A word of caution, however: a spate of dealmaking is pushing asset prices upward, the report says. As a result, the corridor for success is growing narrower, and private-equity (PE) firms can no longer rely on growth alone to generate attractive returns.

"Successful dealmaking calls for careful target selection, accurate pricing and skillful execution, both before and after closing," said Dinesh Khanna, a BCG partner and a coauthor of the report. "We also believe there are significant opportunities beyond the conventional growth and demographics investment thesis."

Interlocking Forces Drive Southeast Asia's Growth

Despite its legacy of political, economic, and environmental turmoil, Southeast Asia has become a magnet for investment. With a population of 532 million and GDP, at $2.9tr in 2011, growing at about 8 percent a year, Southeast Asia is home to an expanding middle class. That creates investment opportunities in industries such as organized retail, consumer products, health care, education, transportation, and telecommunications. Economic liberalization and intra-regional trade are on the upswing, spurring lively competition for customers and capital. Southeast Asia also benefits from its rich endowment of natural resources, which include oil and gas, minerals, palm oil, and
agro-commodities. Strong demand is increasing wealth and powering the growth of adjacent industries such as oil services and logistics and transportation.

Some Sectors Are Growing Extremely Fast

Key sectors of the region's economy are poised for surging growth. Historically, emerging economic subsectors hit an inflection point -- the first upward slope of an S-curve -- when national wealth reaches a given level. When wealth arrives at this tipping point, some economic subsectors expand at a rate that far outstrips the overall GDP growth rate. In Indonesia, for example, the proliferation of modern trade has propelled the mini-mart sector to a 45 percent compound annual growth rate (CAGR) from 2004 through 2007, more than three times the overall Indonesian economy's CAGR of 14 percent.

"Across Southeast Asia, consumer sectors such as beauty products, dental care, life insurance, and private education are in the early stages of similar strong growth surges," said Carl Harris, a BCG partner and a coauthor of the report. "Some of the most attractive investment opportunities in the region, we believe, can be found in sectors currently on the lower slopes of their S-curves."

Competition for Deals Is Fierce

Precisely because Southeast Asia's growth story is so compelling, however, investing in the region is growing more challenging. Several prominent PE firms have already established a foothold in the region, and they and their rivals have committed considerable capital in the past decade. From 2001 through 2011, the amount of documented capital under management in Southeast Asia rose from $11.7 billion to $30.1bn. Because the pace of dealmaking has not matched the growth in capital commitments, some of that capital remains uninvested.

As capital and competition increase, good deals based solely on
income and population growth are growing harder to find. Yet many bargains remain available. BCG believes investors should consider alternative investments theses. Carve-outs from large corporations, conglomerates, and family groups represent a significant opportunity for those wishing to leverage Southeast Asia's lower labor costs.

Many business sectors in Southeast Asia are highly fragmented, offering PE investors a host of potentially suitable candidates for rollups, buy-and-build plays, or consolidation. The breakneck growth of many Southeast Asian economic sectors, meanwhile, has fueled strong demand for infrastructure assets.

Local Knowledge Keeps Firms in the Loop

To improve their chances of success in Southeast Asia, PE firms need to adapt their business models to local customs and conditions. To allow a wide enough scope for potential deals, PE players should be flexible about investment criteria such as debt ratios and be prepared to accept smaller deals and minority stakes. Being flexible has proven to be of strategic value in what remains a relatively small deal market.

Savvy PE firms build local offices in the region with local talent wherever possible. The locals' networks and skill at reading behavioral nuances can be invaluable. PE firms should also consider inviting local investors into selected deals. State-owned PE firms (sometimes called sovereign wealth funds) can provide useful insight into potential targets and help negotiate political obstacles.

To receive a copy of the report, contact Eric Gregoire at +1 617 850 3783 or gregoire.eric@bcg.com.

Source: BCG Perspectives