Myths & Realities of Investing in Asia
Asia Society and Museum
CEO Forum Luncheon

Charles R. Kaye
Co-President, Warburg Pincus LLC

New York, January 22, 2003

When I arrived in Hong Kong in 1994, the private equity industry was in its infancy. There were early pioneers and some early success stories typically built around low-cost labor and manufacturing although there had also been a few successful investments based upon bringing global brands to Asia, I remember the McDonald’s story being notable at the time. As I reflect, I think the real defining events for Asian private equity were the financial crisis of 1997-1998 and then the “internet bubble” of the late 1990’s. The Asian crisis really ended the momentum-based investing that had increased dramatically during 1993-1994 and created a wide variety of stresses within the financial/economic systems as well as the political infrastructure across the region. The effects of this crisis are in many ways still being played out but it was clearly an important inflection point. Interestingly, one of the upsides to the crisis was the perception of an opportunity for private equity investors. Many things drove this trend although it was in part driven by the burgeoning venture capital craze everywhere. Nowhere was this more pronounced than in technology. A great deal of investment capital flowed into Asia during this “internet bubble” period of the late 1990’s. Investors were reaping seemingly astronomical rates of returns in the U.S – why not in Asia? So, what happened ?

Well most of it flowed right back out rather quickly. The investors were usually new to the Asia and sometimes new to private equity as well. A lot of the so-called Asia tech investments were just U.S. dot-com copycats or sometimes not even that. The business models were often unsustainable. The pay-offs were negligible. The investors reduced their exposure to the sector. A lot of them, on their way out the door, announced that successful Asian private equity investing was a myth. I think they’re wrong.

The reality is that just as occurred elsewhere in the US and Europe, the early years can be a real learning experience. However, the rewards to those who persevere are significant. Warburg Pincus, as it is known today, was itself essentially a creation of the 1973-74 recession and bear market in the US. The investments made during that crisis created the platform upon which the firm was built. In many ways, we have the same feeling today about Asia. We’re pleased with the progress of our business. Real values within our own investment portfolio are being created – companies like Bharti, HDFC, AsiaInfo, Harbour, and LG Card - and the opportunities we see continue to get even more attractive. We see encouraging signs with other investors in the region as well as in the local markets in which we operate. We think we have one of the leading private equity franchises in Asia and the fruits of that hard work will be harvested for years to come.

From all of that experience, I would offer a single fundamental principle:

The greatest barriers to external investment in Asia result from a mutual misunderstanding.

Too many venture investors do not adequately understand Asia, the region. Conversely, too many Asian businesses and governments do not understand what it takes to attract the right kind of investor to the region. Mutual misunderstanding. That’s the kind of problem that many of you in this room– working through organizations like the Asia Society -- often deal with. So let’s spend a few minutes talking about some of these misunderstandings – the myths and realities that underlie private equity investing in Asia.

Here's the most basic misunderstanding: For an investor, there's no such place as Asia. As Henry Kissinger once quipped, “When I want to speak to Europe, whom do I call ?” Well, the Euro debates aside, the emergence of the EC and EMU provide some theoretical answers to that question. Now what about Asia? Some people even asked me at lunch why we have 6 offices in Asia – Hong Kong, Beijing, Seoul, Tokyo, Singapore, and Mumbai. It primarily reflects our desire to be “local.” Asia is not a market. The heterogeneous nature of the vast region from Japan to Australasia to India with GDP of $8 trillion (>25% of world GDP) and 3.5 billion people (well over half f the world) means that having a “one-size-fits-all” strategy is the first step to failure. One needs to understand the macro-economic, geo-political, and cultural structures in each country and think about what “mega-trends” will lead to the most interesting opportunities.

Both China and India are domestic behemoths. China has been one of the most remarkable economic transformations in history. However, despite its rich and long history as a society, it is an adolescent in many ways in the development of a modern market economy. As those of you with teenagers know, there are good days and bad days and you don’t really know how they will turn out when they’re 30 or 40. The China story may have started as a global manufacturing exporter but the economy’s continued growth and development will mean that China’s going to have an increasing influence across a range of industries. India may be less talked about although, in our view, is as significant an opportunity. India is an increasingly important player in IT services and now IT-enabled services. Its potential role in the global outsourcing of services is creating many new opportunities and, many of its existing industries can benefit from an access to capital that has largely not existed. Occasionally, I get asked to draw the China-India comparison. My principal comment is that I don’t think it’s a choice. Each has taken a different path although I think has a lot to learn from one another. It is interesting to see the emergence of a top tier of players in leading industries in each country. In India, companies like TCS, Infosys, Wipro and Satyam are breaking away in IT services as are Huawei, ZTE, Shanghai Bell and Legend in IT/Telco hardware in China. Both are good signs and I’ll address them again later. Given that 40% of the world lives in the two countries, let’s hope the old proverb holds true – “Nothing arouses ambition so much as the trumpet clang of another’s fame.” Finally, Korea is perhaps the poster child for success following the Asian crisis. Notwithstanding the latest concerns about North Korea, the election of President Roh Moo-hyun keeps Korea on the path of developing a market economy and one increasingly based on democratic values and principles. Korea is entering genuine developed nationhood and “middle income” status. The unleashing of the Korean consumer and changes in the industrial structure prompted by the ongoing transformation of the Korean financial infrastructure are creating a variety of investment opportunities. Our most notable investment in Korea has been LG Card - the largest Korean credit card issuer with 10 million cardholders and $25 billion in managed assets. We saw LG as a play on the Korean consumer. While Korea has an ongoing tight credit cycle as a result of the very rapid industry growth of the last few years, we believe LG will emerge stronger from this maturation phase and be a real icon on the Korea financial services landscape. In any event, Korea can serve as business hub for North Asia (consider that 700 million people live within 750 miles of Seoul) and a role model of positive economic and political development.

Three different economic stories – three different perspectives on the scale, type and stage of investments we would expect to look for and find. So there really is no such thing as Asian venture investing – Asia is not a market. It is very country-specific (and in some cases even more discrete than that).

Second misunderstanding: Tech investing is not about tech (at least not as we would think about it in the US).

In the US, we tend to be focused on leading-edge innovations – what Clayton Christensen has dubbed “disruptive technologies,” the ones that are going to transform the way we think and act, or at least the way we communicate and do business. Not so in Asia. In nearly every Asian country, the real opportunity for value creation does not reside in technological innovation per se. Sure, breakthrough technological ideas do happen in Asia but most Asian markets are considerably behind the technology that’s already available globally. Think leapfrogging vs break-thru. We invested 18 months ago to help create a company called Harbour Networks in China. Harbour provides Internet-based broadband networking equipment for metropolitan and business data communications networks in China. We invested in a first-class management team, most of them veterans of the country's leading telecom equipment vendor - Huawei. We invested in their laser-sharp focus on a clearly defined high-growth business – bringing broadband access from the metro fiber rings into business districts and into the housing estates. The goal was not to out-innovate Cisco on a global scale but rather to take advantage of their unusual knowledge of local needs and apply it. Just mobilizing what’s already out there, and applying it to mass market needs, is a huge opportunity for a growth-minded company – and a venture investor. The magical ingredient in Asia is not unique intellectual property. It's unique entrepreneurial talent.

A third and related myth – A pan-Asia or US-targeted plan is necessary to really be successful. Expanding abroad is difficult. The competitive environment is challenging. Local customer requirements are different. And it costs a lot of money to build a local sales, marketing and distribution network. I see many Asian entities that grossly under-estimate the challenges and costs of doing business in the US or elsewhere in the world. There are entrepreneurial Asian tech product companies that have made inroads in the international market but they’re really exceptions. Many young Asian tech companies lose their competitive advantage when they go abroad (remember Acer); and at the same time they are paying less attention to the rich opportunities back home. At a minimum, it is important to reach critical mass first. Technology, in this context, is not global. It’s local.

Fourth misunderstanding - If technology is local, then so is management. A lot of superior managers especially technologists in the West have Asian origins. Returning them to Asia with venture funding looked like a viable strategy to some investors. For the most part, it wasn't. The returnees may have terrific experience. But recall that the real opportunity lies in addressing local market needs. Here, the experienced local operator is the essential piece of managerial talent. 2 ½ years ago, we spent a lot of time looking at the India telecommunications landscape – the sector had what I would call a failed deregulation effort. There were many issues but one was that the bidders for new telco licenses, mainly backed by the global telcos, had bid astronomical sums based on the vast population. However, we found one operator who had kept his head screwed on – the company had one license in Delhi and one other small one. He was committed to being a telco operator (not a conglomerate with diverse interests) and to building a world-class business in India. Since then, we have committed nearly $300 MM to Bharti as part of a multi-billion dollar financing program and Sunil Mittal has built the leading integrated telco in India. With more than 2 million mobile subscribers – growing 10% per month – and interests in fixed and long distance as well, Bharti is thriving. Sunil was recently named 2002 Businessman of the Year by Business India, a significant recognition not only of his own accomplishments but also of the rising tide of new entrepreneurs in India. Sunil is a remarkable individual – he learned from early partners like BT and Telecom Italia but it was his ability to understand the local environment that has really made the difference. And this from a man who started by selling bicycle parts. I think one of the real changes I have seen over the last decade has been the emergence of a growing class of real entrepreneurs – not only bright, driven individuals but increasingly experienced in multiple geographies and at more senior levels of responsibility. That bodes very well for investors going forward.

Fifth and final myth – The US and Silicon Valley are the only role models. I could just stop there as I think many have now realized that replicating the valley is not the answer to everything. Bubbles aside, the Silicon Valley success story represented an unusual combination of factors that developed over a long period of time and peaked at an unusual moment in history. Listing overseas companies on NASDAQ and creating local second board growth markets were all too often seen as the ultimate goal. In Asia in particular, many of the necessary factors don’t really exist – mature capital markets, a merger and acquisition industry and culture, and so on. We have found that it is even more important to focus on building a durable business. Ultimately, there are no short cuts – a lesson learned yet again in the last few years. So investors need to be prepared to fund companies thru cash flow breakeven – multiple rounds of fund-raising from multiple investors just are less available. Management needs to recognize that there are actually some real advantages to such an approach – less time fund-raising although it is perhaps harder to find a place to hide when things don’t work. And everyone with interests in the region needs to work to improve the depth and breadth of the local capital markets. One of the real set-backs in the last few years was the focus of market regulators on creating second boards – local markets are not deep and broad to support one market much less two. The emphasis should be on creating sophisticated home capital markets with investors more attuned to local market dynamics.

Let me add some other thoughts on the role of government in attracting private equity. Governments typically understand the important role which risk capital can play in spurring economic development. And investors usually feel the need to recite the usual litany of needs: sound economic policy, transparent regulatory and tax policies, solid corporate governance standards, working legal and accounting infrastructure, well-developed banking and capital markets, forward-thinking social policies especially in education. [And, let’s not forget a nice airport and good hotel.] The list is fine but let me be a bit more specific:

1.)
Focus on rule based versus outcome based regulation. There is no worse feeling for an investor than thinking the game is rigged or having a rightful victory taken away. Circumstances change and everyone recognizes the risks associated with any government needing to address a perceived problem. However, arbitrary decision-making and processes focused on ensuring a specific outcome are troubling. In a similar vein, success stories are to be embraced. Investors take the risk of losing their money because they believe that they will occasionally make a significant profit. That is a good thing when it happens and is re-enforcing to others. Everyone needs those icons-those success stories that inspire others. Remember my comments on Infosys, Satyam, Huawei, and Legend.

2.)
Government should focus its efforts on building the infrastructure to create an attractive investment climate – not be in the investing business. Government-linked investment organizations are at best market distorting and are at worst feeding grounds for political scandal. Governments would be better served to use those dollars more productively. Focus on building the infrastructure that allows new businesses to be created and grow and that attracts providers of risk equity capital. If governments want to create domestic sources of long-term investment, they would be better served to do so as they consider pension systems, insurance, banking and asset management regulation

3.)
Investors need to recognize their own responsibility here. Private equity is about being a long-term value added active investor. Being a private equity investor in Asia takes an even greater sense of responsibility. Taking advantage of legal loopholes in an immature and evolving legal climate and then whining when they get closed is not constructive. Sharing points of view on the complexities of getting things done and offering to be helpful in sharing similar experiences elsewhere is important. Share success as well as difficulties. Help policy-makers and others in the US and elsewhere understand that the simple laundry list is not always the right answer and there is often no substitute for time and making one’s own mistakes – the often-talked-about “reform” is a process, not an end-point.

So what’s the bottom line? How do I feel after nearly a decade in Asian Private equity? Investment eras are defined by certain basic underlying trends. In the 70’s, stagflation and energy crises defined a difficult environment for financial markets. In the last 20 years, technology-led productivity growth and the so-called fifth industrial revolution as well as declining inflation and interest rates lead to a boom in corporate profits and financial markets. It feels as if we are at another of those defining moments. What will be the key factors to define the next decade or two- - to start, I guess I’d say diminished expectations- get used to less about more. Demographics and the graying of Japan and Western Europe, the next phase of technology as the IT revolution becomes more firmly rooted inside companies and how they operate, and certainly terrorism. Finally, the rise of Asia especially China will be a defining element of the global investment climate over the next 20 years. I recognize the myriad issues and problems that Asia will confront as it continues to develop. And it will certainly not be a straight-line. However, the opportunity to be in the middle of it is intoxicating. I love Asia – I love investing in Asia. I appreciate the opportunity to share my thoughts on and to try to address the misunderstandings – some of the myths and realities of investing in Asia. Thank you.