Letter to Our Investors

To Our Investors:

The golden investment window we enjoyed in 2021 stayed open for the first half of 2022. The second half of the year was more a “shutter” market, opening and closing with U.S. inflation and China COVID news. This made for opportunistic investment activity but challenging exits. In the last year, we deployed $3.9 billion in investments, in line with our record level the year before. At the same time, we had several planned IPOs and trade sales of our portfolio companies shelved or scrapped due to poor market conditions. Still, we completed $2.9 billion in realizations. We demonstrated MBK Partners can put out and make money in markets good and not so good.

Equity markets across the world fell precipitously in 2022. The S&P 500 sank by 19.4%, while the Shanghai Composite declined by 15.1%, the Nikkei by 9.4% and KOSPI by a whopping 24.9%. These drops happened despite GDP growth of 2.1% in the U.S., 3.0% in China, 1.1% in Japan and 2.6% in Korea. U.S. inflation hit a 40-year high at 9.1% in June 2022, and the Federal Reserve responded by hiking the federal funds rate in quick succession from 0.25% to 4.50%, making for the fastest interest rate rise in decades. Commodity prices gyrated in the face of the Russia-Ukraine war and other geopolitical tensions. The turbulence led to a market in 2022 in which equities and bonds declined at the same time, for only the second time since 1926.

As we begin 2023, the global economies are showing signs of stabilization and the markets of recovery. Inflation is leveling off, and the major central banks are signaling an end to monetary tightening. The S&P has risen 1.0% year to date, and Shanghai 3.6%, Tokyo 9.4% and Seoul 7.6%. But major uncertainties remain. Will the U.S. and Europe avoid recession? When will the conflict in Ukraine get resolved? Do North Korea’s recent ballistic missile tests signal an escalation of hostilities? How will the ongoing geopolitical tensions between the U.S. and China play out?

The biggest, and for us, most significant, question mark remains China. As China goes, so will the rest of Asia. The Economist’s recent cover headline, “China’s Opening Will be the Biggest Economic Event of 2023,” highlighted the stakes for the global economy. With the lifting of the zero-COVID lockdown in December, we have seen a snapback in pent-up demand domestically, especially in consumer-related sectors. China’s index of manufacturing activity shot up in January and February to its highest level in more than a decade. What remains to be seen is whether this is the beginning of a sustained recovery or what economist Stephen Roach calls “a rubber band effect,” a temporary elastic stretching and contracting. We see China’s productivity growth resuming through this year, even as the world’s second largest economy goes through a secular slow-down.

China is no longer just the export engine to the world but a domestic consumption giant in its own right. China’s private consumption contribution to GDP has been steadily increasing since 2010, while exports contribution has been decreasing. China’s private consumption of RMB43 trillion in 2022 represents 38% of GDP, nearly double its exports. MBK Partners’ investment strategy has focused on domestic consumption plays. From CAR Inc. to eHi and Siyanli to Haihean, our China portfolio has been constructed to benefit from the greatest middle-class rise in modern history. Our consumer thesis in China may be crystallized with a pair of statistics from the rental car industry: there are 460 million driver’s licenses in China but only 280 million license plates. Unmet demand for 180 million cars is why we are owners of the largest and second largest car rental operators in the country.

Complicating China’s recovery and growth story is that under Premier Xi Jinping, there has been a renewed focus on ideology and central control over continuing liberalization of the markets. I have said elsewhere that once the doors of liberalization are opened, they cannot be closed. We believe China will prioritize economic prosperity over its domestic political imperative and resume its growth trajectory, albeit at a less steep slope. And we believe, in light of the ongoing trade war with the U.S., China will direct policy to drive its growth through the domestic market rather than exports. Like Japan before it, China will turn increasingly to domestic consumption. We hold fast to our conviction that over the mid- to long term, China will be the most attractive market in Asia and one of the most important markets in the world.

We spent the bulk of 2022 focused on defending our portfolio, especially Chinese companies during the COVID lockdown period. Although some of our companies faced initial difficulties due to decreased foot traffic, factory shutdowns and restrictions on overseas travel, revenues and earnings have been restored to pre-COVID levels broadly across the portfolio. Some companies even grew significantly during this period. Tasaki’s 2022 revenue and EBITDA increased by 23% and 45%, respectively, over 2019 pre-pandemic results; BHC’s revenue and EBITDA rose by 47% and 41%, respectively. Our sturdy third-quarter and year-end portfolio valuations evidence our success in holding down the fort. On perhaps the more meaningful measure of local-currency marks, our portfolio performed better on average by 0.1x MoE and 320 basis points in IRR across our Funds. By the end of January 2023, substantially all of our portfolio companies were recovered or well on the way to recovery. We believe we were able to weather the COVID storm because of the defensive qualities of our “fortress portfolio”: strong industry and company “moats,” cyclically defensive products and services, strong pricing power and scalable organic growth.

We were active, in the open window periods, in making investments. We were productive especially in Korea, which experienced a flight to quality in deal flow. As the dominant leader locally, we benefitted from this pronounced flight. In Buyouts, we signed or closed all three major transactions announced in Korea in the last two quarters (admittedly, a market share we will be hard pressed to maintain). We completed the acquisitions of Medit, the largest intraoral scanner provider globally, for $883 million in equity, and Osstem Implant (first tranche), the second-largest dental implant manufacturer, for $609 million. We signed to acquire Nexflex, a leading manufacturer of flexible copper-clad laminates, a key component of smartphones and display panels, for $250 million in equity. Earlier in the year, we acquired Dongjin Textile, one of the world’s top three footwear textile suppliers, for $344 million in equity, and Korea Center (renamed Connect Wave), the largest comparison-shopping platform in Korea, for $400 million. In Japan, we invested $236 million to acquire Unimat Retirement Community, a leading provider of nursing care services for the elderly.

In Special Situations, in Korea, we invested $189.0 million in convertible preferred shares in Megazone Cloud, the largest cloud management service provider in Asia. In Japan, we invested $76.0 million in secured loans of Marelli Holdings, a leading global auto parts manufacturer, through secondary purchases at deeply discounted prices. Lastly, in China, we bought $12.5 million in secondary bonds of Tsinghua Unigroup, a semiconductor and chipsets manufacturer undergoing a restructuring.

It is important to note that in our investment strategy we are not just making macro bets. The strong macroeconomic fundamentals of North Asia are clear: the world’s second, third and tenth largest GDPs in China, Japan and Korea and the fastest-growing (over the last two decades) in China. But for us, it’s not about just the scale or the growth but the quality of the growth of these economies. We get inside the thematic trends that are shaping Asia. Demographics really is destiny. We play domestic consumption because of the huge and growing consumer base in our region. Within this broad theme, we recognize the salience of having the two most rapidly graying societies in the world in Japan and Korea. Hence our increasing emphasis on healthcare, especially elderly care, in investments like Tsukui, Unimat and Osstem. We particularly like the developing confluence of healthcare and technology (notably of the consumer-facing variety). Both Medit and Osstem fall into this sweet spot.

Our investment strategy also entails doing increasingly complex “structured investments,” vertical combinations aimed at capturing operating synergies. Our structured acquisitions of Connect Wave together with Danawa (combining the numbers 1 and 2 comparison-shopping platforms) and of Medit concurrently with Osstem (leading players in complementary areas of the dental market) assured revenue enhancement and cost savings up front. We continued to stress add-on investments as well, including Tsukui/Unimat. Such value-added structuring requires a combination of local market knowledge and sectoral expertise, twin hallmarks of the Firm. Many of these transactions also take time. Medit came back to us, on our terms, a year after initial discussion. Patience is a virtue in our business.

In a turbulent market that saw IPO markets shut down across Asia, we made $2.9 billion in distributions in the past year. In Buyouts, we fully exited Doosan Machine Tools, returning $1.2 billion ($2.1 billion including prior distributions), for a 5.7x MoE and 50.0% IRR. We also exited Accordia Next Golf, returning $1.5 billion (including co-investment), for a 2.6x MoE and 21.9% IRR for Fund III, and 1.9x and 61.7% for Fund IV. We completed leveraged recapitalizations for HKBN, Dongjin Textile and MH for a combined $159 million in distributions. From Special Situations, we distributed $26.3 million from CAR Inc.’s CB and bonds. We also exited the remaining Accordia mezzanine investment, distributing a combined $180.7 million for 1.7x MoE and 23.9% IRR.

All our funds continued to perform strongly last year. The recently liquidated Buyout Fund II nearly tripled in value from its inception. Buyout Funds III and IV increased to 2.1 times and 1.6 times in value, respectively (as reflected by the sum of the realized and remaining fair market values). And Special Situations I has doubled since its inception. We view fund value accretion over time versus public market indices as a key performance indicator. These funds have all significantly outperformed the North Asian public markets over the period of their fund life. As seen in the following graph, Buyout Fund II increased 185.1% versus 126.5% in the public markets; Fund III 106.0% versus 56.1%; Fund IV 64.7% versus 3.5%; Fund V 19.4% versus -10.2%; Special Sits I 121.1% versus -6.6%; and Special Sits II 17.1% versus -13.4%.

On an absolute returns basis, the aggregate marks for our six funds at year-end 2022 stood at MoE of 1.8x and IRR of 21.7%. As shown in the following chart, Buyouts Fund II finished at 2.9x and 26.0%, and Fund III was at 2.1x and 15.9%, Fund IV at 1.6x and 17.1%, Fund V at 1.2x and 17.8%; Special Sits I at 2.2x and 40.5% and Special Sits II at 1.2x and 23.8%.

We continue to believe the more meaningful measures of performance are distribution amount and distributions-to-paid-in capital multiple (DPI). Distribution numbers have integrity. They do not move with markets and are not subject to creative accounting. As we have emphasized, we believe our returned amount, now at $18.3 billion, makes us the leader among Asia-based GPs. Our performance leadership is further buttressed by DPI (as well as its cousin, total value-to-paid-in capital). As highlighted in the following table, we have outperformed in both DPI and TVPI the top-quartile benchmarks in our industry.

After three years of COVID, we enter a post-pandemic environment. COVID has changed the way we do business. Online retail is one significant example. We analyze technological disruption risk in every opportunity review. But it is also worth noting even as we changed how we have stuck to our strategy and, equally importantly, how well we have fared. In the three-year period of 2020-22, we raised $9.7 billion in capital for Buyouts and Special Situations; deployed $7.1 billion in capital in investments; and distributed $7.4 billion. Our distributions total is the largest amount returned in this period in Asia. Just as importantly, our portfolio has fared well coming out of the pandemic. The overall portfolio marks went up in this period by 0.11x MoE on average across our funds. Even after the distributions, we have $11.2 billion remaining in fair market value in the portfolio – the largest value total we have had, all to be realized in the coming years.

We are committed to continuing to build the best investment team in North Asia. This year, we added 10 investment professionals. Our new hires share the key MBKP twin criteria of localness and multinational experience. The operating partner team has seen the highest growth, now totaling seven people across our three major offices. As we grow as an organization, we continue to recognize outstanding individual contributions. This year we promoted 15 people, one of the largest promotion classes in the Firm’s history. Notably, General Counsel Christie Tang was promoted to Partner, making her the second female in the partnership.

MBK Partners has been a leader in Asia on ESG matters. We continually support and empower our portfolio companies to advance environmental and social initiatives to build a better environment and a sustainable future. This year, we worked with an ESG consultant to develop a standardized ESG KPI template, which requires portfolio companies to report a comprehensive set of KPIs and detailed information for us to track and evaluate their progress. We remain committed to responsible investing and working “in harmony” with other stakeholders. We believe not only shareholders’ but all stakeholders’ interests can be advanced when the highest standard of corporate governance is maintained.

MBK Partners today manages over $26 billion in capital across our five Buyout and two Special Situations funds. Since the Firm’s founding in 2005, we have made 68 investments across China, Japan and Korea, and we still have over $4.0 billion in dry powder. More importantly, we made 38 realizations and distributed $18.3 billion in proceeds to our investors, one of the highest totals in North Asia. We have the longest-running senior investment team in the region, having worked together for 24 years and through three major
economic upheavals – the 1998 Asia Financial Crisis, the 2008 Global Financial Crisis and the COVID pandemic. And finally, our complementary strategies of Buyouts and Special Situations continue to enable us to scale our home markets to generate significant proprietary deal opportunities and operating efficiencies.

When Chinese Premier Zhou Enlai was asked in 1972 by his U.S. counterpart about the impact of the French Revolution, he reportedly replied, “Too early to say.” We, too, take the long-term view (even if not centuries long). We believe in the continued strong development of the North Asian private markets, despite recent bumps in the road, especially in China. This approach requires patience. There is no “immaculate adoption.” The Asian private equity markets cannot be expected to grow in a leap to the West’s penetration level without messiness and some disruptions along the way. They will develop the way markets invariably develop, with some growing pains. But make no mistake: over the medium and long term, the Asian markets will grow and develop. And we are here to be both agent of change and beneficiary of its fruits. Patience will be rewarded.

Yours truly,

Michael ByungJu Kim
March 10, 2023