China's exit overhang builds

In 2013, new investments to exits show a 9:1 difference.

In China last year 1105 private equity and venture capital deals were announced, but only 126 exits were completed, representing about a 9:1 overhang of unrealised investments, according to data from PricewaterhouseCoopers.

The previous year, there were 805 new investments to 198 exits, representing a 4:1 difference.

“The main issue in private equity and venture capital in China is the overhang of new investments to exits,” said David Brown, PwC China and Hong Kong transaction services leader, speaking at a presentation on China.

In the US and Europe, investments are roughly comparable to exits for a given year, Brown told Private Equity International. China is coming off a buying phase and is expected to follow that trend.

The reason for the overhang is linked to problems with China’s public markets, specifically the 15-month freeze on new public listings, he said, adding that 2013 was the first year that the IPO was not the dominant exit route. Private equity-backed Chinese companies had 35 IPOs last year, all of them in Hong Kong or the US.

The total number of China exits last year (126) also marked the third consecutive year of decline.

However, Brown was optimistic about 2014. He pointed out that a weak first half for deals was offset by a strong second half, as the direction of the new party leadership, which took over in March, became clear to investors. Annual announced deal value rose year-on-year to $35 billion from $23.9 billion. 

PWC expects the second half momentum to continue into 2013, with divestments picking up. “PE exits will rebound as IPO markets re-open, but with mounting pressure to cash out investments, sale by M&A and secondary (PE to PE) will also ramp up this year,” Brown said. 

“One thing is clear, it’s beyond the capability of the IPO markets to deal with [the overhang].”

Brown also noted a spike in PIPE deals last year, which suggests private equity taking advantage of low valuations on public markets. At the same time, data shows evidence of a steady transition from growth capital to buyout deals, “which is on the back of quite low valuations”.  

Growth capital deals fell to 206 from 246 in 2012. Buyouts remained small, with 29 closing in 2013, but they show a steady year-on-year increase since 2009.

“People see the problems around exiting from growth capital deals. If you ask private equity what their focus is going forward, they are interested in buyout opportunities.”

Perhaps the biggest private equity opportunity is the restructuring of state-owned enterprises, Brown said. SOE reform is being driven by the Chinese government. 

“SOEs are being told that the market is liberalising and they will be exposed to greater competition. They are being told to sell off non-core parts, to globalise, and to diversify their shareholders. We talk to CEOs at SOEs and they are under pressure to do some deals — we see it coming through our own business.”