In its World Economic Outlook 2016, the International Monetary Fund projects a slowdown in growth in China from 6.8 percent in 2015 to 6.3 percent next year – much lower than envisaged at the start of 2015.
However, the government’s attempts to improve the quality of growth through structural reform and its nurturing of a consumer driven economy is providing opportunities for investment.
Consumption in China will account for 60 percent of its gross domestic product (GDP) by 2020, according to US research firm International Data Corporation’s report.
Looking forward, the Chinese mid-market is where the opportunity is, market participants told Private Equity International.
“Private equity is about shopping around and finding the right opportunity. When you are looking at sectors, [especially China] what you are looking at is anything consumer – whether it’s education, healthcare or food. We are talking about the basics now, feeding your family, educating your children, putting shelter above their head,” said Peggy Wang, head of private equity and partner at White & Case.
Xuong Liu, managing director at Alvarez & Marsal’s Transaction Advisory Group in Shanghai added: “If you look at long term sustainability in China, you need to look at classes of people who will drive that consumption. And really, it’s reasonable to associate that it will be China’s middle class.”
Healthcare services is a “hot sector” at the moment, said Liu. “This plays into the whole ageing population story of China, the lack of a social safety net, and an undeveloped healthcare system.”
Liu said: “In China, there’s more capital chasing deals. On the flipside, the number of sizeable deals in good companies is probably not commensurate with the amount of capital that is available so asset prices are invariably high. Generally when I speak to clients, good assets still command high valuations.”
The days of pollute-as-you-go, anything-goes developments are almost over.
Derek Sulger, partner at China-based private equity firm Lunar Capital said: “We foresee quality of life issues driving Chinese consumer behaviour moving forward, and very strong growth for mass market premium products.”
He added that the best opportunities will continue to emerge in Chinese consumer businesses, especially those with strong established brands and products that represent compelling value.
A consumer upgrade is happening in China, confirms Myron Zhu, co-head of private equity Asia Pacific at Aberdeen International Fund Managers.
“People are asking who can provide high quality traceable food and have accountability of food at a high premium. The Chinese want to upgrade their lifestyle, eat better and live well.”
Regulatory restrictions and the ways to deal with them will continue to pose a challenge for any international private equity investor in China.
Liu said that some sectors are off-limits for foreign investments and, therefore, alternate ways are found to make those deals possible. “For example, certain types of financial services companies remain difficult to invest in and in certain industries where you need a Variable Interest Entity (VIE) structure to get around regulatory hurdles. The fact that you can only hold contractual rights instead of direct ownership over Chinese companies remain a challenge.”
He added that it is a pressing issue to find good companies in China with sophisticated and capable senior management. “I think if you are looking to develop more sophisticated products or to create international brands, that is a continuing challenge in China. There aren’t that many platforms that are national and very few that are global.”
The private equity industry itself is also at a turning point, said Zhu. “The period of low hanging fruit is over and the private equity market is more competitive. It’s not just about bringing in more money but also adding more value – more firms are moving into the more established, more institutional setups. The firms are selectively seeking operating partners to do the heavy lifting and to provide real managerial consulting.”
Due to China’s complexity and size, private equity firms need to acquire or partner with more local players to fill gaps in their product portfolios, to gain market access, or even to negotiate with regulators at the local, regional, and national levels.
Zhu added that he has witnessed more spinouts, where younger teams raise their next funds as an independent firm. “As an investor, you take additional risk with the spinout or second generation team. But if you believe the team will do well, you have to back them up while they are young and hungry.”
However, fundraising will remain strong in 2016, and firms that have done well previously will have the ability to raise capital, Liu said.