RMB-denominated funds will end up being the net sellers of China’s direct secondaries market sooner than international funds, though the quality of the assets up for sale raises questions, according to a study from China First Capital.
About 56 percent of China’s 7,550 unexited private equity investments are held by RMB-denominated funds by volume. These funds are the same ones already facing significant liquidity and fund life pressures, according to the report.
“The GPs holding these deals often have an unhedged exit strategy of waiting for Hong Kong or US IPOs to resume,” the study explained.
With no IPO exits in sight, “pricing leverage will be steadily transferred to direct secondary buyers,” and the supply-demand ratio will only grow more out of alignment over time.
“Direct secondaries in China are and will remain a buyer's market,” the study concluded.
However, a source at a Hong-Kong based fund of funds believes that it is too early to say whether the secondaries market will take off in China, since there have not been many examples of direct secondaries to date.
The problem of shortened fund life requires a solution, she said, but interested GPs will need to have sufficient insight into a portfolio to value it correctly.
“Secondaries will depend on whether the GP is able to dig deep enough to understand exactly what they're buying into,” the source said, adding that only a small percentage of GP portfolios will even become targets of secondary buyouts.
The study estimates that only 200 of more than 7,000 unexited investments qualify as “quality secondaries” at this point – in other words, secondaries where the companies have grown 25 percent or more per year since acquisition, are compliant from a legal perspective, and the firms actively seek secondary exits.
The secondary market as the alternative exit option will be covered in depth during the Private Equity International Asia Forum, 20-21 March, in Hong Kong. Find out more here.