Control deals in China: ‘Proceed with caution’

China private equity is maturing and GPs are shifting into control deals, but not all are ‘truly experienced’, say Asia-based LPs.

China’s maturing private equity industry has moved from minority and growth funds deals toward control and buyout deals in recent years because of slower economic growth and more founder-owners willing to cede control of their companies. But LPs and GPs must exercise caution before they get to work creating value in their portfolio companies, Asia-based investors said on Friday at the HKVCA China Private Equity Summit 2017.

Pamela Fung, a principal with Morgan Stanley Alternative Investment Partners, warned that a lot of private equity groups talk about control deals but “very few have true experience in doing control deals in China; doing control deals is very different to doing growth deals.”

Doug Coulter, a partner with fund of funds manager LGT Capital Partners, also urged caution. “If we dial back a decade ago, there weren’t any control deals in China; it was a minority growth capital market.”

“Today many GPs are either doing control deals or selling themselves as control managers – talking about operational value add and all that good stuff that managers practice as part of their craft here in Asia,” Coulter said. “But private equity is an idiosyncratic business – it’s the exceptional firms and companies that make the majority of the returns across anyone’s portfolio, LP or GP. Very few managers, maybe 20 percent or less, generate returns that might justify locking of capital for 10+ years.”

While the industry has not seen many control buyouts in China to date, Fung said the market is changing and a few dedicated buyout firms are emerging.

She added that while there are attractive tailwinds in Chinese education, healthcare, technology, consumer and environmental services sectors, most LPs are really looking for managers that “take it another level deeper.”

“What we are looking for are managers who understand industry dynamics, who are experts in the industry: those who understand how government policies play into the sector,” Fung said.

Aside from an increase in control deals, greater specialisation is another shift LPs are seeing in China private equity today. “We definitely are seeing more sector specialisation, particularly in healthcare and technology. But if you don’t have people with deep experience, better to stay away,” Coulter said.