The future of private equity and venture capital in China is threatened by a huge overhang of illiquid investments. US institutional investors and pension funds are at risk in a market that until recently was a source of significant investment profits. Private equity secondaries offer a potential way out,Â according to China First Capital.
Chinaâ€™s private equity industry, having grown in less than a decade from nothing into a giant rivaling the private equity industry in the US, is in the early stages of a unique crisis that could undermine the remarkable gains of recent years, according to a newly-published research report by China First Capital, an international investment bank. Over $100bn in private equity and venture capital investments is now blocked inside deals with no easy exit. A significant percentage of that capital is from limited partners, family offices, university endowments in the USA.
Private equity firms in China are running out of time and options. Exit through trade sale or M&A, a common practice elsewhere, is almost nonexistent in China. One viable solution, the creation of an efficient and liquid market in private equity secondaries in China where private equity firms could sell out to one another, has yet to develop. As a result, private equity general partners, their limited partner investors and investee companies in China risk serious adverse outcomes.
Secondary deals will likely go from current low levels to gain a meaningful share of all private equity exits in China, China First Capital said.
In all, over $130bn is now invested in un-exited private equity deals in China. The un-exited private equity and venture capital deals are screened and analysed across multiple variables, including date, investment size, tier of private equity firm, industry, price-earnings ratio.
Secondary deals potentially offer some of the best risk-adjusted investment opportunities, as well as the most certain and efficient way for private equity and venture capital firms to exit investments and return money to their limited partners, the report finds. The most acute need for exit will be investments made before 2008, since private equity firms generally need to return money to their limited partners within five to seven years. But, more recent private equity and venture deals will also need to be assessed based on current market conditions.
Over the course of the last twelve months, first the US stock market, then Hong Kongâ€™s, and finally Chinaâ€™s own domestic bourse all slammed the door shut on IPOs for most Chinese companies. As a result, private equity firms canâ€™t find buyers for illiquid shares, and so canâ€™t return money to their Limited Partners.
â€œMany private equity firms are adopting what looks to be an unhedged strategy across a portfolio of invested deals waiting for capital markets conditions to improve,â€ according to China First Capitalâ€™s chairman and founder, Peter Fuhrman. â€œThe need for diversification is no less paramount for exits than entries,â€ he continues. â€œMany of the same private equity firms that wisely spread their LPs money across a range of industries, stages and deal sizes, have become over-reliant now on a single path to exit: an IPO in Hong Kong or China. By itself, such dependence on a single exit path is risky. In the current environment, with most IPO activity at a halt, it looks even more so. â€
Secondary activity in China will differ significantly from secondaries done in the US and Europe, he added. Buyers will cherry-pick good deals, rather than buying entire portfolios, and escape much of the due diligence risk that plagues primary private equity deals in China. Sellers, in many cases, will be able to achieve a significant rate of return in a secondary sale and so return strong profits to their limited partners. Private equity-invested companies stand to benefit as well, since a secondary transaction can be linked to a new round of financing to provide additional growth capital to the business. In short, secondary deals in China should be three-sided transactions where all sides come out ahead.
But, significant obstacles remain. The private equity and venture capital industry in China has grown large, but has not yet fully matured. The industry is fragmented, with several hundred older dollar funds, and several thousand Renminbi firms launched more recently, some fully private and some state-owned with most falling somewhere in between.
Absent a significant and sustained surge in IPO activity in 2013, the pressure on private equity firms to exit through secondaries will intensify. According to the report, no private equity firm is now raising money for a fund dedicated to buying secondaries in China. There is a market need. As a fund strategy, private equity secondaries offer Limited Partners greater diversification across asset types and maturities in China.
Private equity has been a powerful force for good in China, the report concludes. Entrepreneurs, consumers, investors have all benefited enormously. Profit opportunities for private equity firms and Limited Partner investors remain large. Exit opportunities are the weak link. A well-functioning secondary market is an urgent and fundamental requirement for the future health and success of Chinaâ€™s private equity industry.
Copyright Â© 2013 AltAssets
A stagnant exit market is likely to cause problems for firms that ventured into China in the boom years
Statistics rarely tell the whole story. However, as China celebrates the Year of the Snake, the most recent figures for private equity exits in the country make sobering reading for those who were convinced that the surge in private equity in the worldâ€™s most populated nation was the ticket to easy returns. In the final quarter of 2012, there was no capital raised by sponsors through primary initial public offerings of companies they backed, no capital raised through sales to strategic buyers and just $30 million from secondary buyouts, according to data from Dealogic.
That collapse in the exit market is creating a huge backlog of businesses in private equity hands that could force many companies to the wall and drive a shakeout in the industry, losing investors billions in the process. Global private equity firms, from large buyout specialists TPG Capital and Carlyle Group to mid-market players like 3i Group, all flooded
into the Chinese market raising capital from international investors for deals on the expectation of outsized returns as the economy opened and boomed. They were joined by thousands of domestic players that raised capital in local currency from the growing band of Chinaâ€™s wealthy individuals eager to get a slice of the market.
Peter Fuhrman, chairman and CEO of investment bank China First Capital, said: â€œIn the course of the last five years China has grown into the largest market by far for the raising and deploying of growth capital in the world. It has been an incredible success story when it comes to talking investors into opening up their wallets and allocating much-needed capital to thousands of outstanding Chinese entrepreneurs.â€ More…
–12 FEB 2013 – ALLEN T. CHENG
Chinaâ€™s once-booming private equity industry is facing a logjam as a dearth of exit possibilities is slowing the flow of new deals in the sector, analysts and industry executives say.
The volume of private equity activity slowed dramatically last year, with some $17 billion invested in more than 700 companies, down from more than $30 billion invested in more than 1,700 companies in 2011, according to China First Capital, a Shenzhen-based investment advisory firm. Virtually all deals in China are minority equity investments in fast-growing private companies rather than buyouts of public companies as in the West. The industry was virtually nonexistent in China at the start of the 2000s but grew rapidly as Western investors rushed to participate in the countryâ€™s economic boom.
â€œYou had an industry that grew very quickly but is not yet fully matured,â€ says Peter Fuhrman, chairman and CEO of China First Capital. â€œThe PE firms raised huge money from LPs around the world and now face the challenge of not being able to exit their investments before the life cycle of their funds run out,â€ Fuhrman says. More…
I can’t say I ever articulated it as a goal, because it always seemed too far-fetched. But, I did achieve something today I truly value. I had an article published in a leading Chinese newspaper under my own name. Well, not the name my parents gave me, but my Chinese name, å‚…æˆ, which is how I’m generally known here. You can click here to see the article. The title, IPOé»„é‡‘æ—¶ä»£ä¸€åŽ»ä¸è¿” ç§å‹Ÿè‚¡æƒè¡Œä¸šå±æœºé‡é‡, can be translated as “With the Golden Age of IPOs Over,Â the Chinese PE Industry is in Crisis”.
It’s an article about problems with unexited PE investments in China, and the block on IPOs for Chinese companies. It appears in the country’s only major national business daily, called 21st Century Business Herald, in English, or 21ä¸–çºªæŠ¥çº¸ in Chinese. Calling it the “Wall Street Journal of China” is a little bit of a disservice, since it enjoys more of a dominant position, both in reputation and in its area of financial reporting, than even the Journal. And I give way to no one in my complete admiration of the WSJ. It is the only newspaper I read and value.
I’ve been an occasional online columnist for 21st Century Business Herald for a couple of years. This may have made them more comfortable when dealing with my rather unusual request, to publish in the daily paper’s news pages under my name an article I submitted to them. This isn’t something Chinese newspapers, especially the major ones, would generally ever do. Media is sensitive in China, extremely well-monitored. I’m just a guy who runs a small advisory firm 1,500 miles from Beijing, and have had no other form of official vetting.
After a day of deliberating, I got word they’d agreed to run the story. I never spoke directly to any of the editors at the newspaper. I wasn’t allowed to. One of the team that manages the online columns acted as middleman.
It was important to me to have the article, as submitted, published, under my name. The article touches on a topic that I think is both important, and little understood — that the block in IPO exits, and the simultaneous cut-off in most new PE funding for private companies in China, is beginning to do real harm to the private sector economy in China. I wanted to make that point, directly and clearly, and not have it be massaged in any way.
I’m a guest in China, and feel extraordinarily privileged to live and work here. There’s nothing in my story critical of government policies, nor should there be. This crisis in China PE industry is largely of its own making. Â Yes, the sudden stop of all IPOs does harm to PE investors. But, for years now, China’s PE industry has been overly-reliant on IPO as its one means of exit. Money flooded in and, even at the best of times, only a trickle leaked out through IPO. Now the trickle has been plugged shut. PE firms, their investors and the entrepreneurs they backed are all in serious peril. PEs may lose their LPs money, which would be very unfortunate. But, the real suffering is likely to be borne by the entrepreneurs, who may actually be doing a great job running their business, but now have a desperate unhappy investor inside and so no way to raise the additional capital they need to keep growing. They face a kind of slow asphyxiation.
Another reason I wanted the article to be published under my name was to try to make sure my company got some credit for the work we’ve done over six months to calculate and assess the scale of the problem of unexited deals in China. The article was published this morning. By lunchtime, electronic versions were popping up all over the Chinese internet, on most of the major financial news websites. In almost all cases, these repackaged versions all deleted my name and that of China First Capital. Pretty much par for the course in China. “Journalistic ethics” are two words not frequently paired in China. The pirated articles now discuss the findings of our research without ever mentioning who actually compiled it. If I were a reader, I’d wonder, “why should I believe any of these numbers when the article doesn’t tell me who the source is?” But, I guess Chinese readers aren’t that fussed.
As readers of this blog clearly will have noticed, Â me and my company have gotten rather a lot of English-language press attention lately. But, not a single one of those articles, or the whole lump combined, gives me even a fraction of the satisfaction and joy I had this morning holding a Chinese newspaper and finding my article in the middle of page 15.–
The chairman of research firm China First Capital discusses Chinaâ€™s growing exit problem, and its possible impact on private equity in 2013.
A growing concern for private equity in China is the lack of IPO exits. How do you see that playing out in 2013?
“I donâ€™t expect any substantial improvement or change in the problems that are blocking IPO exits domestically and internationally. And because the China private equity industry is significantly over-allocated to IPO exits, along with diminishing fund life, [this] will be a time of increasing difficulty for GPs. At the same time, the inability to exit will also continue to prevent [GPs] from doing new deals, and that is where the greatest economic harm will be done. Of course I donâ€™t trivialise the importance of the $100 billion thatâ€™s locked away in unexited PE investments, but the real victims of this are going to be the private entrepreneurs of China. At this point, over half of all [Chinaâ€™s] GDP activity is generated from the private sector. The private equity money and the IPO money is what [businesses] need to grow, because private companies in China basically canâ€™t borrow. They need private equity money and IPO proceeds to continue to thrive. “Â More…
From humble beginnings in 2000, the past decade has seen the Chinese private equity (PE) market blossom into a global powerhouse. However, according to a new report released by investment bank China First Capital (China First), the Chinese market is in the formative stages of a crisis which could undermine all of the extraordinary strides it has made in recent years.
The report, â€˜Secondaries: A necessary and attractive exit for PE deals in Chinaâ€™, notes that while there have been nearly 10,000 deals worth a combined $230bn completed within the Chinese market between 2001 and 2012, around 7500 of those deals remain â€˜unexitedâ€™. This has left approximately $130bn of PE and venture capital investment locked inside Chinese companies with very few exit options available. More…
With Chinaâ€™s IPO gusher now reduced to a trickle, prospects for some of the privately-owned companies which have traditionally boosted much of Chinaâ€™s economic growth could be at risk.
So says Peter Fuhrman, founder and chief executive at China First Capital, a boutique investment bank and advisory firm. His firm has just released a new report warning that new private equity investment has basically come to a halt in China since the middle of last year.
Fuhrman talked to WiC this week about the reasons for the slowdown, and why he would like to see more investors considering alternative exits, including sales in the secondary market. More…
With the door to initial public offerings in China largely shut, private-equity firms invested there are having a tough time cashing out. The alternativeâ€”selling to another buyout firm or a company looking to expand via acquisitionâ€”remains rare in a market where buyers are relatively few.
Private-equity firms are sitting on more than $130 billion of investments in China and are under pressure from investors to find an exit, Shenzhen-based advisory firm China First Capital said in a report last week.
Gary Rieschel, founder of Shanghai-based Qiming Venture Partners, said, â€œThere needs to be a broader number of choices in buyersâ€ in China.
Private-equity firms have generally exited their China investments through IPOs, but the number of private-equity-backed IPOs approved by mainland regulators has plummeted. Meanwhile, the Hong Kong IPO market has softened and sentiment toward Chinese companies in the U.S. has soured because of accounting scandals.
In October, the China Securities Regulatory Commission shut the IPO door completely on the mainland, halting the approval of new listings over worries that a glut of offerings would further weigh on sagging share prices. The Shanghai Composite Index was one of the worldâ€™s worst performers in 2012, sinking to a near four-year low in early December before a rally pulled the index up slightly for the year.
Analysts say they donâ€™t expect the CSRC to approve any IPOs until at least March, when Beijingâ€™s top lawmakers usually hold important annual planning meetings.
The regulator approved 220 IPOs of companies backed by private-equity or venture-capital firms in 2010, but that fell to 165 the following year and 97 last year, research firm China Venture said. There are now nearly 900 companies waiting to list in China, the CSRC said on its website.
Hong Kongâ€™s market, meanwhile, has seen fewer IPOs over the past year as investors soured on new listings after several underperformed the broader market. U.S. private-equity firm Blackstone Group, which owns 20% of chemical company China National Blue Star, scrapped a planned Hong Kong listing of a unit called Bluestar Adisseo Nutrition Group in 2010 due to weak markets. It has yet to list that firm.
Carlyle Group has struggled to exit some of its deals, including two deals it made in 2007, a $20 million investment in Shanghai-based language-training firm NeWorld Education Group and a $100 million investment in Zhejiang Kaiyuan Hotel Management Co. A company spokesman said the holding periods for those investments are normal because private-equity firms usually stay invested for four to seven years. The spokesman also said Carlyle has successfully exited many deals, including the recent sale of its stake in China Pacific Insurance, which generated a profit of more than $4 billion.
In more-developed markets, private-equity firms can count on exiting their investments through sales to rival buyout firms or to companies looking to grow through strategic acquisitions. But in China, private-equity firms have sold stakes to rival firms or other companies only an average of 15 times a year over the past three years, according to data provider Dealogic.
Chinaâ€™s secondary buyout marketâ€”where private-equity firms sell to each otherâ€”remains immature. Among the handful of such deals, Actis Capital sold a majority stake last month in Beijing hot-pot chain Xiabu Xiabu, for which it had paid $50 million in 2008, to U.S. firm General Atlantic for an undisclosed amount.
Domestic consolidation is rare compared with the activity in developed countries. Chinese companies that are still growing quickly may prefer to hold off selling, and there are fewer big corporate domestic buyers.
â€œChina is still a relatively fragmented economy with a disproportionately small number of large businesses relative to the size of its economy and very few national businesses,â€ said Vinit Bhatia, head of China private equity for Bain & Co.
When a private-equity firm does sell a Chinese portfolio company, the size of the deal tends to be small. Last yearâ€™s biggest sale was MBK Partnersâ€™ $320 million sale of a majority stake in Luye Pharma Group, which it bought in 2008. The buyer was AsiaPharm Holdings Ltd.
Usually, though, foreign private-equity firms hold only minority stakes in Chinese companies because full control is tough to get, in part for regulatory reasons. Domestic private-equity firms, meanwhile, are often content to hold minority stakes in fast-growing companies, which can offer healthy returns.
Management may not be on board when a minority investor wants to put the whole company up for sale. Chinese chairmen, who are often the founders of their businesses, prefer to remain at the helm, said Lei Fu, co-founder of Shanghai-based private-equity firm Ivy Capital.
Still, private-equity investors say they are hopeful that more buyers will emerge in China this year, even if the IPO markets stay shut.
The number of strategic Chinese buyers should increase as the government encourages consolidation across industries and as medium-size companies begin growing more rapidly with a rebound in the economy, they say.
â€œFive years ago we would think of multinationalsâ€¦Now we think more local companiesâ€ when looking for buyers, says Huaming Gu, Shanghai-based partner at private-equity firm Baird Capital.
It is imperative for the private equity industry in China to develop an efficient, liquid market for secondaries. Our goal is both to facilitate an active dialogue, as well as help bring this about. Only by breaking the current logjam of no exits in China PE can money again start to flow in significant amounts to capital-hungry private companies. No less than the future fitness of China’s entrepreneurial private sector is at stake.
In the last several days, along with the Wall Street Journal article posted yesterday, five other financial media (New York Times, Bloomberg, AVCJ, PEI, CNN Money) published stories on this topic, referencing research results from China First Capital. I’m pleased to share them.
Private Equity in China: Which Way Out?
HONG KONG — Welcome to theÂ private equityÂ game in China: you can buy in anytime you like, but you can never leave. At least, that is how it is starting to seem for many of the firms that bought in big during the boom of last decade.
Starting from a base of almost nothing in 2000, global private equity funds and their start-up local counterparts rushed into the Chinese market – completing nearly 10,000 deals worth a combined $230 billion from 2001 to 2012, according to a report released this week by China First Capital, a boutique investment bank based in the southern city of Shenzhen.More…
At least 200 private equity portfolio companies in China are attractive targets for potential secondary buyers and the number is likely to grow 15-25% per year as funds come to the end of their lives and find that exit options are still limited.
These companies represent the cream of a much larger pool of investments that are as yet un-exited by Chinese PE investors, according to a proprietary study by specialist investment bank China First Capital. It estimates that more than 7,500 portfolio companies remain in private equity firms’ portfolios from investments made since 2000.Â More…
As other exit avenues for private equity dry up in China, GP-to-GP secondaries could be the only option for the 7,500 unexited portfolio
companies, according to a recent study from China First Capital.
China has 7,550 unexited private equity investments totaling $100 billion that will soon have to be realised through routes other than the traditional IPO, according to a recent study from China First Capital.
As fund lives begin to expire, Peter Fuhrman, chairman and chief executive of CFC, believes the standout option will be GP-to-GP secondary transactions. This is especially true for RMB funds, which have a three-to-five year life rather than the ten years typical with US dollar funds. More…
China’s stalled market for new share listings is severely limiting the ability of private equity funds to cash out their
investments in the country, according to a new research report from China First Capital.
The Shenzhen-based investment bank analyzed more than 9,000 private equity and venture capital deals completed in
China since 2001, and found that more than $100 billion — much from the U.S. — remains invested. More…
Private-equity funds in China are still holding 82 percent of the companies theyâ€™ve invested in since 2007, as the frozen market for initial public offerings keeps them from exiting, a study showed.
Funds hold 6,584 companies after disposing of 1,445 and seeing 20 go bankrupt, according to a report from China First Capital, a Shenzhen-based firm that advises on private equity and mergers. Investors still hold companies valued at $94.3 billion, compared with a total of $194.7 billion, according to public data compiled by the firm and its own research.
Chinaâ€™s IPO market has been shuttered by regulatory delays, while concern that accounts have been misstated has closed off U.S. bourses to Chinese companies. Firms are under pressure to return money to investors as funds raised several years ago approach the end of their cycle, while the market for sales to industry investors or other funds remains underdeveloped.
â€œThe larger issue has been one of reduced access to public markets for PE invested deals, rather than simply lower valuations,â€ said the China First Capital report. Private equity in China is â€œover-allocated to IPO exit.â€
The backlog of IPOs pending approval in China grew to more than 800 in December as regulators stopped allowing new offerings on concern that they may weigh on the market. Companies raised $14.6 billion through IPOs last year in mainland China, down 64 percent from 2011, data compiled by Bloomberg show.
Private equity firms in China have raised $137.7 billion since 2007, including a record $48.1 billion in 2011, according to the Asian Venture Capital Journal. Meanwhile, new investments fell 27 percent to $21.9 billion last year, the biggest drop ever, according to AVCJ.
Of 7,500 unexited investments since 2001, at least 200 of them are â€œquality secondaries,â€ or companies that have grown 25 percent a year since the original investment and can be sold to another private-equity fund, China First Capital said.
Itâ€™s only a moderate exaggeration to say that everything Iâ€™ve learned of value and enduring truth about politics and economics over the last 25 years came from the editorial pages of the Wall Street Journal. For just as long, the one writing goal Iâ€™ve held onto was having an op-ed published there. Todayâ€™s the day.
â€œCease and Desist on Delist-Relist“â€ is running in todayâ€™s Asian edition. I’m delighted. I owe a huge debt of thanks to the Journalâ€™s Joe Sternberg who encouraged me to submit the piece, and then did masterful work shaping and reworking the text from earlier blog posts.Â
I’ve known my fair share of editors. When I was atÂ Forbes Magazine many years ago, I had the good fortune to have a fair percentage of my stories edited directly the then Editor-in-Chief, Jim Michaels, who richly deserves the reputation as one of the finest ever in business journalism. He was a maestro. Other Forbes editors? Often klutzes. Joeâ€™s editing work is of Michaels quality. I have no higher standard, or stouter praise.
The full text as published by the Journal is copied below. For anyone whoâ€™d like to read the earlier draft, about 15% longer than this version, you can click here.Â
ByÂ PETER FUHRMAN
Foreign private-equity firms have a history of running into trouble in China. Generally consigned to buying minority stakes instead of the traditional buy-out-and-turn-around model they mastered back home, several big-name firms have become collateral damage in various corporate fraud sagas. Yet now some PE investors look set to jump into what could be the worst China investment move of all: the “delist-relist” deal.
The theory is simple. Hundreds of Chinese companies have gained listings in the U.S. via reverse takeovers, injecting all of their assets into a dormant shell company with shares traded on NASDAQ, AMEX or, more commonly, over-the-counter. Only then do the Chinese firms discover the enormous compliance costs associated with being listed in America, not to mention the low valuations for U.S.-traded shares relative to what a Chinese company could pull from equity markets back in China.
Enter PE investors to buy out the American shareholders, delist in the U.S., and then cash out by relisting in China. Several such deals have already been hatched, including one by Bain Capital to spend $100 million taking private NASDAQ-listed China Fire & Security Group; two deals orchestrated by Hong Kong-based Abax Capital, the planned buyouts of NASDAQ-listed Harbin Electric and Fushi Copperweld for more than $700 million; and Fortress Group’s financing to take Funtalk Holdings’ private. Conversations with market participants suggest quite a few other PE firms are now actively looking at such transactions.
Yet while the superficial appeal is clear, the risks are enormous and unmanageable, and have the potential to mortally wound any PE firm that tries.
The first problem relates to the aspect that most excites PE firms about delist-relist deals: the low share price in the U.S. The assumption generally is that this is simply bad luck. Many Chinese companies ended up trading over-the-counter or at low valuations on NASDAQ as a result of their reverse mergers. Share prices stay depressed, the theory goes, because American investors don’t understand the company’s business or trust its accounting.
That may be too generous to the Chinese executives. Those managers were foolish to have done a reverse merger in the first place. One can infer the boss has little knowledge of capital markets and took few sensible precautions before pulling the trigger on the backdoor listing that has probably cost the firm at least $1 million in fees to complete and ongoing regulatory compliance. An “undervalued asset” in the control of someone misguided enough to go public this way may not be undervalued after all.
Next, there are the complexities of taking a company private. For instance, class-action lawsuits have become fairly common in any kind of merger or acquisition deal in the U.S., with minority shareholders often disputing the valuation. With Chinese companies, distance, differences in accounting rules, and unusual corporate structures are likely to lead to bigger disputes over what a company is actually worth.
As if all that weren’t bad enough, it is far from certain that these Chinese companies, once taken private, will be able to relist in China. Any proposed initial offering in China must gain the approval of the China Securities Regulatory Commission. There is a low chance of success. No one knows the exact numbers, but from my own conversations with Chinese regulators, it seems likely that only 10%-15% of the more than 150 companies per month that applied to list last year gained listings. Companies whose U.S. listings failed will almost certainly suffer a serious stigma in the CSRC’s eyes. PE firms could end up owning firms that are delisted in the U.S. and unlistable in China.
Making a failed investment is usually permissible in the PE industry. Making a negligent investment is not. The risks in these deals are both so large and so uncontrollable that if a deal were to go wrong, the PE firm would be vulnerable to a lawsuit by its limited partners for breach of fiduciary duty. Such a lawsuit, or even the credible threat of one, would likely put the PE firm out of business by making it impossible for the firm to raise money. In other words, PE firms that do delist-relist deals may be taking an existential risk.
Why, then, are PE firms considering these deals? Because they appear easy. The target company is usually already trading on the U.S. stock market, and so has a lot of disclosure materials available. Investing in private Chinese companies, by contrast, is almost always a long, arduous and costly slog requiring extensive due diligence. Delist-relist seems like an easy way in, especially for smaller, less experienced PE firms.
By some counts, America’s largest export to China is now trash and scrap for recycling. These delist-relist deals have a similar underlying logic, that PE firms can turn American muck into brass in China. But that’s a big and very dangerous gamble. The only people certain to do well out of these deals are U.S. investors who sell out now at a small premium in the “take private” part of the deal.
Mr. Fuhrman is chairman and chief executive of China First Capital. This column is adapted from a report recently published by CFC.
The indispensable economy?
China may not matter quite as much as you think
THE town of Alpha in Queensland, Australia, has only 400 residents, including one part-time ambulance driver and a lone policeman, according to Mark Imber of Waratah Coal, an exploration firm. But over the next few years it should quintuple in size, thanks to an A$7.5 billion ($7.3 billion) investment by his company and the Metallurgical Corporation of China, a state-owned firm that serves China’s mining and metals industry. This will build Australia’s biggest coal mine, as well as a 490km (300-mile) railway to carry the black stuff to the coast, and thence to China’s ravenous industrial maw.
It is hard to exaggerate the Chinese economy’s far-reaching impact on the world, from small towns to big markets. It accounted for about 46% of global coal consumption in 2009, according to the World Coal Institute, an industry body, and consumes a similar share of the world’s zinc and aluminium. In 2009 it got through twice as much crude steel as the European Union, America and Japan combined. It bought more cars than America last year and this year looks set to buy more mobile phones than the rest of the world put together, according to China First Capital, an investment bank.
In China growth of 9.6% (recorded in the year to the third quarter) represents a slowdown. China will account for almost a fifth of world growth this year, according to the IMF; at purchasing-power parity, it will account for just over a quarter.
For the first 25 years of its rise, China’s influence was most visible on the bottom line of corporate results, as it allowed firms to cut costs. More recently it has become conspicuous on the top line. Audi, a luxury German carmaker, sold more cars in China (including Hong Kong) than at home in the first quarter. Komatsu of Japan has just won an order for 44 â€œsuper-large dump trucksâ€ from China’s biggest coal miner.
The Economist has constructed a â€œSinodependency indexâ€, comprising 22 members of America’s S&P 500 stockmarket index with a high proportion of revenues in China. The index is weighted by the firms’ market capitalisation and the share of their revenues they get from China. It includes Intel and Qualcomm, both chipmakers; Yum! Brands, which owns KFC and other restaurant chains; Boeing, which makes aircraft; and Corning, a glassmaker. The index outperformed the broader S&P 500 by 10% in 2009, when China’s economy outpaced America’s by over 11 percentage points. But it reconverged in April, as the Chinese government grappled with a nascent housing bubble.
China is, in itself, a big and dynamic part of the world economy. For that reason alone it will make a sizeable contribution to world growth this year. The harder question is whether it can make a big contribution to the rest of the world’s growth.
China is now the biggest export market for countries as far afield as Brazil (accounting for 12.5% of Brazilian exports in 2009), South Africa (10.3%), Japan (18.9%) and Australia (21.8%). But exports are only one component of GDP. In most economies of any size, domestic spending matters more. Thus exports to China are only 3.4% of GDP in Australia, 2.2% in Japan, 2% in South Africa and 1.2% in Brazil (see map).
Export earnings can, of course, have a ripple effect throughout an economy. In Alpha, the prospect of selling coal to China is stimulating investment in mines, railways and probably even policing. But these â€œmultipliersâ€ are rarely higher than 1.5 or 2, which is to say, they rarely do more than double the contribution to GDP. Moreover, just as expanding exports add to growth, burgeoning imports subtract from it. Most countries outside East Asia suffered a deteriorating trade balance with China from 2001 to 2008. By the simple arithmetic of growth, trade with China made a (small) negative contribution, not a positive one.
China plays a larger role in the economies of its immediate neighbours. Exports to China accounted for over 14% of Taiwan’s GDP last year, and over 10% of South Korea’s. But according to a number of studies, roughly half of East Asia’s exports to China are components, such as semiconductors and hard drives, for goods that are ultimately exported elsewhere. In these industries, China is not so much an engine of demand as a transmission belt for demand originating elsewhere.
The share of parts and components in its imports is, however, falling. From almost 40% a decade ago, it fell to 27% in 2008, according to a recent paper by Soyoung Kim of Seoul National University, as well as Jong-Wha Lee and Cyn-Young Park of the Asian Development Bank. This reflects China’s gradual â€œtransformation from being the world’s factory, toward increasingly being the world’s consumer,â€ they write. Gabor Pula and Tuomas Peltonen of the European Central Bank calculate that the Philippine, South Korean and Taiwanese economies now depend more on Chinese demand than American.
Trade is not the only way that China’s ups and downs can spill over to the rest of the world. Its purchases of foreign assets keep the cost of capital down and its appetite for raw materials keeps their price up, to the benefit of commodity producers wherever they sell their wares. Its success can boost confidence and productivity. One attempt to measure these broad spillovers is a paper by Vivek Arora and Athanasios Vamvakidis of the IMF. According to their estimates, if China’s growth quickened by 1 percentage point for a year, it would boost the rest of the world’s GDP by 0.4% (about $290 billion) after five years.
Since the crisis, China has shown that its economy can grow even when America’s shrinks. It is not entirely dependent on the world’s biggest economy. But that does not mean it can substitute for it. In April the Bank Credit Analyst, an independent research firm, asked what would happen if China suffered a â€œhard landingâ€. Its answer to this â€œapocalypticâ€ question was quite â€œbenignâ€. As it pointed out, Japan at the start of the 1990s accounted for a bigger share of GDP than China does today. Its growth slowed from about 5% to 1% in the first half of the 1990s without any discernible effect on global trends. It is hard to exaggerate China’s weight in the world economy. But not impossible.