Issues in China’s investment environment – IPOs, economic growth, shadow banking, systemic reforms – are increasingly unclear, but GPs are finding a wider variety of opportunities that require deeper involvement, according to speakers at HKVCA’s Asia Private Equity Forum in Hong Kong.
In his keynote speech, Shangzhi Wu, chairman of CDH Investments, cited several challenges. LPs backing China funds are demanding satisfactory fund performance and GPs will need to show a high success ratio, take “quick and forceful action” when an investment goes off track and exercise downside protections.
“All GPs will have to have to address these issues,” Wu said.
On the deal side, Wu said dynamics between China’s growing consumer market and cost-efficient companies in developed markets are creating more cross-border opportunities.
As an example, he mentioned CDH-backed Shuanghui International’s $7 billion deal for US pork producer Smithfield Foods. The synergies were clear: China’s pork market is five times the size of the US market, while US pork costs are 60 percent of China’s, he said.
“As the Chinese consumer market becomes more important, that becomes good for cross-border transactions.”
China’s old and new economies are also merging, creating more opportunity as the internet integrates into old industries. An example is CDH’s investment in eHi Car Services, which is the second largest in China. Revenues went from $50 million to $500 million in about three years while the number of vehicles increased 50x, he said.
“What’s interesting is that 87 percent of the orders are through mobile phones. The internet is revolutionizing many industries and we have to include that in our [private equity] investment strategy.”
Operational work has also become a requirement, the panelists agreed.
“Operational involvement is very much a key part of our investment evaluation,” said Frank Tang, CEO and managing partner at FountainVest Partners. “Can we add value? Do we have people we know who can come in and solve major issues? That will have a major effect on valuation. Either we have the capability ability to fix certain issues or we walk away. In the future, those with operational capabilities will win.”
Finally, the speakers noted “a new wave of SOE (state-owned enterprise) reform” that aims to provide some form of mixed ownership with foreign companies to improve competitiveness.
XD Yang, managing director and co-head of Asia for the Carlyle Group, especially liked the SOE opportunity and the potential to add value through restructuring.
“These can be very successful investments, particularly the larger SOEs. There’s a lot of competence and talented people in the organization and they are much stronger than the typical private company. A private equity firm can make a big difference through corporate governance and by bringing the management team into the mix by giving them incentives.”
However, he said the challenges are that negotiations on valuations tend to take a long time and SOEs require a lot of man hours for operational work.
The panel believed strong returns in China are still possible, though not as fast as before. FountainVest’s Tang said strong returns in China maybe can no longer be made in 18 months but in 3 – 5 years, particularly with China's slowing GDP growth.
“Over a 3 – 5 year period we should expect a [potential portfolio] company to double in size. On that basis we go into the investment,” Tang said.