US-China trade battle creates uncertainty for private equity

Having just dealt with the repercussions of the US tax reform on their business, private equity firms and their portfolio companies are now bracing for the potential impact of escalating trade tariffs between China and the US.

The new US tariffs on $50 billion-$60 billion worth of Chinese goods meant to equalise trade between the two countries, and the retaliatory move by China to tax $3 billion of US goods, will increase costs for private equity-backed companies in certain sectors.

But for now, the real challenge for private equity investors doing business in or with China is not knowing the details of President Donald Trump’s new tariffs, particularly the exact list of goods that will be taxed higher.

“Really the only story for private equity investors is uncertainty,” says David Adelman, a partner with Reed Smith.

“This unfortunate uncertainty that has resulted from the protectionist tendencies of the Trump trade policy team had some impact on the confidence investors have, and frankly capital flows in both directions have been affected.”

Adelman, a former US ambassador to Singapore, represents private equity investors who invest in China as well as funds that seek capital flows out of China.

When Trump announced the tariffs toward the end of March, he also gave US Trade Representative Robert Lighthizer about 15 days to come up with a list of proposed products that will be taxed higher. It will be followed by a public comment period, which could last up to 60 days.

While the markets won’t know for some time which Chinese industries and products are going to be the targets of the US tariffs, broadly speaking, businesses with parts of their supply chain in China or those importing goods from China will be impacted.

“Unfortunately, when you look across private equity, particularly mid-market manufacturing, retailers, and consumer goods businesses, there are a lot of companies importing significant quantities of goods from China,” says Jeremy Swan, national director of CohnReznick’s financial sponsors and financial services industry practice.

“We would expect increasing costs for a lot of those businesses, which would obviously impact profitability.”

Once more details come out, and if the plan goes through, firms will be able to determine more precisely the increase in costs and whether moving to suppliers and importers in non-tariff countries makes sense from a financial perspective.

Portfolio companies selling to the Chinese market, particularly in the agricultural arena, will also be impacted.

China revealed on Monday the list of 128 goods they will start taxing higher. The additional tariffs, either 15 percent or 25 percent depending on the goods, will hit rural America the hardest, targeting, meat, fruits, nuts and wine exports among others.

Swan believes PE-backed businesses won’t dramatically change the way they operate, though.

“I’m not sure we’re going to see a huge surge in private equity firms exiting businesses that have close ties or heavy imports from China,” Swan says. “I think it will be more of a rationalisation of values.”

Just like it did with developments leading to the US tax reform, the private equity community is keeping a close eye on announcements from the administration regarding  whether the new tariffs will take place and in which form.

“The conversations I’m having about this issue with our clients is ‘How much of this is talk and how much of this is real’,” said Adelman.