As the US-China trade war rumbles on casualties are beginning to pile up on either side. Huawei Technologies is reeling from a US blockade of component suppliers while China is probing US blue-chip FedEx for delivery failures.
For private equity funds, though, there's a potential opportunity to begin picking up assets on the cheap.
These funds have plenty of firepower for deals. At the end of June 2018, private capital ready for deployment surpassed $2 trillion, a record amount according to data providers Preqin, and about 18% of that sum, or $360 billion, has been set aside to buy companies in Asia.
While portfolio and retail investors have been dumping Chinese equities in droves, redeeming about $200 million-worth of stock in May alone, according to data from EPFR, private equity firms are taking a longer-term view of the Middle Kingdom’s growth potential.
In particular, they are hankering after the Chinese operations of multinational companies as they are usually sizeable, have widely recognizable brands and are relatively easy to finance. So far, some of the biggest corporate carve-outs have been in the fast-growing consumer consumption sector, offering private equity funds plenty of scope to make fat returns on their investments.
And it's made them hungry for more.
This trend has already been on a roll as multinationals struggle to compete with nimble local competitors. Ride-hailing firm Uber and Yum Brands, the operator of KFC, have already hived off their Chinese subsidiaries and sold them. US media firm Viacom is also mulling whether to scale back in China, as is German wholesaler Metro and French retailer Carrefour, various market sources have told FinanceAsia.
The US-China trade war is likely to accelerate the pullback. A survey by the American Chamber of Commerce mid-May showed US and Chinese tariffs are having a negative impact on the vast majority, 74.9%, of its members’ businesses.
Xin estimated that there has been $3 trillion worth of foreign investment in China that could be sold “so we will see if we can pick up something good.”
Private equity real estate funds are also closely monitoring foreign company retreats for bargains. Ivan Ho, the Hong Kong chief executive of real estate investment firm KaiLong, thinks multinational companies are not as aggressive about expanding in China anymore and that this will impact property prices in Shanghai where many of them have chosen to locate their China headquarters.
“Time for us to cherry-pick some of the good opportunities in the China region,” chimed in Charles Lam, a managing director in real estate investing at Baring Private Equity Asia, who is on the lookout for logistics companies and business parks to buy as the trade war continues.
BROKEN SUPPLY CHAINS
China’s desire for more autarchy after the US weaponised access to components for telecoms equipment makers ZTE and, more recently, Huawei, could also create investment opportunities.
For one, it is likely to transform China’s chip industry. China imported $260 billion-worth of semiconductors in 2017, according to a study by the China Semiconductor Industry Association. China, the world's largest consumer of chips, is now trying to wean itself off this reliance on overseas technology by investing in domestic design and fabrication.
Domestic chipmakers are now blossoming as a result of the state’s enthusiastic husbandry.
“Because of this [trade] tension forward-looking logs or orders have skyrocketed because they are the only source now to fuel domestic demand,” said Linda Luo, a managing director at KHL Capital, a technology and healthcare-focused private equity firm.
Private equity funds have traditionally sought to marry advanced US technology to China's massive market place. As an example, Citic Capital bought Santa Clara, California-headquartered Cmos chipmaker OmniVision, in 2016 and helped it to expand in China.
Now, the smart move is to back ambitious Chinese chipmakers, Citic Capital’s Xin said. “Anything in the US, you always find a copycat.”
Of course, such investments won’t be a slam dunk; these companies are still relatively slow and years behind their US peers in chip design.
The Chinese government’s new drive towards greater self-sufficiency, which promises to transform swathes of its domestic industry, is also creating formidable competitors for private equity funds in the form of state-backed investment vehicles.
“The semiconductor sector is going crazy!” said Wayne Shiong, a partner at venture capital investor China Growth Capital. He said it is tough to compete with government-backed funds for deals as they have deep pockets and are willing to pay high prices.
Much of that investment is guided by the state-controlled China Integrated Circuit Industry Investment Fund, which invests across the entire chip supply chain and has raised about Rmb140 billion ($20.2 billion) since its 2014 launch.
Chinese chemical-sensing chip company Quanta Eye, which generated revenue of just Rmb10 million ($1.5 million) last year, was recently valued at a pricey $100 million after raising capital from government-related funds, according to a market source.
Beyond China, as already indicated, private equity firms are eyeing Southeast Asian companies that could benefit from the re-routing of supply chains out of China. Olympus Capital Asia has already backed Vietnamese e-commerce and logistics company SCommerce, for one.
Not that private equity firms are having it all their own way, given many of the companies already in their portfolios are likely to suffer from trade flow disruption. KHL Capital, for example, recently acquired a Taiwanese broadband business that uses chips from HiSilicon, Huawei’s in-house chip design unit, in its set-top boxes. It is now having to rethink its supply chain.
“We are told by regulators that we are no longer allowed to use any PRC supply chips in Taiwan,” said KHL Capital’s Luo. She did not name the portfolio company in question but KHL Capital bought China Network Systems, the largest broadband operator in Taiwan, in 2018.
She also told FinanceAsia that Taiwan’s ruling on Chinese components is not official yet, but that regulators are guiding companies in this direction. KHL Capital’s portfolio company has not yet switched to another component supplier but will consider its options for future supply contracts.
The trade war is also proving tough on private equity firms caught trying to raise funds from institutional investors such as pension or sovereign wealth funds.
A fundraising drive takes on average a year to hit its target but fund administrators can offer an early indication of any changes in the market.
James Donnan, a managing director at Intertrust in Hong Kong, said that the number of private equity and venture capital fund launches his team are working on has halved in the first half of this year versus a year ago.
He said that it is also taking funds longer to raise capital, whereas in the gung-ho atmosphere a year ago it wasn’t uncommon for funds to launch and close simultaneously.
Even so, private equity funds are keen to spend the capital they have already accumulated.
A few fund managers think they have a chance of persuading Chinese companies listed in the US to place themselves in private hands, encouraged by the growing consternation among US politicians over a lack of transparency at many Chinese companies, especially with regards to state influence.
Stephen Bannon, Trump’s former chief strategist, said Chinese companies should be shut out of American capital markets. “The next move we make is to cut off all the IPOs, unwind all the pension funds and insurance companies in the US that provide capital to the Chinese Communist Party,” Bannon told the South China Morning Post.
“A lot of the Chinese companies listed in New York will think about listing again in Hong Kong,” said Jian Guang Shen, chief economist, at JD Digits, the financial technology arm of JD.com.
This could be with private equity investors help or they could just hedge their bets, as Alibaba is mulling, by opting for a secondary listing in Hong Kong and keeping their primary listing in the US.
Ashok Pandit, Deutsche Bank’s global co-head of sovereign wealth funds and pension fund coverage as well as head of financial sponsor coverage for Asia Pacific, said that discussions with management and shareholders should be more strategic and question whether the company is being incorrectly valued due to a lack of liquidity or the wrong investor base.
“If there are assets that have strong cash flows – take sectors like education and healthcare – those are strong candidates for take privates,” he added.
While the thinking behind many of these themes may still be forming in the minds of many eager private equity professionals, they still have plenty of time to fine-tune their plans and make their pitches.
As James Lau, Hong Kong’s secretary for financial services and the treasury at HKVCA event in Hong Kong, said: “[It] seems obvious that tensions are going to be around for a while.”