In private equity, China is (still) the next big thing

The US and European Private Equity (PE) industry has taken repeated hits after the escalation of the financial crisis in September 2008. LBO markets came to a halt through banks’ inability and unwillingness to lend.

PE investments lost value because of the economic downturn, and successful exits were largely impossible due to the shutdown of equity capital markets. The industry’s woes continued with the escalating sovereign debt crisis in Europe.

The latest obstacle was presented in the form of regulatory frameworks which might pose great challenges in the future. As a consequence, fund managers began to look into China as a safe haven for investing.

First signs of a beginning surge of PE in China have shown in late 2009 with Blackstone’s entry into the market, raising a 5bn RMB China-only fund. Many industry insiders were bullish on the market, believing that the potential in an ever-growing economy was limitless.

Also, the construction of Renmimbi-denominated funds with Chinese-only investors seemed to allow the circumvention of the strict regulatory guidelines offshore fund investors usually face.

An additional pennant of hope was the introduction of the “Chinese NASDAQ”, the ChiNext segment of the Shenzhen Stock Exchange in 2009, allowing for lucrative exit scenarios of VC and (R)LBO deals. Plus, many Asian banks were unfazed by the crises in Europe and the US and thus willingly continued to lend.

However, following this promising start, PE business in Asia took some hits along the way. First, buyout funds running RMB-denominated funds needed more time for the fundraising than anticipated.

Another unexpected roadblock came in the form of heightened regulatory scrutiny. In May 2012, the NDRC (National Development and Reform Commission of China) stated that foreign-sponsored funds, regardless of investor base and currency denomination, would face the same restrictions as offshore funds.

The third and most recent hit was the European sovereign debt crisis which slowly began to creep into China in early 2012. First signs of a weakness in growth of the Chinese economy have already begun to surface. The problem for PE is: an economic downturn does not allow for successful portfolio company restructurings or exit scenarios, both of which hurt investor value tremendously.

Yet, in spite of these obstacles and judging by the sentiment of industry insiders, China still seems the next big thing in Private Equity.

A recent survey among PE industry insiders by data/service provider Preqin (published in “Preqin Quarterly Q3/2012” and “Preqin Special Report Asia”) reveals:

Just as many respondents believe that Asia presents the best current investment opportunities (36 percent), as believe that America is the best current environment (37 percent), whereas only 17 percent feel that way for Europe 58 percent of the survey respondents feel that China currently presents the greatest investment opportunities among the Asian markets, despite its growth woes and in contrast to rivals India (36 percent), and Japan (1 percent) 49 percent of respondents aim to increase their capital allocation in Asia over the long term (36 percent even in the next twelve months); only 6 percent aim to decrease allocation.

Over the last year, Asia, especially China, has surpassed Europe as the number two PE market behind the US. In Q3/2012 alone, Asia closed more PE funds (49) and raised more capital (15.7 bn USD) than Europe (22 funds with 14.7 bn USD in fundraising).

These numbers are interesting, especially given that China is still a difficult environment for foreign investors due to regulatory difficulties, possible lack of Guanxi among the fund managers and uncertainties about the currency development.

However, the opportunities seem to outweigh the challenges, which is why the numbers suggest that China is still the next big thing in Private Equity.