• Industry: Private Equity
  • Type: Business and industry issue
  • Date: 12/8/2011

Capitalizing on growth: China 

Capitalizing on growth: China

Increasing consumption among a rapidly expanding and urbanizing middle class and a focus, in the internationally traded sector, on moving up the value chain present attractive opportunities for PE investors in China, although high valuations and governance standards remain as issues.

Headline targets for economic growth mask wide disparities between cities, regions and sectors. Investors may have to look beyond the centers of Beijing, Shanghai, Tianjin and Chongqing where competition for assets can be fierce and pricing high, but the scale of the opportunities remain impressive: 160 Chinese cities have more than a million residents1 and by 2015 half of China’s population of 1.4 billion will be city dwellers2.

PE investors are focused on this growth story, with increased activity expected in sectors from building materials to energy, power, healthcare, financial services, technology, automotive and consumer goods/services.

The PE industry in China has increased substantially in recent years and this trend should continue, particularly with regard to domestic RMB funds. While increased competition has bid up price levels, activity in the market remains brisk. A contrast may be drawn between the international houses, who have adopted a more cautious approach, focusing on longer term growth capital plays with trade sales likely to account for an increasing proportion of exits, and domestic PE players, who have favored shorter term investments directed towards an IPO exit.

Chinese companies are starting to recognize the value PE can bring in assisting management teams to improve portfolio company operational performance, and this is improving reputation among entrepreneurs and policymakers. More recently, the necessity for enhancements to the governance of portfolio companies has attracted attention and this is clearly an area in which PE houses may add value.

PE houses will need to build on their successes, taking a hands-on approach, developing local networks, conducting thorough due diligence, improving governance and working closely with management teams to create value.

Market analysis

China’s leaders seem keen to keep growth levels under control with the 12th Five Year Plan targeting 7–8 percent annual growth3, down from an average of 10-11 percent over the past five years4. While recent history suggests that the target will be exceeded, these growth levels are the envy of governments the world over. That said, considerable challenges remain to be overcome including inflation, inflated real estate valuations, non-performing loans to state owned enterprises (SOEs), an ageing population and a rise in social instability as a result of the huge societal changes underway. Given economic conditions in OECD countries, exports will decline in importance as a driver of growth and economic policy is being refocused around measures to increase domestic consumption.

Private equity is becoming an established part of the landscape, with many business owners seeing PE as a source of finance for capital expenditure, M&A and working capital. The global financial crisis has barely slowed PE activity, with US$19.2 billion of investments in 20105.

In recent years RMB funds, which have been raised by both domestic and international investors, have grown in importance, accounting for 78.3 percent of funds raised in 20106. Government policy is generally supportive of private equity, though there are concerns that enhanced enforcement by tax authorities on offshore gains and regulatory protection for as yet undefined key national industries and companies could stifle some investment activity.

Policy changes to allow China’s massive insurance and securities companies to participate in PE, along with increased interest from wealthy individuals, Sovereign Wealth Funds and international institutions point to a long-term increase in the supply of capital to PE general partners.

1CNBC, 10 February 2011

2Xinhua 5 March 2011

3Xinhua, 5 March 2011

4World Bank, October 2011

5Asia Venture Capital Journal, 25 May 2011

6Asian Venture Capital Journal, 25 May 2011


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