As hundreds thronged a financial conference in Hong Kong last year to hear an executive of US private equity firm Bain Capital, Doug Coulter took a seat in a nearly empty room next door at a separate session on the secondary part of the buyout industry in Asia.
Coulter, Asia head of private equity for LGT Capital Partners, was encouraged by what he saw.
"I just thought, 'Wow, nobody is covering this. This is a great opportunity ,'" Coulter recalled, reminiscing about the 2011 Asia Venture Capital Journal event.
Five years after global buyout giants first flocked to the region to tap its growth, Asia's private equity market has reached a tipping point. Maturing funds, a crop of inexperienced managers and global market instability are all opening the door for so called secondary players to come in.
Lexington Partners, Pantheon and Green Capital have launched in Hong Kong in the last year alone, joining LGT and others already here.
NewQuest, which spun off from Bank of America's private equity arm, recently opened in Hong Kong as well. Most of the major secondary firms are now set up in Asia, taking a crack at what is a relatively small field compared to the traditional buyout industry.
These firms face a budding opportunity and a major challenge, as they too are susceptible to the region's volatility and will be playing in a smaller market than in other parts of the world.
Secondary investors operate in several ways. They can buy stakes in private equity funds from investors seeking an exit, take over managing a company or a portfolio of companies held by a private equity firm, or they can team up with a private equity firm doing a leveraged buyout by offering cash to support a bid.
Secondary players in Asia have performed all three of these functions in the last year. While the market here is just getting started, around the world, industry analysts expect there to be $30 billion in secondary transactions this year, more than triple the amount two years ago.
Newquest
Tucked away behind the bustling central business district of Hong Kong is a new building with no name, the number "8" being the only identifying sign.
On the 26th floor, in a freshly painted office, NewQuest Capital Partners looks and feels like a startup, even though it is made up of a team of veteran industry professionals.
"Not many people know about this building," said Darren Massara, an American of Italian heritage and the former Asia head of private equity at Merrill Lynch, now the managing partner of NewQuest.
Not many people know the private equity market Massara plays in, either. Secondary market activity tends to grow when the primary private equity sector stalls, and requires new investors and managers to support the industry.
NewQuest, with backing from HarbourVest, Paul Capital, LGT and Axiom Asia, was formed when Bank of America dumped Merrill Lynch's private equity arm after rescuing the brokerage in 2008. NewQuest now manages Merrill's former private equity portfolio.
Newquest estimates that $200 billion of private equity capital invested in Asia since 2005 has yet to exit. With IPO markets shut and many Asia private equity funds fully invested and seeking new funds, the pressure is on both buyout firms and their committed investors -- known as limited partners (LPs) -- to show investment returns.
That is where the secondary firms come in. The firms specialise in buying these commitments from LPs that want to cash out of a private equity fund. Secondary firms assume that commitment and the ups and downs that can come with it, such as eventual profits from the sale of various holdings.
A strong run in the first half of last year saw private equity-backed Asia Pacific M&A hit its best figures since 2006 on volume of $33.2 billion, according to Thomson Reuters data.
But fourth-quarter volume plunged 67 percent to $3.9 billion, the data shows, as equity and debt availability dried up in the second half amid global economic turbulence fed by Europe's debt crisis.
In that economic turmoil, the struggles of private equity managers in the region grew, with sources pointing to India's private equity sector as a brewing trouble spot, where a lot of money was raised, with very little coming out.
And even though LPs are still pouring money into Asia, that money is going mainly to top-performing funds. Many of Asia's first-time funds are expected to go out of business.
That is another area opening up for secondary firms in Asia. Primary private equity funds avoid the practice of taking over the struggling portfolio of a peer, but certain secondary firms are happy to do so.
Another secondary area opening up in Asia is investing alongside leveraged buyouts.
When Bain Capital acquired Japan's Skylark restaurant chain from Nomura last year, the equity cheque needed for the deal was a massive $1.3 billion. Bain signed for $1 billion and its limited partners, including HarbourVest, came in to provide the other $300 million.
India, China
The challenges secondary players face can be daunting. These include investing in a poorly run private equity fund, co-investing in a buyout deal that fails, and failing to revive a struggling portfolio of companies.
Asia's secondary market role has been small until now, largely because the region's private equity boom only kicked off in 2005. Fund and deal sizes tend to still be smaller than in the United States and Europe.
That is changing, as the early wave of investments are coming due for exits now.
"Asia will be a bigger part of the deals universe," said Tim Flower, Principal at HarbourVest Partners, Asia . "You've got to be here if you want to have complete global coverage."
The same drivers that influence the secondary market in the rest of the world are at play in Asia.
Australian banks and Japan's megabanks, like their counterparts in Europe and the United States, are selling private equity stakes, in part because of the 'Volcker rule' and Basel III capital rules, which offers a massive opportunity for secondary firms to fill.
In addition, sovereign wealth funds and pension funds are pruning their exposure to alterative assets such as private equity amid the economic downturn, cutting underperforming managers from their rosters - another window for secondaries.
GIC, the Singapore sovereign wealth fund, is selling $750 million of private equity and other funds it no longer wants to invest in, and will redeploy the money to other better-performing managers, according to sources familiar with the matter.
India is a current focus for secondary specialists, where overcrowding in the private equity space, coupled with high valuations and now shuttered IPO markets mean secondary activity is rising.
Tens of billions of dollars have been raised for India private equity activity. But getting that money out has been a challenge. Exits through the Indian IPO market dropped 66 percent in 2011 to $85 million in 15 deals, according to data from VCCircle.
China is also on the radar, as the country's roughly 3,500 funds, many of them start-up firms suffering from last year's market selloff, face an industry shakeout.
Besides the $200 billion in unexited positions in Asia, NewQuest estimates an additional $110 billion is sitting on the sidelines, waiting for investment.
As private equity veterans like to point out, it's easy to put money into a company. Asia's first-time funds are finding out how difficult it can be to get the money out.
"There is likely to be substantial dealflow in the secondary arena for some time to come," said Harbourvest's Flower.
