Dealmaking is back on the table for private equity firms focused on Asia. After the biggest global health emergency in more than a century put an almost complete stop to in-person site visits and meetings, executives are once again seeking opportunities where they can see potential for transformation and profitable disposal in the future.
According to research from McKinsey, the global economic recovery from Covid has rapidly increased the demand for logistics and distribution services, which has far outstripped supply. This has caused PE behavior to shift. Its due diligence of prospective investments has increasingly focused on companies that rely on supply chain resilience.
Getting products from design and manufacturing and into markets along secure distribution routes will always be a key requirement for companies no matter what economic and geopolitical storms they may have to adjust to. This focus on distribution is heightening the interest in deals for companies that make supply chains work.
For example, according to research from global law firm K&L Gates, there were 53 PE deals involving logistics and supply chain in the U.S. from the beginning of the year up to August 2022 worth a total of $20 billion. This compares to $7.9 billion in 2020, and $5.1 billion in 2019.
Before private equity firms attempt to seize opportunities arising from the pandemic, either in sectors with robust supply chains, or in the supply chain sector itself, they should be aware of some of the critical changes that have been affecting investments in Asia in recent years.
The complexities of supply chain businesses compel private investors to understand the inner workings of the sector and subsectors that support the overall supply chain ecosystem.
Three factors in particular are impacting the supply chain sector in China.
The first focuses on the political and economic tensions between the U.S. and China, which have been barely reduced since a new American presidency began in 2021. There are no signs of U.S.-China relations improving as each country continues to assert itself globally. Business is much happier when these tensions are dialed down and, conversely, much more nervous when they ratchet up again. This tension leads to uncertainty and unpredictability, making companies more cautious about going ahead with deals.
The second factor was already making an impact before the pandemic. The health crisis only sped up what numerous companies had been thinking about: is it wise to have supply chains so focused on China? According to McKinsey, China accounted for 35 percent of global manufacturing output in September 2020. Because of the heavy reliance on supply chains in China, companies have begun diversifying production away from the country, though without leaving it completely, to decrease risk.
Spreading the Load
A single thread supply chain is no longer appealing because the risk is far too high. Companies now want to implement an agile, multi-faceted supply chain in multiple locations. Central and Eastern Europe, with highly educated, low-cost labor forces, Vietnam, India, Mexico and Malaysia are examples of locations where businesses are setting up or expanding manufacturing operations, as well as looking at reshoring and near-shoring options.
A 2020 survey from market analysis and research firm Gartner found that: “One third of companies with global supply chains have moved their sourcing and manufacturing activities out of China or plan to do so in the next two to three years.”
Competition for foreign direct investment from other Asian countries, such as Malaysia, which continues to attract some big international companies from industries such as semiconductors, cars and chemicals, Vietnam and India, have also spurred this move towards supply chain diversification.
Thirdly, the U.S. and China have diverged on how to manage the pandemic since the very beginning. While vaccination is still mandatory to enter the U.S. for non-U.S. citizens, other requirements such as mask wearing have long since gone away, and quarantining is non-existent. China pursued a zero-Covid strategy from the start, which consists of lockdowns, lengthy quarantining and flash testing of communities around the country. China’s strict enforcement of these policies has made entering the country much harder than leaving it.
These restrictions have hindered all companies, not just private equity firms that want to visit prospective targets or overseas companies that want to re-connect with local operations, and have also slowed the plans of Chinese companies who want to expand abroad to diversify their supply chain risk.
Effective Due Diligence
All of this means that the reshaping of global supply chains is making private equity firms reassess and often rework investment decisions and post-deal transformation strategies in three ways:
- There has been a greater focus on supply chain due diligence.
- Supply chain concerns are subject to extra scrutiny in evaluating potential acquisitions, as is the ability to pass supply chain disruption costs down the chain.
- Supply chain pressures are also influencing post-acquisition strategies, with the need for transformation and innovation to build long-term supply chain resilience increasingly taking center stage.
In this context, optimizing the supply chain for resilience becomes a fundamental lever in private equity value creation, protecting against future shocks while boosting operational performance and competitiveness within portfolio companies.
The importance of due diligence comes from the fact that not all opportunities will be the same and it will not be possible to assess them identically. A company’s perspective about a transaction will depend on whether it is a buyer or a seller and how quickly it wants to get out of the market or location it is in. Some target companies will want to get on with the next step in their strategy, so a purchase at a deep discount may be possible. Others may be able to hang on longer to obtain the best price for the business they are selling.
The upheaval of the last two years has emphasized supply chain risk and resilience, and the importance of due diligence when assessing any M&A transaction. The key role China plays in global production output should also focus minds on the robustness of supply chain arrangements in that country.