With or without foreign investors, China deals will still get done
Local private equity groups tap cheap funding to seize on opportunities from exits
Henny Sender is the founder and managing partner of Apsara Advisory, a strategic consultancy for financial services companies. She was previously a managing director at investment company BlackRock.
While macroeconomic clouds darken over China, net inbound investment flows dissolve and tensions crackle across the Pacific, not all is gloom and doom.
As foreign strategic investors and international debt and equity buyers take cover on the sidelines, Chinese private equity investors are taking advantage of bearish market sentiment and cheap yuan financing to seize profitable opportunities resulting from this exodus.
The negativity is particularly strong in the public markets -- domestic Chinese stocks are down about 11% so far this year -- but the impact on private markets has also been significant, if less visible. Most international investment firms are not investing in either China's public or private markets for now.
The bearish mood prevailing today is perhaps the deepest in memory. This is in large part because of the carnage in China's property market, a sector that previously accounted for as much as 30% of gross domestic product.
"This is the first time ever that China is facing a slowdown that is more than just a cyclical downturn," said the Beijing-based representative of a major international investment firm. "You need more management skill in a 4% to 5% GDP [growth] world in China than when it was an 8% GDP [growth] world."
In the private markets, which are less subject to scrutiny from politicians or regulators on either side of the Pacific, the pickings -- and the financing -- are easier and conditions can play to the strengths of skilled management.
Yichen Zhang, who set up the private equity arm of state investment company CITIC in 2002, said his firm was turning back to its original focus on buyouts instead of taking minority stakes in target companies. "With slower growth and a more mature market, control matters more and we are coming back to our original strategy," he said.
At the Hong Kong Monetary Authority's Global Financial Leaders' Investment Summit this week, many speakers suggested there is more downside risk in U.S. private markets than in China's today. In the U.S., returns have been driven by cheap debt taken on in the near-zero interest era, but that time is over. These days, for the first time in a while, interest rates are lower in China and set to remain so given the country's lack of inflation.
As a result, cheap financing is a major consideration contributing to the attraction of Chinese private markets. Ten years ago, private equity buyers looked to international banks to finance their deals. Today, Chinese banks are happy to lend money to finance transactions on attractive terms at a time when they are not getting much demand from households and other companies.
Hong Kong-based PAG is among those hunting for bargains as international investors retreat. Earlier this year, it put $500 million into online streaming service iQiyi, which boasts over 100 million subscribers and is both cash flow positive and profitable. PAG has locked in a minimum 20% return on its investment, according to people familiar with the transaction.
There are other shifts at work in global investment circles that are having an impact as well. For example, before the U.S. Federal Reserve started raising rates 18 months ago, most investment firms preferred to supply growth capital to their portfolio companies to take advantage of the then-abundant liquidity. But these days, portfolio managers prefer to exercise control.
"For buyouts and large checks, it is very much a buyers' market, so we get to control terms," said PAG Chairman Weijian Shan.
State-owned enterprises are among the players becoming more active in China's private markets. These include local governments and enterprises they own which are putting money into domestic investment funds as officials search for an alternative source of revenue in the face of slowing land sales.
An important factor that has added to hesitations about China among international investment firms is the question of exit, as the traditional ways to cash out of an investment in the country, such as selling to an international strategic investor or an overseas initial public offering, have become more challenging.
Chinese state-owned enterprises are stepping into this gap too. Hangzhou State-Owned Capital Investment and Operation Co. agreed earlier this year to buy Yingde Gases from a company controlled by PAG for $7.2 billion, according to deal data service Mergermarket.
PAG originally took Yingde private in a deal valued at $2.6 billion in 2017. The deal stands to make Yingde one the firm's most lucrative investments.
Aging Chinese entrepreneurs looking to retire are also becoming a greater source of deal flow, CITIC's Zhang said. "In China, the one-child policy means more opportunity for us because with family-owned company succession, sometimes the one child does not want to inherit the company."
To be sure, the green shoots in the market are still fragile. But as developed markets slow, a recovering China would be good for the world and even better for the contrarians.