Zhao: PE must add value as China slows

China’s GDP growth will likely slow to 6%, meaning alpha will now come via value creation, said Hony Capital’s CEO John Zhao, speaking at PEI’s Value Creation Forum: China 2013.

China’s annual GDP growth will likely slow to 6 percent as the era of high growth shifts to an emphasis on efficiency and productivity, and private equity will do well to follow, said John Zhao, chief executive officer of Hony Capital, in the keynote speech at PEI’s Value Creation Forum: China 2013 in Beijing.

“These are times of reflection for the private equity industry, when we ask what will make us sustainable. Our answer is: a focus on value creation,” Zhao said.

“It’s all about concrete things you do to help your company become more valuable. Even in very challenging economic times like this, not one of our portfolio companies is in crisis. Many are facing the difficulties, but they are taking the opportunity beef up cash flow and efficiency and investment, getting ready for the time when the exit window opens.”

Vinit Bhatia, partner and head of private equity practice at Bain & Company, used a data presentation at the Forum to reveal a bleak picture of investment activity in China.

We don’t mind if the overall economy settles down a bit. It gives you the ability to figure out where the opportunities are for restructuring and business improvement – where you can create value over time. When growth is high, these things do not get revealed

John Zhao, CEO of Hony Capital

In 2012, private equity deal value in China was down 40 percent while volume fell 50 percent. In the last quarter of 2012, only $2 billion was invested in China across 28 deals. 

“Those are some of the lowest numbers we’ve seen since the global financial crisis. But Q1 [2013] numbers were even worse than Q4. It’s been a rough six months for anyone trying to put money to work in China.”

However, echoing Zhao’s comments, he said the drastic decline in investment activity has made value creation a strong priority. According to a Bain & Co survey of GPs in China, private equity is putting much more attention on profit growth today rather than arbitrage or leverage, and the majority of respondents cited creating value for portfolio companies as their firm’s differentiation.

In addition, GPs surveyed said they would spend the next 1-2 years focusing on existing portfolio work rather than sourcing new deals. The average planned growth rate for the investment team was 20 percent while the figure for operational team growth was 50 percent.  

As China’s economic transition deepens, Zhao cited investment opportunities in urbanisation plays (service, retail, logistics, education, medical services) cross-border, both inbound and outbound, and, particularly, industry consolidation.

China's provincial governments all used incentives to attract businesses and manufacturing, which resulted in overbuilding, he said. 

The average planned growth rate for the investment team was 20 percent while the figure for operational team growth was 50 percent

From a Bain & Co survey of GPs in China

“We built things in excess and there is a lot of waste. That’s why we have more than 300 automakers and more than six thousand pharmaceutical companies. It’s now challenging operating a business in China and it gives private equity the opportunity to restructure and consolidate industries.”

Zhao said 6 percent is a healthy pace for China’s economic growth. 

“We don’t mind if the overall economy settles down a bit. It gives you the ability to figure out where the opportunities are for restructuring and business improvement – where you can create value over time. When growth is high, these things do not get revealed.”