Wednesday, February 9, 2011

Foreign private equity players face big squeeze in China

(SINGAPORE) The odds are increasingly stacked against foreign private equity (PE) players in China, as they face greater competition from peers and domestic yuan funds.

These new domestic players are redefining the PE landscape in China with swift deal-cutting and their willingness to stomach higher valuations. Foreign players find themselves increasingly priced out.

Many of the domestic yuan funds, even if they have a sizeable capital of a billion yuan, are able to 'make investment decisions within minutes', Johnson Teh, managing director of Singapore-based Black Swan Equity Partners told BT.

According to Alvin Li, managing director for direct investments at CCB International Asset Management (which now has only US dollar PE funds), there are currently more than 2,000 yuan-denominated PE funds on the mainland, of which most are small with capital of under 100 million yuan (S$19.4 million).

They know the market very well and are able to sew up small deals quickly without much fuss. The competition is intense - a number of firms compete for each deal, he said.

Competition is not just coming from domestic players. Foreign PE players themselves are rushing to put their money to work.

Latest data from Thomson Reuters shows that some US$246 billion in PE commitments have been made in Asia Pacific and Japan since 1995, but only US$173 billion or 69.8 per cent of commitments has been invested in portfolio companies or other PE entities.

Mr Teh noted that many Hong Kong-based US and UK funds that raised funds just before the 2008-2009 financial crisis and stayed liquid during the period are now eager to snap up deals, so some have started to match up to the valuations offered by the Chinese domestic PE funds.

'We are ultimately chasing the same assets in China. That's where it gets intense,' Mr Teh said. 'Many PE players are rushing in and paying high valuations to the asset owners, which we personally see as creating a bubble.'

This could erode returns for PE investments in China at a time when the inflation bubble and prospect of policy tightening have raised investment risks too, he added.

Last year, 82 PE funds set up in China raised 27.6 billion yuan, more than double the 12.96 billion yuan raised by 30 funds during the previous year, according to Beijing-based fund consultancy Zero2IPO.

Of the 82 PE funds, 71 are denominated in yuan, although they raised a combined total of only US$10.7 billion, compared with US$16.94 billion by generally much bigger hard-currency funds.

Apart from state-owned enterprises, China's domestic PE funds are run by well-connected private individuals. Some operate largely on the strength of relationships with local government or entrepreneurs - though the bigger domestic PE players like Hony Capital and Legend Capital are said to abide by traditional PE rules.

Global players believe they can distinguish themselves from the pack through their operational expertise, international network and other resources beyond merely providing capital.

More foreign PE firms are mulling the prospect of launching yuan-denominated funds in China or tapping the upcoming pilot QFLP scheme in Shanghai, Beijing and Tianjin for qualified foreign limited partners to convert investments into yuan.

One Singapore-based fund manager at a US PE firm told BT that the company has been in discussions in the past few months to launch an onshore yuan fund. London-based 3i is also said to be seeking to raise a yuan-denominated fund to invest in Chinese private equity.

Blackstone Group, the Carlyle Group and TPG Inc have already launched yuan-denominated PE funds in partnership with local governments or companies, after the government relaxed rules allowing them to do so.

In a bid to be 'local' and stay close to the ground, some foreign players like Carlyle and Blackstone have also set up offices on the mainland and hired locals with strong local knowledge.

But regulatory factors in China do not appear to be in their favour.

Foreign investors are restricted from certain downstream investments, such as in sensitive sectors, secondary stock market, bond trading market or real estate investment, said Anthony Zhao, a senior partner at PRC law firm Zhong Lun.

Deloitte China has also pointed out that there are market concerns about the capacity of the A-share markets to support IPOs that could stem from yuan funds seeking to exit from portfolio companies.

The wait for approval from the China Securities Regulatory Commission for a Shanghai listing is estimated to be five years.

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