China in seven trends

The Chinese private equity market is maturing. As the world’s most populous country shifts from a reliance on debt-fuelled investment to a consumption-driven economy, the private equity industry is starting to shift from growth capital to buyout deals.

“As the economy matures and focuses overall on efficiency improvement rather than growth, buyouts will become more dominant,” says Yichen Zhang, founder of CITIC Capital, which won Firm of the Year in China in the latest PEI Awards.

It’s a gradual change, but one that is set to intensify in the years to come, market participants say.

“China buyouts are evolving – how they will take their final shape has yet to be seen. But we are all on the learning curve and climbing that learning curve fast,” Wu Shangzhi, the founder and chairman of CDH Investments, one of China’s oldest private equity firms, told PEI last year.

China-focused funds in 2017 raised a total of $8.1 billion, down from the $17.3 billion raised in 2016, as investors poured more capital into pan-Asia funds.

Of the $8.1 billion for China,
$6.25 billion came from 19 domestic fund managers. Among the largest funds were the $1.6 billion CITIC Capital China Partners III and the $1.3 billion Orchid Asia VII, according to PEI data.

The average size of China-focused funds fell from $640 million in 2016 to $386 million in 2017.

But China-focused fundraising for 2018 seems to be on a growth trajectory. Longstanding firms CDH Investments, CITIC PE and Hopu Investment Management are targeting between $2 billion and $2.5 billion for their latest vehicles.

While buyout deals are regarded as having a bright future, it should be noted that venture capital and growth equity remain the most favoured strategies, attracting 84 percent of capital from the China-focused managers.

That compares with just 8 percent for buyouts and 8 percent for funds of funds and co-investments.

As China’s private equity market matures, sector-specific funds are becoming more popular, particularly those focused on tech.TMT-focused funds made up 64 percent of sector-specific funds in 2017, followed by healthcare at 13 percent, biotech and consumer goods, each with 5 percent, and cleantech and renewables at 3 percent, PEI data show.

“In terms of sectors, the economy overall is shifting more from investment-driven to consumption-driven. And the next generation is more focused on better living so consumption upgrade is a major theme,” says Zhang.

Investments made by China-focused private equity and venture capital firms reached $86.9 billion in 2017, significantly higher than the $67.3 billion recorded in 2016, and closer to the five-year high of $88.7 billion in 2015. Domestic deals numbered 754, up slightly from the previous year’s 658. Meanwhile, outbound deals, although still heavily scrutinised by state regulators, climbed to 315 in 2017, compared with 278 in 2016, according to data from S&P Global Market Intelligence.

The UK was the most favoured deal destination, with $18.5 billion of deals, equivalent to 44 percent of the overall $49.3 billion of China outbound deals. The US came second at $8.8 billion and Hong Kong was third at $7.9 billion.

A major force behind the increase in deal value and size are technology-related transactions, which made up the largest chunk (36 percent) of overall deal value for the year. Big-ticket deals last year included SoftBank Group’s $5.5 billion investment in ride-hailing company Didi Chuxing, KKR’s $200 million investment in finance management platform Shenzhen Suishou Technology and Warburg Pincus’s $180 million series D investment in business park operator D&J.

Industrials, consumer discretionary and telecommunication services sectors recorded $14.8 billion, $11.1 billion and $9.3 billion worth of deals, respectively.

But there are worries that the tech sector may be overheating “For growth deals there is still a lot of capital chasing the internet and new economy but valuations can appear bubbly,” says Zhang.

The LP universe has expanded significantly in recent years. The big insurers have embraced alternatives as have wealth platforms such as CreditEase Wealth Management and Noah Holdings. The big state-backed conglomerates are also showing an interest in private equity.

“A lot of Chinese state-owned enterprises are now investing in private equity funds. In the past they would typically make the [direct] investment themselves. Now they are more willing to participate as an LP,” says Bee Chun Boo, a Beijing-based partner with law firm Baker McKenzie.

Private equity money increasingly comes with a previously unusual feature of deal-making in China: majority control. Bain & Company’s Asia-Pacific Private Equity Report 2018 says that more company owners are willing to cede control, labelling it “an important transformation”.

This is a crucial change for a number of reasons, not least the ability to drive operational change in a slowing economy.

“Minority stakes are fine when everything is growing but if you have a dip it’s difficult to drive value from a minority position,” says Guido Justen, head of alternatives at the German fund investor Helaba Invest.

 There are more than 16 million companies set up in China, of which 86 percent are individually-or family-owned, according to Kyle Shaw, founder and managing director of ShawKwei & Partners, a mid-market manager with offices in Hong Kong and Singapore.

“The one child policy has also created management succession issues because the younger generation does not necessarily want to run the family business. This is creating challenges in succession planning and opportunities for private equity firms like us to step in and buy good businesses.”

David Pierce, managing director and head of Asia for HQ Capital, says China’s one-child policy has a large part to play in the growing acceptance of private equity control.

“The biggest driver for increased majority control deals lies in Chinese history. In 1979 the country opened to joint foreign enterprises,” says Pierce.

“Private business only started in the mid-1980s. Many of the people that started those companies are now in their 50s and 60s and typically have only one family member able to take on operational management of company because of the one-child policy.

“Now in many cases that child may not have the ability or interest in taking over, so owners are now looking to sell.”