Perspectives
R E P R I N T
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Behave Like a Venture
Capitalist
Reprinted by permission of The Asian Wall Street
Journal © 1998 Dow Jones & Company, Inc. All
Rights Reserved worldwide.
From great crises come great opportunities;
Asia’s ongoing financial meltdown is no exception. Many multinationals are finding that the
time is right to acquire Asian assets, and access to
once closed markets has never been better.
Borrowing the principles of risk management
from the domain of venture capital and applying
them to the situation in Asia will allow the
acquisitive multinational to tailor an approach
that is both creative and robust.
Until recently, companies on the prowl for investments in Asia were often frustrated by two
unpalatable realities. First, a distinct absence of
willing sellers meant that there was not much
available to buy. Both asset inflation, which flattered managers and convinced them of their ability to add real value, and a “less than AngloSaxon” process of capital allocation, which often
rewarded conglomeration, conspired to make
selling a business more a sign of failure than
anything else. Second, on the rare occasion that
a seller did emerge, asset inflation had often
made market values so far in excess of
discounted cash-flow values that no amount of
synergy could earn back the implied value
premium. No wonder, then, that the expansion
of industrial companies into Asia was largely
greenfield. Or that today the best shorts are
Asia-dependent equipment suppliers.
Conventional wisdom now says that all Asia is
for sale, and at fire-sale prices. Multinationals are
setting up M&A task forces and there are so
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many investment bankers rumbling round the
region that levels of hot air are becoming alarming. Having said that, it is undoubtedly true that
in many industries market values are below
prospective cash-flow values for the first time in
a decade. Exuberance is understandable, but it
does need to be tempered with a healthy dose of
caution. The issue is not so much whether multinationals should expand in Asia — after all, the
region still has a large, literate, low-cost labor
pool that is prepared to work hard and save a lot
— but rather how to structure and time the
expansion.
The risk factors, starkly illustrated in recent days
in Indonesia, reside in the aftershocks of the
crisis and are all topics about which pundits are
blowing hard. The Japanese economy? Yuan
devaluation? The Hong Kong-dollar peg? Joseph
Estrada, president of the Philippines? Bankruptcy
legislation in Thailand? Malaysia’s banking
system? Habibie? Hedge-fund managers looking
for volatility are drooling.
There are enough things that could go wrong
that some things will go wrong; but only a fool
would try to forecast precisely which, or when.
More foolish still would be to pin your plans on
one particular set of forecasted outcomes. The
point is that forecasting breaks down in the face
of complexity. This puts strategists in a quandary
as they contemplate their acquisition plans for
the region. Should they put things on hold until
the situation becomes clearer? What if a competitor secures the best targets by moving more
boldly?
One solution is to approach the situation as a
venture capitalist, rather than as the typical
industrial investor. The venture capitalist knows
that 20 to 30 percent of his investments will be
dogs, that about half will be so-so, and that about
one in five will be a big winner. Unfortunately,
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C A P I T A L I S T
he doesn’t know which will be which. Faced with
this uncertainty, the venture capitalist seeks to
structure risk-management mechanisms into his
investments such that he can limit his downside
in transactions that go sour and participate in
more of the upside in the success stories. The
following principles of risk management utilized
by venture capitalists will help multinationals
devise a winning approach when it comes to
acquisitions in today’s Asia:
• The cliché about there not being “one Asia” is
true, especially when you think about your
potential investments as a portfolio in which
risk must be diversified. Asian economies will
recover at different speeds and with varying
degrees of volatility along the way. Consider a
set of smaller investments across countries, each
one representing an option on a much greater
investment if the right economic conditions
materialize. Under the circumstances, multinationals would be foolhardy to invest heavily in
one particular country to the exclusion of all
others.
• Find ways to build operational linkages across the portfolio in ways that can manage risk. If demand in country A slumps, the
ability to export surplus capacity to your market position in country B may be critical.
• Do not automatically seek majority in a target.
Explore the possibility of taking a minority
stake. Bolster the power of the minority position by taking board seats and by incorporating
super-majority voting requirements or veto
rights over key decisions.
• Endeavor to negotiate a management contract
that gives you operating control and that generates performance-based fees in addition to the
dividends and capital gain that accrue directly
from an equity position. At a minimum, insist
on the appointment and secondment of your
people to key positions.
• Build into the agreements the possibility of
acquiring additional equity through call options
or convertible debt with a preferred yield.
• Manage the downside by incorporating a
“material adverse changes” clause that would
allow you to unwind your position with a put
option to the seller.
• Do not let the bankers off the hook. Your
equity should not be used to take out or guarantee debt in the target. Instead, seek interest
deferral and extensions of repayment schedules
to reduce the present value of the loans
outstanding. Consider sharing the upside with
the bankers if they guarantee your put option to
the seller.
• Finally, and this may sound like heresy to some,
think about collaborating with your competitors
by making joint investments. After all, co-investment is a key operating principle among
venture capital firms. Consider establishing a
direct investment fund to be jointly capitalized
by you and two or three of your fiercest
competitors, and use this as the vehicle for
acquisitions. In addition to the risk-diversification benefits, this might also reduce overly
competitive bidding situations that can push up
acquisition prices to extreme levels.
An industrial group recently asked whether it
should be aiming to invest $500 million or $5 billion in Asia. The ideal answer is both — because
by taking minority positions, with call options on
the majority if things go well, or put options to
the major shareholders or their bankers if things
go badly, both outcomes could eventuate.
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Asia remains highly uncertain. But uncertainty
and opportunity go hand in hand. Managers’
response to the crisis should be neither to rush to
exploit opportunities nor to avoid risks at all
costs. They should strive to navigate the risks
wisely. Using the investment philosophies of the
venture capitalist will allow companies to build a
portfolio that will stand the test of time, whatever
the outcome for specific Asian economies.
Nick Bloy
Mr. Bloy is a vice president in the Kuala Lumpur office
of The Boston Consulting Group.
© The Boston Consulting Group, Inc. 1998
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