We are also tracking a lot of interest from funds that have traditionally not invested in the region in a significant manner, spending time learning about the region with a view to making meaningful investments here.”

Among the largest PE deals so far this year are Blackstone’s US$1.6 billion deal with Singapore-based engineering firm Interplex and RRJ’s US$1 billion acquisition of Singapore-based Fullerton Health.

Looking ahead, Dechert remains upbeat on the outlook of the PE market. With rising interest rates and uncertain valuations, private credit is becoming a popular financing mode due to its greater flexibility on financing terms compared to traditional bank financing, higher leverage levels, and greater predictability.

Private debt/direct lending, distressed debt and venture capital will remain top-of-mind for PE firms over the next 24 months, the report says.