Some notes below (for personal reference only, so any mistakes in transcription are my own):

His new book “Money Games” is the inside story about a major private equity deal he led in the late 1990s, which involved an American investment firm (Newbridge Capital) acquiring what used to be the largest bank in Korea (Korea First Bank), which failed during the Asian Financial Crisis and was nationalized by the Korean government.

He wrote the book because he felt there was a dearth of literature on private equity. There are some well known books, such as Barbarians at the Gate, but that story dealt only with the dealmaking part of the KKR-RJR Nabisco transaction. It didn’t cover what happened post-investment. In fact, KKR stayed invested in the business for about 15 years and eventually lost US$750m when they sold RJR Nabisco. Henry Kravis likes to say that any idiot can buy a business, but it is what happens to the business after you acquire it that matters. To date, there is no book talking about a private equity deal from beginning to end. Even though private equity is much talked about, there is very little understanding about how it works. He aims to fills that void – covering the deal from negotiation, investment, turning around the business, growing the business and until the eventual exit. This is important because private equity has become a very significant industry – in the US, for example, there are now more companies controlled by private equity firms than there are publicly listed companies. He also thinks it might help people understand the industry in the present context of an economic crisis because that deal also happened in the middle of a crisis.

Backdrop of the deal – market was in total turmoil in 97/98. On October 23rd of 1997, the Hang Seng index dropped 16% in a single day. By December of that year, Korea’s stock market had dropped 49%. The Korean won also lost 65.9% of its value against the US dollar in that year. The FX reserves of the country had dropped to US$8.9bn, astonishing when you consider that Korea is the 10th largest OECD economy (and was the 10th largest economy back then too). For context, his firm PAG currently manages US$40bn. The IMF eventually came in with the largest ever rescue package (~US$58bn) on the condition that Korea undertook restructuring measures, including the sale of two of its failed nationalized banks to foreign investors for the simple reason that credit culture and sound banking practices were lacking in Korea; these had to be brought in from the outside.

The deal was very complex and presented very difficult decisions at almost every turn for the Korean government. The economy was in its worst crisis since after the Korean war. Furthermore, the country felt humiliated when the IMF forced it to open its doors to foreign investment and sell control of what used to be the largest bank in Korea. By the end of 1997, the government was encouraging its citizens to sell their jewelry and gold to replenish the coffers of its FX reserves. ~150 banks in Korea failed in 1997/1998. Government used trillions of won to bail them out, and this was all taxpayers’ money. The government therefore had the responsibility to get best possible deal from foreign investors. Because they had little experience in doing this, they they were afraid every step of the way that they would make a mistake when dealing with sophisticated foreign investors.

While his sympathy was with the Korean government, it made it very difficult for them to build trust during the process. Eventually he did something he had learnt about many years ago, by offering a full refund policy to the Korean government. He structured it such that if he proposed something, he would be obligated by it, and wouldn’t backtrack. However, if they agreed to something and later changed their mind, they were allowed to backtrack, if they thought he took advantage of them or offered something that was not in their interest. He first learnt about the refund policy when he was living in the US, where whenever he would buy his wife a gift, she would never like it and go back to the shop to get a refund or replacement. When he later moved to HK, the refund policy wasn’t common practice, so he stopped buying gifts for his wife as didn’t want to be blamed for wasting money! What he realized was that without a refund policy, the Korean government would be reluctant to accept a deal. With a refund policy, they could backtrack and that happened on at least two occasions during the process. On one occasion, he actually made a mistake that involved a term that was too favorable to his firm, so went back and said he made a mistake, amending the term so it was in their favour. It was a long process but it always takes a long time to build a relationship, and you have to think about it from the perspective of the other side.

Other questions/topics covered in the talk:

On how private equity and the acceptance of the asset class has changed in Asia over time – back in the 1990s, there were very few private equity players in Asia. In fact, when the Korean government decided to sell the two banks, they engaged MS to be the sell-side advisor. MS sent out 40 invitations to financial institutions, mostly banks, some financial investors but not many. Out of the 40 invitations sent, only two players showed up – Newbridge Capital and HSBC. There were very few large transactions at the time. PE deals typically ranged from US$20-50m dollars, not more than that.

The market has also changed drastically. Korea in terms of economic size at the time was about the same as China and SEA, today that is completely different. From 1990-2019, the Chinese economy grew ~36x. Japan’s economy was ~4x China’s economy at the time, and now China is ~3x Japan. At the time, people thought SEA and China were too small. Newbridge Capital had ~US$100m when he first joined, ~US$400m when they invested in Korea First Bank. Today, his current firm (PAG) manages ~US$40bn. So the amount of capital available today is much larger but the market has also become much larger. 10 years ago in China, would struggle to find an investment opportunity that would allow you to invest US$100m, today they don’t invest in any deal less than US$100m. When they invested in China Music Corp about 5-6 years ago, they put in in US$100m to own about half of the company, and 5 years later it went public under the name Tencent Music following a merger. Now the market cap is ~US$25-30bn and the company has ~800m monthly unique subscribers. That’s how large scale some of the companies have become.

On the suitability of private equity for retail investors and how they can gain access – in his view, private equity is generally not a game suitable for or played by retail investors. There are, of course, different types of private equity models – buyout firms, growth capital, venture capital etc. But, by and large, it is a high risk business. The LPs are institutional investors, generally sophisticated and willing to take the risk. One interesting recent innovation, however, is by Temasek, which has basically securitized its diversified and balanced portfolio of PE fund investments and issued bonds against it, in order to help broaden access to private equity (see here for more). 

On whether there might be a middle market gap in Asia – he doesn’t really see this as a problem today. For example, in their buyout fund, they don’t invest less than US$100m per deal, but they also set up a growth fund for companies that were looking to raise capital in the US$20-60m range. The primary difference is control in buyout vs. being a minority investor in growth capital. Venture capital is even more different because you are investing at the startup stage, sometimes pre-revenue and often pre-profit. Buyout funds can’t really afford to lose money on any single deal, while VC funds expect only a couple of their investments will work out. Different games, but they meet different needs.

On what he looks for when investing in banks – when investing during a crisis, you are primarily concerned about further downside, so you want to make sure you are not taking too much risk. In a bank deal, if you control the bank, you are responsible for the risks with new loans, but you don’t want to take risks on the legacy loans. They wanted to make sure the government was responsible for all the legacy loans. That was a major point of contention, as the government wanted to pass on the risk to the investors. It was not a risk they could take, however, because capital only represents ~5% of the total assets of a bank. If you have bad loan ratio of more than 5%, then your capital is likely to be wiped out (assuming that the 5% all goes bad). For the bank they acquired in Korea, the bad loan ratio was 30% and that was still an understatement. No matter however much capital you put in, you could still be wiped out if you are taking the risk of legacy loans. Today, the situation is different – banks are too expensive to own because the capital ratio has increased so much. But lessons from past crises have helped banks in all these countries. So many banks failed in Asia in 1997/1998 but if you fast forward 10 years to 2008/2009, none of the banks in Asia failed. Most of the issues were in the US and Europe. Asian banks had all learnt their lessons from 1997/1998 and had recapitalized themselves, improved the risk management systems, increased their reserves for bad loans. If you fast forward another 10 years from 2008/2009 to today, in the latest crisis, almost none of the banks in the US and Europe got into trouble.

His thoughts on SPACs – in general, he does not think they are a good proposition for retail investors. You don’t really know what you are buying into, and you are trusting the sponsors to make money for you (although there are certain safeguards against them walking away with your money). You also don’t know what business the sponsor will buy, what price they will pay etc. From the perspective of his firm, they have enough capital (probably faster than they can invest it), so it is not necessary to raise capital via a SPAC. But there is a glut of capital today and investors are desperate to invest in opportunities where they think they can make money.

On the IMF’s involvement in Korea during the Asian Financial Crisis – there was a lot of criticism in general centered around the IMF’s austerity programs and tightening the belt, cutting budget during a crisis, arguably worsening the economic situation when stimulus was required. In Korea, however, the crisis had already happened before the IMF was involved. The government was not happy with some of the conditions, one of which was to force the sale of the failed banks to foreign investors in the belief they would bring in best practices and credit culture to restructure the banking system. Provided US$58bn in exchange for restructuring measures, selling two banks. In the end, the government only sold one bank (the other deal which tried to negotiate with HSBC failed). Today, by contrast, these seems to be a consensus that during a crisis, you have to stimulate demand and the economy, support SMEs in order to get the economy back on track.