Setting the record straight on private equity in China

It is too early to tell whether Mainland private equity will succeed or fail, says Vincent Pun.
In the August cover story, FinanceAsia was negative about private equity but hugely bullish about venture capital in China. Vincent Pun, head of research at the Asian Venture Capital Journal, disagrees with this notion.

Our cover story was negative on private equity (PE) in China, but you are more positive. Why?
Compared with the private equity landscape in the US or Europe, China's market is still at a very early stage and is a long way off from becoming a mature market. Therefore, it is too early to say whether Chinese private equity is successful or a failure. All the players in China (including government officials, fund managers and institutional investors) are still learning about Chinese-style PE. When the correct formula (i.e. investment structure, rules and regulations) is worked out, it will be no surprise that China will become one of the most important PE markets in the region. Of course, it could take some time to grow.

What genuine, successful private equity deals can you point to?
ItÆs true that although there have been quite a number of private equity-backed buyout investments made in China over the past few years, such as investments in Henan Shuanghui, Harbin Pharmaceutical and Shangdong Deosen, we have yet to see successful exits.

How is the ratio between funds raised and funds invested in China changing? What does the trend show?
Before 2003, no so-called "buyout fund" had been officially launched in China. Hony Capital was probably the first one of this kind. In these past two years, more private equity funds were launched to primarily focus on China's buyout opportunities, e.g. CDH China Fund III, CITIC Capital China Partners, Eagle-Bear Stearns Retail Fund, and China Harvest Fund. And certainly, western players are playing a very active role in the market such as Warburg Pincus, Goldman Sachs, Carlyle, Blackstone and TPG Capital

Is the pace of deal flow accelerating in China?
Yes, in terms of both deal volume and value, the figure for the China buyout market is accelerating. In 2003, there were just six deals tracked totalling just $28 million. The number jumps to just below $1 billion in 2006 accounting for 18 deals. For the year-to-date 2007, we have seen 10 deals announced for $658 million in value. Although it cannot compare with other key buyout markets in the region such as Australia, Japan, and Korea, it has been a good start so far. Once China finds its own way to develop the private equity market, there is no doubt China will emerge as one of the important buyout markets.

How is the pace compared to India? Do you have any idea why deals might be going faster in India?
According to AVCJ Research figures, India made five buyout deals totalling $144 million in 2003. The figure climbs to $1.3 billion for 18 deals. As of today 2007, we have tracked approximately $450 million in deal value. You can see the pace is actually about the same. Of course, China's economic scale is three times bigger than India's. It is rational if the market expects the same multiple difference for buyouts.

How does China compare to the rest of Asia (including Japan) in terms of buyout deals?
As of 2006, China just accounted for 3% of the region's buyout deal value and less than 10% in terms of deal volume. Japan and Korea's buyout market jump-started after the Asian financial crisis and Australia also caught investorsÆ attention these last few years thanks to its mature economy and a stable legal and financial system.

How do buyout volumes compare to venture capital (VC) volumes?
The ratio for buyouts to VC is 1:15 by deal volume, so there are far more VC deals than PE deals. In term of deal value, the ratio is 1:7. It's no surprise as buyout deals are usually larger in size.

Do you think the reason for the lack of PE deals in China is political, or do you think it's just because it is an emerging market?
I think the political factor is one of the reasons and indeed this may happen in any part of the world. Since China is still an emerging market for private equity and the deals may involve changes of control for certain sensitive businesses or SOEs, it is natural for the government to move forward step-by-step. The Blackstone investment case for the state-owned investment company is one of the examples. China is learning about private equity. It is prudent to understand the rules of the game before competing on the course.

Which sectors are most popular for PE investment? Is this the same as for VC investments?
Consumer/mass market and financial services are the most popular sectors for PE players, who can thus benefit from riding on the coat-tails of China's continuous economic growth. VC investments focus more on the technology side. Growth/expansion capital is also targeting the consumer/mass market sector.

Who are the most active PE players in China?
There are quite a lot. The active ones include Temasek, GIC, Goldman Sachs, Warburg Pincus, CDH, Carlyle and H&Q.

How do foreign PE players compare to domestic PE players?
Foreign players are still taking a large portion of the PE market. But some of the local funds are now up and running, such as the Bank of China/Bohai Industrial Investment Fund, Hony Capital and CDH. I can foresee domestic players will pick up a larger portion gradually in the near future.
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