Mita Djajadiredja is a senior partner at Hadiputranto, Hadinoto & Partners. Mita has more than 20 years of experience in M&A and private equity, as well as corporate alliances, including joint ventures, shareholder agreements and strategic business alliances. Mita advises a wide range of domestic and international clients across various industry sectors, including real estate, insurance, finance, manufacturing and trading. Mita has consistently been ranked as a leading lawyer by leading legal directories, such as Chambers Asia and Asia Pacific Legal 500 for several years.
Gerrit Jan Kleute has more than 10 years of experience assisting multinational clients in cross-border transactions in both Asia and Europe. He has been involved in mergers and acquisitions work, as well as corporate restructurings and asset disposals for both private equity buyers and sellers and strategic players.
GTDT: What trends are you seeing in overall activity levels for private equity buyouts and investments in your jurisdiction during the past year or so?
Gerrit Jan Kleute: We see continued keen interest in Indonesia, with international private equity firms (PE) retaining teams in the country, such as Affinity, Carlyle, etc, as well as deals being done by regional teams such as CVC, TPG, Partners Group, Navis Capital and KKR. ‘Local’ firms include Saratoga, Nusantara Partners, Falcon House Partners and Northstar (although the funds are raised overseas, the partners are Indonesian).
While there is this keen PE interest in Indonesia, the number of signed and closed PE deals is still relatively limited, for reasons we will explain later. The number of published PE investments remains stable at around 10 deals per year, while that of published exits sits at around five. In addition, there are a number of processes for more regional business, often in the food and beverage sector, with activities in Indonesia in addition to other countries. We will not focus on these kinds of transactions in this article as such transactions are generally quite different in approach and size compared with purely Indonesian deals.
Mita Djajadiredja: The market in Indonesia generally consists of mid-market transactions, with deal sizes between US$25 million and US$150 million. The value of many Indonesian target companies is generally smaller than one would see in other overseas markets, as the activities of Indonesian companies are typically limited to Indonesia. Another relevant factor limiting the deal size is that most transactions are joint venture deals rather than full buyouts. The smaller deal size allows PE investors to get a feel for the market without too much exposure. It also offers opportunities for investors with a compelling buy-and-build strategy, provided they secure buy-in from the other shareholders.
Sectors where we do see large deal sizes are the infrastructure and energy sectors and increasingly the e-commerce sector.
GJK: Deal sourcing remains challenging in Indonesia, perhaps even more so than in other countries. Having a pre-existing relationship with the sellers in any jurisdiction creates a competitive advantage in a sale process. In Indonesia, many potential target companies are family owned or controlled businesses (whether or not listed). In their decision to sell, selling families often allocate a heavy weighting to the personal chemistry between the selling family and the buyer. The preference of the management of the target company and alignment of the strategy (including, very importantly, plans with key management) are also very relevant factors. Being the highest bidder does not necessarily result in winning the deal. In addition, many deals are still concluded without an auction or other form of broader sale process being organised. Having strong local roots or local contacts, whether or not the team is based in Jakarta, is therefore crucial in being successful in Indonesia.
MD: The value gap remains a relevant issue in deals for both strategic and PE buyers. We have seen various sales processes for Indonesian assets that were unsuccessful because of a gap in the valuation offered by potential buyers and those expected by the sellers.
GTDT: Looking at types of investments and transactions, are private equity firms primarily pursuing straight buyouts, or are other opportunities, such as minority-stake investments, partnerships or add-on acquisitions, also being explored?
GJK: The number of straight buyouts we see in Indonesia is fairly limited. In several sectors Indonesia restricts foreign investment to a limited shareholding. For this reason alone most deals are not straight buyouts. For example, warehousing businesses can be owned for no more than 67 per cent by foreign shareholders; insurance companies for no more than 80 per cent by foreign shareholders.
In addition, Indonesia is a market where one needs strong local contacts and a good understanding of the general way of doing business. Having a reliable local partner helps to navigate these complexities and is another reason why one doesn’t often see 100 per cent buyouts.
Because of the the tax advantages, a relatively large number of Indonesian companies are listed. These listed companies often have a limited free float and a large controlling shareholder. Take-private and delisting procedures are rare because they are complicated, costly and lengthy. This is another reason why PE investors decide against a straight buyout.
MD: As we mentioned before, many sellers are not willing to sell their entire stake or even a controlling stake. They want to remain involved in the business – sometimes as the majority shareholder, sometimes as a large minority shareholder. In our view, this is probably the key reason for the prevalence of joint venture type deals in Indonesia. This means that the PE investor often ends up in a situation with limited levels of control or even no formal control over the target. Turning around and rationalising the business therefore requires buy-in (if not consent) from the other shareholders, who might not have the same professional approach to these matters. The PE approach in Indonesia therefore needs to be different from what one typically sees overseas. Some funds have been clearly successful at navigating these challenges.
With changing macro-economic conditions, the key is identifying exceptional companies, working with the families and bringing value and growth to the business. One area of particular interest to firms remains the e-commerce and other digital sectors with continued funding rounds. These investments also show the interest in the (online) leisure sector in Indonesia – driven by growing local tourism and the Indonesian government’s plan to substantially increase the number of foreign tourists. Other active sectors are healthcare, including CVC’s investment in Siloam Hospital (a hospital group), Saratoga’s investment in Awal Bros Hospital Group (a hospital operator) and Navis Capital’s investment into Tawada Healthcare (a medical device distributor). Of course, the fast moving consumer goods sector remains in favour given the growing middle class. Other sectors that remain active are the infrastructure and energy sectors. And the real estate sector currently is very active.
GTDT: What were the recent keynote deals? And what made them stand out?
MD: The purchase by KKR of PT Unilever Indonesia Tbk’s food spread business for
2.92 trillian rupiah. The deal stands out as it forms part of KKR’s global acquisition of Unilever’s food spread business, but with a very specific Indonesian angle, given that the Indonesian legal entity is listed.
The acquisition of 19.9 per cent shares owned by Trinugraha Capital SA (a consortium of private equity funds that includes TPG and Northstar) in PT BFI Finance Tbk by Compass Banca has attracted attention from many bidders, certainly in the early stages of the process. The complexity in this deal evolved around an ongoing litigation in which title to a substantial part of the shares in the capital of the company is disputed.
Of course, we also have to mention the ongoing Go-Jek funding rounds. The latest Series E funding round raised around US$1.5 billion from backers such as Google, Temasek and JD.com.
GTDT: Does private equity M&A tend to be cross-border? What are some of the typical challenges legal advisers in your jurisdiction face in a multi-jurisdictional deal? How are those challenges evolving?
GJK: Most investments are structured through offshore legal entities, so in that sense private equity deals in Indonesia are mostly cross-border deals. Also the transaction documents are often governed by Singapore law, which introduces another cross-border element into the transactions.
We also see an increasing number of regional deals for businesses with activities in Indonesia and other SE Asian countries. Often these deals are run out of Singapore or Hong Kong. In such deals we work on an integrated basis without our colleagues in our other offices, to ensure we can deliver a seamless one-stop solution to the client. In view of the above-mentioned international aspect of any Indonesian transaction, on purely Indonesian deals we also often end up working hand in hand with our Singapore team. Hiring a firm that can cover all relevant jurisdictions is probably the best way for clients to deal effectively with coordination and timing issues in these multi-jurisdictional deals.
MD: As regards challenges, we don’t think the challenges of doing private equity deals in Indonesia are any different from the challenges faced by other investors. We have mentioned the negative list, which limits foreign shareholding in certain sectors. In addition, the usual Indonesian challenges on labour issues (termination rights on change of ownership), compliance risks and a longer completion process apply. These challenges make deals, even if offshore, more difficult to execute in comparison with other ASEAN countries such as Singapore and Malaysia. Transaction timing and getting things done in Indonesia can delay (multi-jurisdictional) deals, and this is unlikely to change soon.
“There is no prohibition on an Indonesian company providing financial assistance in connection with the acquisition of shares in its own capital or in the capital of its parent company.”
GTDT: What are some of the current trends in financing for private equity transactions? Have there been any notable developments in the availability or the terms of debt financing for buyers over the past year or so?
GJK: While financing capacity is generally ample around the region, most PE deals done in Indonesia in recent years were growth capital oriented and did not need financing, at least at the time of investment. Since many deals involve minority deals, it is (commercially) not possible to push down the debt and security. Such deals also generally don’t result in a change of control, which means that also no mandatory repayment event in respect of the existing financing of the target company is triggered. However, we sometimes see the new shareholders decide to refinance anyway, sometimes with the aim of financing a payout to shareholders. PE players with their strong relationships with banks and deep insight into covenant terms are often able to reduce the costs of financing. Where an investment is funded in part through a bank loan, offshore banks are used as a result of restrictions on foreign firms to borrow onshore.
There is no prohibition on an Indonesian company providing financial assistance in connection with the acquisition of shares in its own capital or in the capital of its parent company, subject to the general corporate benefit principle. Often the corporate benefit issues appear in a transaction that involves a debt pushdown. In some industries, the company needs approval from the regulator before it can obtain a loan or provide any security.
GTDT: How has the legal, regulatory and policy landscape changed during the past few years in your jurisdiction?
GJK: There are no specific regulations aimed at private equity investors. Private equity is treated no differently from other investment, including as regards tax.
In July 2018, the Indonesian Financial Services Authority introduced a new rule on takeover of public companies. This new rule introduces a limitation on the mandatory tender offer (MTO) exemption with regard to a rights issue. Under the new rule, the exemption only applies if the control is acquired as a result of a ‘shareholder obtaining shares by exercising its rights in proportion to its shareholding’. Therefore, if the control is acquired in a rights issue other than through a shareholder exercising its rights in proportion to its shareholding (eg, buying rights from other shareholders), it would be subject to the MTO requirements. This limits the possibility of getting around an MTO sometimes used in (PE) deals involving listed target companies. On the other hand, the new rule now clearly exempts a takeover that has been announced in the IPO prospectus of a public company from the takeover and MTO requirements set out under this rule. This might create an interesting exit or entry path for PE investors.
In July 2018, the government also launched a new online single submission (OSS) system, which (in time) will make the licensing process in Indonesia easier and faster. There is a substantial mindset change with the new OSS system. Rather than the government monitoring compliance prior to licences being issued, the OSS system assumes that companies will self-assess and will ensure compliance, with the ultimate sanction being that a non-compliant company’s registration will be frozen, and dealings with the government will be delayed or will become more difficult, until there is compliance. Once fully functional, the OSS system should make transactions faster to complete.
Perhaps more important is the family issue, where the second generation offshore educated family members are more accepting of private equity, understand the value private equity can bring and take a longer term view with private equity firms to build up enterprises into stand-alone businesses that are ultimately listed.
GTDT: What are the current attitudes towards private equity among policymakers and the public? Does shareholder activism play a significant role in your jurisdiction?
GJK: Unlike in more developed markets, people have a fairly neutral perception of private equity investors. There are no negative associations with the concept of private equity investors. At the same time it remains a fairly new concept, so a degree of education on the operation of a private equity fund is typically part of the discussions on transactions. Private equity investors are also not high on the agenda of policymakers in Indonesia.
Because shareholdings in many Indonesian companies are very concentrated and often in the hands of one family, one doesn’t see many takeover battles in Indonesia. Without a deal or at least an understanding with the controlling shareholder, there perhaps also is little point in pouring money into a company without getting any level of control in return. Aggressive approaches also do not fit very well with the Indonesian spirit of cooperation. Investors who are perceived not to behave as such will not easily be accepted by the controlling shareholders.
GTDT: What levels of exit activity have you been seeing? Which exit route is the most common? Which exits have caught your eye recently, and why?
MD: Over the past few years, the number of announced exits has been somewhat lower than the number of announced investments. This is partially because of adverse market conditions in various sectors and the generally worse than expected economical performance of Indonesia. Most recently also the decrease in the rupiah (IDR) against the USD, with the IDR recently hitting its lowest point since 1998, is affecting exits (and PE returns generally). When converted into USD even the best performing portfolio companies show weak returns at best. This negative trend in particular affects portfolio companies acquired during the period 2011 to 2013 when the IDR was substantially stronger.
Equally important is that exits in Indonesia are typically more complicated than elsewhere. There is no developed secondary market. Many investments are joint ventures with other shareholders and the pre-emption and tag rights of such other shareholders require careful planning to be able to offer deal certainty to a potential buyer. And even with careful planning, it sometimes remains difficult to offer this certainty, in which case alternative solutions must be found to make it attractive for potential buyers to look seriously at the opportunity.
GJK: Also some of the more aggressive structures used to be structured around the letter of the foreign investment restrictions, such as loans, exchangeable bonds or convertible bonds, making an exit more difficult. Not all potential buyers have the same risk appetite for such structures or are only willing to consider them at a substantially discounted price.
In situations where the exit is for a minority stake, clearly the buyer spectrum interested in such opportunity is also limited. This is why a substantial number of exits is structured through IPOs. The IPO exit also allows for a more favourable tax treatment (as we will discuss below) as well as an easier and perhaps staggered exit.
GTDT: Looking at funds and fundraising, does the market currently favour investors or sponsors? What are fundraising levels like now relative to the past few years?
MD: Fundraising is mostly not done in Indonesia given the regulatory environment (including tax) is not conducive; consequently, fundraising is generally done offshore.
GTDT: Talk us through a typical fundraising. What are the timelines, structures and the key contractual points? What are the most significant legal issues specific to your jurisdiction?
MD & GJK: Fundraising is generally done offshore in money centres, so is not relevant to Indonesia.
GTDT: How closely are private equity sponsors supervised in your jurisdiction? Does this supervision impact the day-to-day business?
GJK: Private equity sponsors are not specifically supervised in Indonesia. They are treated very much like any other investor. Depending on the sector in which the target company is active, there may be monitoring or approvals required, but, again, those are not different for other strategic investors.
“Any private equity firm that can minimise the tax consequences through innovative structuring has an advantage.”
GTDT: What effect has the AIFMD had on fundraising in your jurisdiction?
MD & GJK: We do not believe this question is relevant to Indonesia.
GTDT: What are the major tax issues that private equity faces in your jurisdiction? How is carried interest taxed? Do you see the current treatment potentially changing in the near future?
MD: Private equity investors are taxed no differently from any other investor (including a carried interest that is treated as gain). The usual tax rules apply – including for offshore private equity firms, whether or not gain is protected under any double tax treaty and if not any sale of shares is taxed at 5 per cent of the transaction value (unless listed when rates drop to 0.5 per cent for founders and 0.1 per cent for other shareholders).
For Indonesian sellers, any gain is treated as ordinary income and taxed at 25 per cent for corporates and 30 per cent for individuals. These high tax rates can be a thorn in pricing negotiations, especially where the seller is a founder of the target company (in which case the capital gains taxes have a big impact on the net proceeds for such seller). Any private equity firm that can minimise the tax consequences through innovative structuring has an advantage – whether assisting with loans to pay out retained earnings, converting retained earnings into equity, depending on circumstances doing an immediate IPO or having a clear route to an IPO in the short term (so the tax rate of 0.5 per cent applies) or otherwise allowing an appropriate restructuring to take place.
GJK: The Indonesian Tax Office’s close scrutiny on structures, including restructurings pre investment, the use of special purpose vehicles to treaty shop, and on convertible instruments, means structuring deals need to be considered carefully, and there is no sign such scrutiny will diminish. One of the key tax issues is convertible instruments, which must be converted at fair market value – otherwise if at a discount, which is what private equity firms want, any differential is taxed as additional interest. The Indonesian Tax Office is also scrutinising an alternative loan and warrant structure (segregated into loan and discounted warrants on which theoretically no tax should be paid except on loan interest) and has yet to make a determination on whether this structure is taxable as a convertible instrument.
GTDT: Looking ahead, what can we expect? What might be the main themes in the next 12 months for both private equity deal activity and fundraising?
GJK: We believe that private equity in Indonesia is here to stay. It is becoming more and more part of the mainstay of dealmaking. Sellers are starting to realise the advantages in having a strong partner on board who is focused on value creation and at the same time is not a competitor. Also the fact that private equity investor needs to exit eventually is generally seen as positive as it allows the family to regain full control over the company.
In addition to the deal sourcing, coming up with approaches to bridge the value gap will be crucial. We are already seeing an increase in the use of tailor-made purchase price methods with earn-outs and other performance-based elements. These methods offer possibilities to get to a higher enterprise value secured by adjustments in case the assumptions underlying the valuation are not realised. While structuring such purchase price methods, one needs to be careful that it doesn’t become too complicated for both parties to understand, especially taking into account that sellers often have much less experience with sophisticated financial modelling than the average PE investor.
Finding the balance between the rigorous compliance and reporting requirements expected by private equity funds and the realities of a developing country such as Indonesia will also remain a key challenge in the next years.
MD: Finally, there will be presidential and parliamentary elections in April 2019. Deal activity may slow down nearer the time of the elections, with investors taking a wait-and-see approach in view of these elections, which will have an important impact on Indonesia’s direct future.
The Inside Track
What factors make private equity practice in your jurisdiction unique?
Having a strong PE/M&A practice, with multiple practitioners focusing on specific industry sectors, allows HHP to bring industry and regulatory knowledge to deals. HHP has a strong capital markets practice that assists PE houses seeking to do PIPE deals, taking a position in a company pre-IPO as well as listing companies for exits, being a more popular exit mechanism rather than trade sales. HHP is also able to draw on the Baker McKenzie network to provide an integrated solution in multi-jurisdictional deals.
What should a client consider when choosing counsel for a complex private equity transaction in your jurisdiction?
With a larger number of firms providing quality advice, regular deal experience is key to ensure that market practice, whether international or domestic, is known . In addition, industry specific knowledge is also key to ensuring a deal gets done properly and reaches closure. Lastly, given the smaller size of Indonesian law firms, the depth and breath of teams and their ability to provide a one-stop solution to multi-jurisdictional deals is also a key consideration. Judging a firm on price alone may not ultimately be the way to go.
Mita Djajadiredja and Gerrit Jan Kleute
Hadiputranto, Hadinoto & Partners, member firm of Baker McKenzie International