China’s private equity industry in at a peculiar crossroads. The mainland PE market has been flourishing in recent years due to steady industrial growth, but for the firms themselves, the exit route appears to be choked as of now.
From a near-zero base in 2000, global private equity funds and their start-up local counterparts rushed into the Chinese market — clocking nearly 10,000 deals worth $230 billion (Dh844 billion) between 2001 to 2012. But according to a report released recently, of those deals, some 7,500 remain “unexited”, meaning that private equity investors are yet to find a way to cash out of their investments and pocket profits.
In mature markets, private equity firms usually sell to peers in a given industry or to other PE funds. But the Chinese private equity market has been mostly reliant on one exit route: the initial public offering (IPO). Historically the exit route for PE companies has been an IPO either on the Mainland China markets, or the US markets, but at the moment the two routes don’t look very encouraging.
Weak markets
The year 2012 was a markedly slow period for the sector, mainly due to a very depressed Mainland stock market throughout the year. Weak markets prevented PE firms from obtaining a higher valuation when they wanted to exit their PE investments via IPOs. The situation became more tough when Chinese regulatory authorities virtually showed the red light to new stock listings since last summer. The backlog of applications for companies waiting to list on the Shanghai and Shenzhen markets has grown to nearly 900. Many of those include private equity investors seeking to cash out. At the same time, the overseas option is also closing down. Interest among investors in American stock markets for new offerings from China remains low and hostile after a series of accounting fraud scandals involving Chinese companies. One agile player was Carlyle Group, one of the world’s largest private equity firms, which managed a good run by selling its remaining stake in China Pacific Insurance Co last year. Carlyle began selling its stake in the insurer in late 2010 and earned about $4 billion from stock sales over that time, five times the $800 million it had invested between 2005 and 2007.
The bottom-line for rest of the domestic and foreign private equity firms is that there is no easy way out. If PE companies need to exit in 2013, they will have to be creative because few options are now available.
Interest intact
Despite problems with exit route, there is still a lot of enthusiasm. The mainland PE industry has been flourishing in recent years due to breathless economic growth in China. Also, private small and medium enterprises are greatly attracted to PE funding as major banks ignore them in favour of State-owned enterprises. Between 2007 and 2012, PE fundraising activities grew exponentially — from $13.7 billion to $38.8 billion.
This year began well with leading Chinese private equity firm China Science and Merchants Capital Management indicating that it will invest more than $1.76 billion in at least 300 companies this year. The more attractive segment for foreign PE firms this year will be the health care sector which is in the midst of a boom. Global private equity firm Actis Capital made a minority investment in specialist medical equipment manufacturer Micro-Tech (Nanjing) Co, a sign of how China’s burgeoning health care industry will become increasingly attractive to PE entities. The much touted clean-energy sector, on the other hand, is down in the popularity scale. The number of equity investment deals in the over-invested clean-energy sector in 2012 reached a six-year low, with only eight deals working out.
More flexibility
The PE market, overall, promises to be good this year as regulators are making all the right noises. At the beginning of the year, China Securities Regulatory Commission took a significant step. It allowed overseas yuan capital to come in to boost PE investments. Shanghai will be the first pilot city to launch the Renminbi Qualified Foreign Limited Partnership programme that permits overseas raised yuan to be repatriated back to the mainland to invest in unlisted companies through the PE investment vehicles.