Embracing operational change in China(2)

A terrible 2012 for Chinese private equity activity has (finally) put the spotlight on the need for real operational work at portfolio companies – a key topic at this week’s PEI Asia Forum 2013.

China was the main talking point outside the panel sessions at Private Equity International’s Asia Forum in Hong Kong, where more than 200 delegates gathered over a two-day period to discuss key issues in Asia’s private equity industry.

Disappointment in the region’s two growth engines, China and India, was only part of the story. The mood was serious but not negative and optimism was tempered (a few of the speakers’ firms were in fundraising mode, but there was a refreshing lack of spin on stage).

Buzz at the coffee breaks was around Derek Sulger, partner at Lunar Capital, and his frank words during a panel on how to succeed in China’s slowing market. Sulger’s view was unequivocal: do real operational work to put a company on a growth trajectory, even after exit. He also spoke about seizing the opportunity arising from China’s food safety scares to instill an ESG culture in a business and move ahead of the pack. Sulger, who founded Lunar in 1999, has long been an evangelist for hands-on improvement, but the message seemed to resonate with delegates in a way it hasn’t before.

Friday Letter

“Deals can be done if you have something to offer [the entrepreneur],” Sulger concluded. Later his comment was recalled by a source who suggested China’s deal volume and value fell in 2012 not necessarily due to a poor IPO market, but because the market has moved way too fast for the industry: while a number of firms in the region do focus on operational improvement – witness the Asian winners in our Operational Excellence Awards – the PRC simply does not have enough private equity firms that can provide the real operational improvements entrepreneurs and founders want.

Echoing Sulger’s call for operational work was Huisheng Yang, managing director of PRC-based Tiantu Capital. “Offer more than capital,” he said. Yang estimated that with the pre-IPO market gone, 2,900 out of China’s 3,000 RMB fund managers are now inactive.

But progress hasn’t stopped with them. Smart RMB fund managers are trying to reconfigure their businesses. “They are asking us what Western LPs are looking for and how they can formulate their business to appeal to that type of market,” said Christopher Hunter, managing director of Cambridge Associates in Beijing. “A sizeable component of the RMB market will be very interesting over the next few years. Some will be very successful.”

The conference was full of such developmental insights. These aren’t remarks that set off fireworks. In fact some of

They are asking us what Western LPs are looking for and how they can formulate their business to appeal to that type of market.

Christopher Hunter

these messages, like the need to focus on operational work, aren’t by any means new. Yet now they seem to be being taken much more seriously, and are getting widely discussed and absorbed – which is a big shift. When China’s easy money story was intact, there was little need to do so.

Another key talking point at the conference – a bit more surprising – was Japan, which is now popping up in internal firm discussions, delegates said. Japan and its zero growth economy really hasn’t changed, but new market-friendly leadership and a $160 billion stimulus has improved business sentiment, as have several recent 7x-8x exits from firms such as Unison Capital and Advantage Partners. If Japan revives, one source said, it could have a strong impact on the region as well as the way Western investors allocate to it. Asia is home to the world’s second and third largest economies, after all.

Bad or good news in the region, however, isn’t expected to whipsaw deals, exits and fundraising (in an audience poll, a majority said Asia would have only modest deal growth this year). The message from conference speakers and delegates was perhaps more mundane but far more important: Asia’s private equity industry is institutionalising and clearly moving forward with more measured steps.

PS – PEI’s forthcoming April issue will feature a special report on Japan’s private equity industry.

We'll also address the drive for operational excellence in China at PEI's upcoming Value Creation Forum: China on 3 July in Beijing.