Private equity firm Warburg Pincus brings lots of cash and contrarian discipline to its big Asia push, but its real edge is brainy locals.
By Allen T. Cheng
January 2003
Institutional Investor Magazine
“Before I got a mobile phone, my wife used to have a tough time getting ahold of me when I went on business trips. She got really frustrated,” says New Delhibased Ikea International marketing executive Arun Chandra. Then he bought a cell phone. “Now,” he says, “she doesn’t need to remember all the prefixes for wireline connections and can reach me anywhere in India or in the world just by dialing my number.”
Chandra’s testimonial is as pleasing as a clear wireless signal to the ears of Sunil Bharti Mittal, chairman and group managing director of Bharti Tele-Ventures, India’s largest mobile phone operator. Mittal wants to expand his client base roughly fourfold, to 10 million subscribers, over the next three years, and with the help of Warburg Pincus, he just might do it. The New Yorkbased global private equity firm holds a 20 percent stake in the mobile phone company, and as the 45-year-old Mittal says, “Not only has Warburg given me $293 million, its executives have given me the best financial advice on managing Bharti.”
Jetting in monthly from the firm’s Singapore office, Warburg partners encouraged exbicycle-parts salesman Mittal’s grand expansion plans: Last year Bharti spent $328 million to snap up four rival mobile service providers and secure nine new mobile and four fixed-line licenses covering 16 of India’s 28 states and seven territories. The firm’s participation also helped convince Singapore Telecommunications (Institutional Investor, November 2002) to invest in Bharti and provide substantial technological advice. Analysts now believe the Indian company’s annual revenues will triple to $1 billion within three years.
Bharti may be Warburg’s biggest Asian holding, but it’s only one of more than 30 -- and a number of others also look very promising. Among them: China’s top telecom networking company, AsiaInfo Holdings; India’s biggest housing lender, Housing Development Finance Corp.; and South Korea’s leading credit card issuer, LG Card Co. All are growing fast.
“There are many venture capital firms but very few quality VCs,” says James Ding, president and CEO of Beijing-based AsiaInfo. “Warburg Pincus is the best I know in China.”
Warburg Pincus, it appears, has solved the riddle of how to succeed in Asian venture capital. Even the most promising young Asian companies are starved for money. Yet 18 venture firms have shuttered their Asian operations in just the past year or two, and new private equity investments in the region (ex-Japan) fell from $7.7 billion in 2001 to $3 billion last year, according to Asian Venture Capital Journal, which tracks such activity. Warburg, on the other hand, invested $200 million last year -- nearly 6 percent of the region’s total private equity outlay. It was Asia’s leading pure venture capital (excluding buyouts) investor. The firm has built a $1.5 billion Asian portfolio -- most of the money was invested after the Asian financial crisis in 1998 -- and Warburg may put a further $2 billion or more into the area by 2007.
Arguably, Warburg is now the most influential private equity firm in Asia. The U.S.'s well-connected Carlyle Group, H&Q Asia Pacific (which made a spectacular sixfold return on its $30 million 1998 investment in South Korea’s Good Morning Securities Co.) and regional specialist Walden International all have Asian portfolios comparable in size to Warburg’s. But none has anything like Warburg’s cash trove.
The firm’s New Yorkbased vice chairman, William Janeway, estimates that as much as a third of Warburg’s newly raised $5.3 billion global fund and a further $250 million to $300 million from existing investment vehicles could go to Asian companies.
“Warburg Pincus will certainly help drive trends in the industry in the years ahead,” says Richard Roque, a managing partner of William E. Simon & Sons (Asia), occasional Warburg co-investor and chairman emeritus of the Hong Kong Venture Capital Association. Among those trends: bigger stakes in the portfolio companies and greater emphasis on senior management skills. Warburg’s Asia commitment is also a pretty big bet for a firm best known for hugely profitable early-stage investments in U.S. companies, like applications infrastructure builder BEA Systems, medical services provider and insurer UnitedHealthcare and leading storage software maker Veritas Software Corp., and for turnarounds at Mellon Bank and toy maker Mattel.
“Asia [ex-Japan] is the most rapidly growing part of the world economy. We see it as a growing portion of our overall portfolio,” says Janeway. Warburg’s Asian portfolio stands to match or even exceed its European holdings within five years. The firm’s current holdings are U.S., 65 percent; Europe, 20 percent; and Asia, 15 percent.
Rising economies such as China’s and India’s, where Warburg plans to invest the bulk of the money, will continue to gain for decades, says Janeway, who personally oversees his firm’s global technology investments. Where Warburg differs most from its Asian rivals is in betting on the emergence of a huge consumer market in India. A handful of other firms have invested in Indian software companies around Bangalore and Madras, but virtually none is shepherding consumer-oriented businesses like Bharti. “We want to plug into these megatrends around the world,” Janeway says. “Asia is very important to us.”
Warburg’s nearly 23 percent compound annual return (net) over 30 years attests to a certain savvy in portfolio management. But having scads of cash doesn’t mitigate the considerable risks of Asian investing. Warburg has thus far written off about 8 percent of its Asian investments -- approximately $100 million worth -- and some dark clouds are gathering on the horizon: Regional growth has lost momentum, equity markets are down, and political risks remain ever-present. Asian governments have often halted promising economic reforms that risked jeopardizing social stability. In recent months terrorist attacks in Bali and the Philippines, nuclear threats exchanged by India and Pakistan and disclosures about North Korea’s furtive nuclear weapons program have only underscored the prevalence of risk.
Moreover, seeking out opportunities in underfinanced parts of the world carries special perils even for successful investors. Although Warburg may be able to find first-class investments like Bharti, it may not be able to extricate itself from them in a timely fashion in Asia’s illiquid markets.
Warburg’s one Asian exit attempt proved to be an embarrassing failure: The firm tried to sell part of its 32 percent stake in Chinese outdoor advertising company Media Nation upon its listing on the Hong Kong Stock Exchange in January of 2002, but the market was in a tailspin and suspicious investors couldn’t understand why Warburg would want to sell.
“Fund managers felt Warburg’s sell-down indicated a lack of faith in the company,” says Allen Lee, deputy editor of the Asian Venture Capital Journal. Warburg had to call off the sale. Shortly thereafter sketchy reports surfaced of management infighting at Media Nation. Warburg’s lead Asia partner, Chang Sun, stepped in to restructure the company. “We made the mistake of not detecting the underlying management problems,” he acknowledges. “The business is still a great one, however.”
WARBURG’S HISTORY IN ASIA IS REMARKABLY short. Charles (Chip) Kaye, who last April became co-president of Warburg’s global operation, was dispatched less than a decade ago to Hong Kong to develop an Asian counterpart to the firm’s U.S. and European businesses. He returned to New York in 1999, after five years in Asia, but left behind a rapidly growing investment portfolio, a strong senior management team and a network of offices that encompassed not only regional hub Hong Kong but also Bombay, Seoul, Singapore and Tokyo.
One of Warburg’s earliest investments under Kaye, in 1995, was a $25 million stake in Bank Tiara Asia of Indonesia, a part of the family-run conglomerate Ometraco Group. The bank was professionally managed and highly profitable. But when the Asian crisis hit in 1997, Bank Tiara was devastated, eventually becoming one of the dozens of failed private banks taken over by the Indonesian government. The crisis in the region “was totally out of our control,” recalls Sun. “We were fortunate we had only that investment in Indonesia.”
That jarring experience shaped Kaye’s view of investing in Asia. He wanted real local knowledge familiar with other parts of Asia. “From early on Chip saw India and China as big but poor,” says Sun. “Because the markets are big, there is plenty of room to grow. His theory turned out to be right. Most people write off Southeast Asia these days.”
Shortly after the Bank Tiara debacle, Kaye hired a number of highly regarded Asian nationals, who have gone on to play key roles in guiding Warburg’s investments in the region. Among his recruits were Sun, 46, a onetime air force officer in China’s People’s Liberation Army with an MBA from the Wharton School and experience on Wall Street and in Hong Kong working for Goldman, Sachs & Co., and Shanghai-born technology specialist Wayne Tsou, 35, who holds an undergraduate degree in electrical engineering from the University of Michigan, a master’s in the field from the California Institute of Technology and a joint law/MBA diploma from Harvard University. In 1997 they joined Kaye and Dalip Pathak, 51, an extremely able Indian executive who had come on board from the World Bank’s International Finance Corp. in 1995.
“Our ability to attract unusual individuals who are both world-class talent and Asian locals and then build an environment in which their potential can be unleashed is one of the most important things we have done,” says Kaye. Pathak is so highly thought of at the firm that in September he was promoted to head up Warburg’s European operations out of London.
The bright new hires, together with Kaye, directed Warburg’s attention toward China, India and, to a lesser extent, South Korea. These countries are likely to remain the focus of the firm’s fresh investments in the region.
WARBURG IS BASING ITS ASIAN INVESTMENTS ON three expected developments over the next decade, says Janeway: the emergence of large-scale consumer markets, the creation of world-class manufacturing operations that can serve as centers for global outsourcing and the establishment of a vastly improved technological infrastructure. India and China, which together account for a quarter of the world’s population, are likely to be major beneficiaries of these trends; a vibrant middle class, like Bharti customer Chandra, will begin to form -- and spend. Included in this upwardly mobile group will be a class of well-trained entrepreneurs, like Mittal, who will attempt to take advantage of liberalized markets.
Warburg has plowed $750 million into more than a dozen companies in India and $300 million into a dozen Chinese enterprises. “China, with a per capita gross domestic product of $1,000, and India, with a per capita GDP of $500, are about to take off,” contends Sun. He sees per capita GDP in both countries quadrupling in two or three decades. Declares Sun, “We want to be there when they take off.”
India and China, while rich in entrepreneurial talent, are poor in financial resources. “The capital markets are still in their nascent stages,” points out Sun. “Therefore, there will be opportunity to arbitrage. When good companies don’t have opportunities for funding, they come to us, and we can exert tremendous influence.”
Although South Korea is in a later stage of development, it meets Warburg’s investment criteria. “Korea is unusual as it represents a relatively sizable country entering middle-income status,” explains Kaye. “The unleashing of the Korean consumer and changes in the industrial structure after the Asian crisis are prompting the ongoing transformation of the Korean financial infrastructure. This is creating a variety of interesting investment opportunities.” Financial institutions, branded consumer products and services and export-oriented manufacturers hold allure, says Hwang Sung Jin, head of Warburg’s South Korea portfolio.
In India, Warburg is betting that the government will continue to withdraw from its intrusive role in the private sector. That expectation is based in part on the experiences of portfolio companies like Moser Baer India, an optical electronics company that sold a 23 percent stake to Warburg for $80 million in 2001. Executive director Ratul Puri, 30, recalls that his family-owned business struggled with the notorious Indian bureaucracy for about half of its 20-year existence.
“Up through the early ‘90s, my father [Deepak Puri, Moser’s 60-year-old chairman] had to go to the government to get permission for production quotas,” says Puri. “I remember once he sought to get permission to make 6 million compact discs, and the government gave him permission only for 600,000 discs. We had all these orders from overseas that we couldn’t fill.”
The Indian government, however, has gradually permitted its entrepreneurs to export with fewer and fewer restrictions, allowing companies like Moser to become global players. Since 1998 Moser has established itself as one of the world’s largest manufacturers of recordable video compact discs. Warburg’s investment is helping the company build a 110-acre manufacturing park in Noida, an industrial town outside of New Delhi. Moser’s ambition: to become the largest VCD maker in the world.
Mobile phone company Bharti is benefiting from New Delhi’s decision to permit private companies to compete with state monopolies. Since Bharti won its first mobile phone license in 1995 -- the year the government opened up the sector to private players -- the company’s AirTel-branded service has come from virtual nonexistence to take the No. 1 market position, with a 28 percent share; its government-owned rival controls less than 3 percent.
Rajesh Khanna, a Singapore-based Warburg partner who oversees the India portfolio, says the firm intends to devote a lot more investment to the telecom industry. “Overall, in the next five to seven years we will see significant growth,” says Khanna. India has 8.5 million mobile subscribers, a penetration of less than 1 percent of its total population. By contrast, more than 16 percent of China’s citizens, or 200 million people, use mobile phones. Analysts expect India’s mobile market to grow to 50 million users by 2007.
One measure of Warburg’s own expectations: Its $293 million investment in Bharti is its third largest in the world, behind the $500 million it has put into communications systems and software play Avaya, a U.S.-based Lucent Technologies spin-off, and the $445 million it has given to Bermuda-based insurer and reinsurer Arch Capital Group.
IN CHINA, WARBURG IS APPLYING THE SAME strategy of pursuing companies positioned to reap benefits from exploding consumer markets, outsourcing-geared technology and government liberalization of certain markets. The firm’s leading bet is AsiaInfo, which has greatly benefited from the gradual easing of restrictions on private telecom businesses. AsiaInfo is now the country’s top integrator of telecom systems for China’s biggest mobile phone operators. With the nation’s number of mobile users projected to double to 400 million in the next decade, AsiaInfo is expected to continue its rapid growth.
Warburg is also trying to foster stronger Chinese capital markets. The idea is to encourage entrepreneurs but also assist venture capitalists like itself. In June Sun founded the China Venture Capital Association to push for entrepreneurial rights and to fight discrimination against the private sector. He gathered more than 50 private equity specialists for the association’s launch in Beijing.
“Warburg co-founder Lionel Pincus helped set up the National Venture Capital Association in the U.S. 30 years ago,” says Sun. “If we can do the same in China, we can push venture capital forward. The time is ripe: The entrepreneurial pool is getting bigger.”
Perhaps Warburg’s most direct consumer play is in South Korea, where its biggest stake is in LG Card, the country’s leading debit and credit card issuer. Following aggressive liberalization of South Korea’s financial sector, card usage has increased nearly fourfold in just a few years. “We’ve grown very quickly, but we still have much room to grow,” explains H.C. Lee, the company’s CEO.
IN EACH OF THESE COUNTRIES, WARBURG’S investment strategy revolves around “partnering” with management to achieve a positive long-term outcome. That means the firm places a lot of emphasis on the person running the show. “All these companies we invest in -- we wouldn’t invest without the guy at the top,” says Tsou. “Many VCs start with a technology or a business model and then recruit a CEO. We must start with an outstanding CEO. For us, if the CEO is no good, it’s not worth investing.”
Bharti’s Mittal, for example, had in five years built AirTel into northern India’s leading mobile service before Warburg made its investment. “We met with a number of players,” recalls Pulak Prasad, a Singapore-based Warburg managing director who helps run the India portfolio. “We found in Sunil that he really had deep domain knowledge in telecom and was very profit focused and had a very balanced view on life instead of having tinted glasses. He had an impeccable understanding of finance in telecoms and had a great team, a great entrepreneurial team.”
Similarly, Warburg got to know Li Yinan, a former senior vice president of Shenzhen-based Huawei Technologies Co., and studied his business plan for a broadband equipment maker before investing $53 million with him. “His depth of market knowledge was absolutely impressive,” Tsou says of Li, who helped build Huawei, with its strong government connections, into China’s leading telecom equipment vendor, ahead of even U.S. giant Cisco Systems. (Huawei may be better known in the U.S. these days for building Iraq’s mobile phone network over the objections of the U.S. Congress.)
When Li, 31, and four colleagues approached Warburg in mid-2001 after they’d left Huawei, all they had was a vision of breaking into the Ethernet and data-switching business for carriers and commercial enterprises. “He wanted to build a next-gen market leader that was free of Huawei’s bad habits,” says Tsou. “We took a bet and helped Li recruit his full management team and built his company.” Li’s Harbour Networks Co. grossed $20 million last year and made a small operating profit. Brags Tsou, now a Harbour Networks director, “It has emerged as one of the leaders of next-gen broadband equipment in China and is taking market share away from Huawei, Cisco and the big boys.”
Warburg’s broadly diversified approach to investing includes searching for out-of-favor sectors. Operating with few industry restrictions, the partners put money into everything from early-stage companies to turnarounds and provide buyout financing. The firm liquefied much of its portfolio around the world in 1999 and 2000 when equity markets were still surging, returning $12 billion in cash and securities to its limited partners. It was a stunning move -- and brilliant in hindsight.
“We are truly contrarian,” says Tsou. “When others were investing, we were holding back. We had the wisdom to see we were investing into a bubble. People are always irrational. When it’s high, they don’t sell. But when it’s low, they’re afraid to invest. We’re just the opposite.”
“Most important,” adds vice chairman Janeway, “we believe very deeply that a company’s ability to generate positive cash flow on a predictable basis is the single most important criterion. No matter how cheaply or freely available capital may be, one should never lose sight of that fundamental truth. When the stock market loses track of it, that’s when we’re contrarians.”
Warburg operates through a single pool of funds and one global partnership. “This one pool of resources allows local managing directors to draw upon the resources and talent of partners globally when it comes to investment decisions,” says Asian Venture Capital Journal’s Lee. “They can do this because every partner shares in the same incentive scheme. When an investment in Asia does well, partners elsewhere share in the gain too.” Most of Warburg’s rivals tend to have different funds for different regions or industry sectors, which can preclude sharing of ideas among partners.
Having a large trove of cash allows Warburg to act independently -- and therefore swiftly. Says Sun, “We have enough money and proprietary deal flow that we don’t need to get into large investment clubs, which has a downside of slowing deals down.”
The global nature of Warburg’s portfolio serves as a lure to entrepreneurs seeking access to international customers and expertise on foreign markets. Harbour Networks’ Li says: “They have a lot of investments in technology in the U.S., and this helps us to build strong ties with companies in the U.S. From a business point of view, we need outsiders who have a different management point of view.” Adds LG Card’s Lee: “We are a local company -- we didn’t know what global standards were. With Warburg Pincus’s help, we could change our way of thinking to become more shareholder-oriented and transparent. As a result, our Korean institutional investors feel we are more reliable and have peace of mind.”
Warburg’s independent streak doesn’t sit well with some. One outsider describes the firm’s partners as “arrogant.” Even CEOs of Warburg-backed companies concede the firm drives a hard bargain, which can lead to bad feelings.
AsiaInfo’s Ding relates that when he and co-founder Edward Tian, both U.S.-educated techies, put together their business plan back in 1997, they offered Warburg 15 percent to 20 percent of a company then valued at $90 million in exchange for an $18 million investment ($10 million from Warburg, which in this case co-invested with venture capital firms ChinaVest and Fidelity Ventures, which put up the rest). Over a year of talks, Warburg and the other co-investors were able to squeeze out a 30 percent stake in AsiaInfo from Ding and Tian.
“They were very tough,” recalls Ding, betraying a bit of resentment. “They knew the telecom sector well, and they felt our valuation was too high. At that time, we really didn’t know enough about valuations.”
Tsou recalls the discussions differently. “Yes, there was a huge valuation gap between what the founders demanded and what we offered, because the two sides had very different beliefs about the basis of that valuation: the prospective projected financial performance of the company,” he says. “We thought the founders’ projections were overly aggressive and unrealistic based on our experience and understanding about the market.”
In the end the two sides settled on a wager of sorts. If AsiaInfo’s sales hit a target, the investors’ stake would be 15 percent; if not, the investors got 30 percent. Ding and Tian fell well short of the bogey, so Warburg and its co-investors held on to the larger stake.
“Though they’re tough,” says Ding, “they definitely helped us the most among our investors.” Warburg’s Sun persuaded Ding and Tian to take the company public on the Nasdaq Stock Market in early 2000. “At first, we didn’t want to -- we didn’t feel we were ready. But they convinced us of the timing,” says Ding. “Going public has been very good to us.”
As with all of its Asian investments (save the aborted Media Nation sale), Warburg did not try to use the public offering to cash out its AsiaInfo holdings. That begs the question of when and whether it will find another suitable opportunity to exit the company. With Asian IPOs slowing to a trickle, local acquisition activity subdued and global markets down sharply, Warburg has little choice but to stick with its current companies for the long haul. Says William E. Simon’s Roque: “With a little good luck and timing, Warburg will do well in Asia. But much will depend on luck and timing.”
