25 Years of Private Credit: Find the Gap, Mind the Gap, Fund the Gap

25 Years of Private Credit: Find the Gap, Mind the Gap, Fund the Gap

ADM Capital has been a credit provider to mid-market corporates across Asia Pacific for 25 years. In that time, much has changed.  Asia Pacific economies have become more sophisticated and their financial systems more resilient. Capital markets in the region have grown strongly and regulatory environments have improved beyond recognition.  The region’s growth over the period has been exceptional. In the 14 countries in Asia Pacific where ADM Capital currently operates, total GDP has grown by 589% to almost US$2.25 trillion, a growth rate 184% above the global average.

Despite the structural changes and stellar development, the core market dynamics remain the same. The region continues to be the world’s growth engine and mid-sized companies, which are largely driving this growth, continue to need flexible funding, yet availability is challenged. Underlining the funding void that exists, only ~7% of global private credit assets are located in Asia Pacific[1], despite the fact the region accounts for one third of global GDP and two thirds of incremental global growth.

Another constant in the past 25 years has been ADM Capital’s investment principles. We remain fully focused on finding and funding the gap afflicting mid-sized companies in the region by providing capital for their sustainable growth. We combine top-down country and thematic investment preferences with the idiosyncratic risks derived from our bottom-up sourcing approach, and look to provide investors with diversified, uncorrelated portfolios.

Find the Gap

As specialist investors, ADM Capital has consistently and successfully identified funding gaps across a dynamic and complex continent, navigating through several market cycles.

We began investing in the aftermath of the Asian Financial Crisis in 1998 to address squeezed liquidity for companies arising from balance of payments issues in fast-growing Southeast Asian economies that could not honour their foreign currency liabilities due to limited FX reserves. ADM Capital’s first fund took on a number of these distressed positions in specie, aggregating a majority creditor position, and working them out. The firm’s mission was to provide solutions to the market chaos.

Our remit then expanded into non-performing loan workouts in Korea and special situations across the rest of the Asia Pacific region. As growth returned in 2004 led by China’s booming exports, companies sought funding to fuel their growth ambitions. This led to ADM Capital selectively participating in high yield opportunities, especially in Indonesia and later in China, at a time when the number of investors in Asian high yield bond markets was limited.

Following the 2008 Global Financial Crisis, banks withdrew substantially from the market due to regulation-induced risk aversion. This increased the funding gap dramatically for smaller, growing companies.

During this tumultuous period, we identified the need for responsible investments to address the vast and visible negative environmental impacts that lamentably accompanied corporate growth. This led to ADM Capital integrating sustainability into its investment process to enhance risk management and create long-term value.

Wide Geographic and Sector Footprint

ADM Capital’s geographic and sector foci have been shaped by where funding gaps have emerged and by sourcing exciting, risk-adjusted opportunities through an extensive pan-Asia Pacific network.

In the early noughties, this included distressed situations in Southeast Asia, bridging financing opportunities in China as its economy boomed, and then growth capital in India. From 2015, we capitalised on a trend of increasing intra-regional trade out of Australia, specifically financing Australian investments linked to other Asian markets through borrowers, customers or suppliers. Australia, Southeast Asia, China and India now account for the majority of our investment portfolios.

Elsewhere, we have increasingly explored frontier markets, taking small positions in well-recognised companies or those fulfilling a well-documented gap in the market.

In the past five years, our vast Asia Pacific footprint has enabled us to capitalise on the rising number of intra-Asia Pacific deals related to the regionalisation of trade, driven by geopolitics and supply chain issues. This trend was outlined in a recent article from The Economist: How Asia is Reinventing its Economic Model.

At sector level, ADM Capital has always been agnostic. However, we negatively screen defence, alcohol, gaming and other sectors to ensure we meet our sustainable principles and align with IFC’s Exclusion List. Reflecting growing incomes in Asia Pacific and the rise of Southeast Asia as a tourism hub (the region today accounts for 27% of global tourism receipts), we have sourced and financed deals in various property-related sectors including hospitality, hospitals, outsourcing centres, data centres, office buildings, and logistics hubs.

Diverse Use of Funds

While we have been agnostic about the end use of funds, we have historically prioritised growth funding opportunities and avoided refinancings. We have helped facilitate share buybacks, financed acquisitions, and invested in companies and various special situations that could not be funded via traditional sources. Additionally, we have increased our participation in cross-border funding situations, which are typically underserved in the region, by leveraging our structuring and pan-Asia Pacific experience. The trust we have built with our investee companies has often resulted in our role expanding – for example, replacing their traditional funding supply for working capital.

Sharpened Focus on the ‘Missing Middle’

When ADM Capital was established in 1998, private credit in Asia was a rarity. Our playbook, therefore, focused on deal sizes ranging from US$10 million to US$70 million. Over the past 25 years, consolidation in the industry, the entry of new players, and direct investments from asset owners, have made the space for larger deals a crowded place. At the same time, as the venture capital industry grew, sub-US$20 million deals in early stages were suddenly able to find funding. In recent years, we have sharpened our focus on what we call “the missing middle”, which refers to deal sizes of US$20 million to US$80 million. This space lacks competition from other lenders or pressure on price, downside protection or covenants.

Additionally, as our investee companies grow, we continue to selectively lead syndications on large transactions and provide co-investing opportunities to limited partners. We expect this trend to continue as transaction sizes edge higher.

Mind the Gap

During our early years, we learned that investing in deals brought to us by intermediaries in the market was an easy solution to fill the funding gap, but our minority holdings and limited direct relationship with borrowers prevented us from intervening in challenging times. The syndicated deal space also became more crowded. Facing these twin challenges, in 2010, we pivoted to focus largely on bilaterally sourced private credit.

From a geography perspective, we have always been cognisant that Asia Pacific comprises a unique mix of developed, emerging and frontier economies with varying degrees of legal provenance. Therefore, we ensure that downside risks are truly covered despite taking over-collateralised positions. We also place a strong emphasis on ensuring that underlying business fundamentals and growth prospects remain strong. This includes adopting a tested investment process and a private equity-style approach to due diligence to mitigate risk and preserve capital. Furthermore, we seek majority share pledges from counterparties, including via offshore controlling vehicles, to ensure we can take over, hand over or sell off to other parties in case of default and a lack of other remedies.

ADM Capital is unbiased when it comes to sectors and, having lent to 34 industries, we find ways to alleviate divergent risk via complex structuring. For example, in the manufacturing space, we are mindful of accentuated sustainability risks and seek to measure, monitor, and ameliorate standards via our documented E&S action plans. Taking another example, the property sector tends to be buffeted by macro rather than micro factors, and we seek diversity in our funding across geographies and end use. In service sectors, where there may be limited access to hard collateral, we look for companies where cash flows are stable and predictable via contractual obligations with customers, and where businesses operate in clearly underserved markets and demand is explicit. Taking unrelated collateral to improve our risk-return profile is paramount. Our shorter-dated positions, averaging two to three years, enable us to act nimbly and refocus across mini-cycles as needed.

Sustainable investing is deeply embedded in ADM Capital’s philosophy. We recognised more than twenty years ago the role strong ESG could play in mitigating risks that otherwise could reduce financial viability. We have witnessed over the years that sustainable businesses outperform their peers, attract better exits, and drive positive change on a larger scale.

Demonstrating this commitment, our founding partners established the ADM Capital Foundation in 2006 to identify and draw attention to the environmental side effects of growth in Asia. We followed this in 2008 by becoming the first Asia ex-Japan fund manager to sign up to the UN Principles for Responsible Investing. From 2012, we began to systematically integrate third-party environmental and social due diligence into our investment process. Our efforts to improve portfolio company ESG performance are expected to support exits and improve valuations.

Fund the Gap

Flexibility in funding is the hallmark of our investment philosophy. Compared to other debt funding, we provide buffer in the early years, especially for nascent industries or companies. This takes the form of lower coupons, back-ending some part of the return, bulleting rather than amortising payments, and equity-linked returns.

To offset these risks, we seek to secure ourselves with high coverage ratios through unrelated and diversified pools of collateral, aligning interest via equity contributions, personal guarantees, and substantial pledges of counterparty wealth. Additionally, we typically obtain board positions at these companies to ensure we can correct course early.

From a sustainability perspective, we invest in companies only after a thorough diligence check and the formation of action plans for improvement. We have progressed towards investing in those companies with some sustainability bias via the fulfilment of various sustainable development goals, and by encouraging them to achieve stretch sustainability targets through hands-on guidance. We are increasingly looking to turn these stretch targets into sustainability-linked incentives as we continue to develop our approach.

Finally, credit is supposedly a self-liquidating mechanism but that has not stopped us from thoroughly securing our exits. Initially, this was largely achieved by ensuring multiple exit mechanisms at the point of investment. Subsequently, we have informally used our relationships in the market to help companies facilitate an exit and, more recently, have established a Partnerships team to optimise our relationships with a network of banks, private equity funds, other credit funds, asset management companies, brokers and service providers who can improve portfolio exit velocity.

Future Opportunities

The past 25 years have seen strong shifts in the demand and supply of funding across the Asia Pacific region. However, the sizeable funding gap for small-and-medium-sized enterprises remains ever-present. As 2023 draws to a close, continuing high interest rates, tightening in bank lending standards, and a slowdown in private equity activity are exacerbating the gap. High yield and non-rated G3 bond issuances in Asia ex-Japan are noticeably lagging FY2021 levels and may well remain subdued through 2024, creating opportunities for alternative credit funds to fill the void and access better quality credit.

Looking ahead, rapidly regionalising supply chains, the digitalisation of economies, the urgent prioritisation of developing climate resilience and adaptation, and a focus on specialised businesses transcending borders are key trends to observe. They will require nimble, flexible and creative capital solutions, and ADM Capital is well positioned to finance this strong pipeline of opportunities across borders.

Turning to individual Asia Pacific markets, in Australia we expect to see continued opportunities in carbon capture, smart city initiatives and EV-based opportunities for which traditional funding is scarce. As global companies seek to diversify their supply chains, “Make in India” manufacturing opportunities are coming to the fore, as evidenced by Apple’s decision to produce its iPhone 15 in the southern state of Tamil Nadu, as well as in China. As in other Asian countries, we also expect to see smart city developments ratchet up as India’s urban population continues to grow – India is expected to add an additional 416 million urban dwellers by 2050.

In China, we expect a growing number of opportunities to emerge as the government prioritises increasing domestic consumption, securing technology self-reliance and social sectors like eldercare. Given the ongoing difficulties in the property sector, pockets of opportunity in the distressed space could begin to look interesting.

In Southeast Asia, tourism is bouncing back to pre-pandemic levels, and this is translating into a pipeline of hospitality assets and logistics operations. Alongside this, we see potential opportunities emerging as Asian “tigers” begin to evaluate meaningful upgrades to their infrastructure and governments increase their focus on developing smart cities. For example, it is expected that by 2045 83% of Indonesia’s population will live in urban areas[2], up from 58%[3] in 2022. To meet this seismic shift, the government is implementing its 2017 “100 Smart Cities Movement” to innovate and digitise existing city infrastructure. Lastly, we see intra-regional opportunities proliferating as Southeast Asian nations increase their investment within the region.

We welcome all comments and questions at ir@admcap.com

 

[1] (Preqin, 2021)

[2] (PT Telekomunikasi Indonesia, 2023)

[3] (Trading Economics, 2023)