M&A investment bank

M&A Policy & Policy-making in China — A Visit to China’s Ministry of Commerce

(Me in borrowed suit* alongside Deputy Director General of the Policy Research Department, China Ministry of Commerce)

China’s Ministry of Commerce invited me last week to give a private talk at their Beijing headquarters. The subject was the changing landscape for M&A in China. It was a great honor to be asked, and a thoroughly enjoyable experience to share my views with a team from the Policy Research Department at the Ministry.

For those whose Chinese is up to it, you can have a look at the PPT by clicking here The title translates as “China’s M&A Market: A New Strategy Targeting Unexited PE Deals”.

My China First Capital colleague, and our company’s COO, Dr. Yansong Wang offered our firm’s view that the current crisis of unexited private equity deals is creating an important opportunity for M&A in China to help strengthen, consolidate and restructure the private sector. Buyout firms and strategic acquirers, both China domestic and offshore, will all likely step up their acquisition activity in coming years, targeting China’s stronger private sector companies.

Potentially, this represents a highly significant shift for M&A in China, and so a shift in the workload and travel schedule of the Ministry of Commerce officials. M&A within China, measured both in number and size of deals,  has historically been a fraction of cross-border transactions like the acquisition of Volvo or Nexen

The Ministry of Commerce occupies the most prominent location of any government department in China, with the exception of the Public Security Ministry. Both are on Chang’an Avenue (aka “Eternal Peace Street” on 长安街)a short distance from Tiananmen Square

The Ministry of Commerce plays an active and central role in economic policy-making. Many of the key reforms and policy changes that have guided China’s remarkable economic progress over the last thirty years got their start there. The Ministry of Commerce is also the primary regulator for most M&A deals in China, both domestic and cross-border.

The key sources of growth for China’s economy have shifted from SOEs to private sector companies, from exports to satisfying the demands of China’s huge and fast-growing domestic market. In the future, M&A in China will follow a similar path. That was the main theme of our talk. More M&A deals will involve Chinese private sector companies combining either with each other, or being acquired by larger international companies eager to expand in China.

Ministry officials were quick to grasp the importance of this shift. They asked if policy changes were required or new administrative practices. We shared some ideas. China’s FDI has slowed recently. That is an issue of substantial concern to the Ministry of Commerce. M&A targeting China’s private sector companies represents a potentially useful new channel for productive foreign capital to enter China.

M&A, as the Ministry officials quickly understood, also can help ease some of the pain caused to private companies by the block in IPOs and steep decline in new private equity funding. In particular, they focused their questions on the impact on Chinese larger-scale private sector manufacturing industries.

I found the officials and staff I met with to be practical, knowledgeable and inquisitive. Market forces, and the exit crisis in China’s private equity industry, are driving this change in the direction of M&A in China. But, policies and regulatory guidance issued from the Ministry of Commerce headquarters can – and I believe will — also play a constructive role.

* Three days before my visit,  the Ministry of Commerce suggested I should probably wear a suit, as senior officials there do.  By that time, I’d already arrived in Beijing, so needed to borrow one from a friend. The suit was tailored for someone 40 pounds heavier. As a result, as the above photo displays, I managed to be overdressed and poorly-dressed at the same time.

 

 

China’s IPO Drought Spurring Interest In M&A — FinanceAsia

FinanceAsia

 

With slim hope of exiting through a lucrative public listing, Chinese entrepreneurs and their investors are considering sales.

China’s huge backlog of initial public offerings is creating an exit crisis for maturing private equity funds — and an opportunity for international investors interested in buying something other than a bit of a state-owned enterprise.

For China’s entrepreneurs, the dream of earning a rich valuation through an IPO is over, but the result could be a healthy increase in acquisitions as owners slowly come round to reality: that selling to a foreign buyer is probably the best way of cashing out.

There is no shortage of candidates, thanks to the unsustainable euphoria at the height of China’s IPO boom. The number of firms listing in China, Hong Kong and New York was only around 350 at its height, yet private equity funds were investing at triple that rate. As a result, there are now more than 7,500 unexited private equity deals in China.

“IPOs may start again, but it will never be like it was,” says Peter Fuhrman, chief executive of China First Capital, an investment bank that specialises in advising on private equity deals. “The Golden Age is likely over. There are 10,000 deals all hoping to be one of the few hundred to reach IPO.”

As long as the window to a listing was open, China’s entrepreneurs were willing to hold out in the hope of selling their business at a valuation of 80 or 100 times earnings. Even last year, when the window to IPO was firmly closed, few bosses chose to sell.

“Private equity activity was fairly muted in 2012 — you could count the meaningful exits on one hand,” says Lindsay Chu, Asia-Pacific head of financial sponsors and sovereign wealth funds at HSBC. But sponsors still have a meaningful number of investments that they will need to exit to return capital to LPs [limited partners].”

However, both Fuhrman and HSBC note signs of growing interest in M&A — or at least weakening resistance to the idea.

“I’m conservatively optimistic about leveraged buyouts,” says Aaron Chow, Asia Pacific head of event-driven syndicate within the leveraged and acquisition finance team at HSBC. “The market is wide open to do these deals right now, as financing conditions are supportive and IPO valuations may not provide attractive exits.”

Indeed, the ability to use leverage may be decisive in helping foreign buyers emerge as the preferred exit route for China’s entrepreneurs. Leverage is not an option for domestic buyers, which are also burdened with the need to wait for approvals, without any guarantee that they will get them.

This means foreign acquirers can move quicker and earn bigger returns, which may prove enticing to bosses who want to maximise their payday and get their hands on a quick cheque.

If this meeting of the minds happens, foreign buyers will get their first opportunity to buy control positions within China’s private economy, which is responsible for most of the country’s growth and job creation.

“The beauty here is these are good companies, rather than a troubled and bloated SoE that’s just going to give you a headache,” says Fuhrman. “It’s still a bitch to do Chinese acquisitions — it’s always going to be a bitch — but private deals are doable.”

Some of those deals may involve trade sales to other financial sponsors, as a number of private equity funds have recently raised capital to deploy in Asia and are well placed to take advantage of the opportunity, despite the challenges.

“There’s a lot of talk in Europe about funds having difficulty in their fund-raising efforts, but for the most part we’ve not seen that in Asia,” says Chu. Mainland companies will attract most of the flows, he says, but there are also opportunities across the region. “China is always going to be top of the list, but Asean is becoming an even bigger focus thanks to good macro stories and stable governments. Singapore, Indonesia and Malaysia are all attractive to private equity investors.”

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Private Equity Secondaries in China: Hold Periods, Exits and Profit Projections

How much do you need to invest, how much profit will you make, and how long before you get your money back. These are the investment variables probed in China First Capital’s latest research note. An abridged version is available by clicking here. Titled, “Expected Returns: Hold Period, Exit and Return Projections for Direct Secondary Opportunities in China Private Equity” the report models both the length of time a private equity investor would need to hold a secondary investment before exiting, and then charts the amount of money an investor might prospectively earn, across a range of p/e valuation levels, depending on whether liquidity is achieved through IPO, M&A or sale after several years to another investor.

This new report is, like the two preceding ones (click here and click here) the result of China First Capital’s path-breaking research  to measure the scale of the problem of unexited PE investments in China,  and to illuminate strategic alternatives for GPs investing in China.  China First Capital will publish additional research reports on this topic in coming months.

As this latest report explains, “these [hold period and investment return] models tend to support the thesis that “Quality Direct Secondaries”  currently offer the best risk-adjusted opportunities in China’s PE asset class.”  Direct secondary deals involve one PE firm selling its more successful investments, individually and usually at significant profit, to another PE firm. This is the most certain way, in the current challenging environment in China, for PE firms to return capital plus a profit to the LPs whose money they invest.

“Until recently,” the China First Capital report points out, “private equity in China operated often with the mindset, strategy, portfolio allocation and investment horizon of a risk arbitrage hedge fund. Deals were conceived and executed to arbitrage consistently large valuation differentials between public and private markets, between private equity entry multiples and expected IPO exit valuations. The planned hold period rarely extended more than three years, and in many cases, no more than a year.  Those assumptions on valuation differentials as well as hold period are no longer valid.”

There are now at least 7,500 unexited PE deals in China. Many of these deals will likely fail to achieve exit before the PE fund reaches its expiry date, triggering what could become a period of losses and dislocation in China’s still-young PE industry. PE and VC firms, wherever in the world they put money to work, only ever have four routes to exit. All four are now either blocked or difficult to execute for China private equity deals. The four are:

  1. IPO
  2. Trade sale / M&A
  3. Secondary sale
  4. Buyback / recapitalization

Our conclusion is the current exit crisis is likely to persist. “Across the medium term, all exit channels for China private equity deals will remain limited, particularly when measured against the large overhang of unexited deals.”

Direct secondaries have not yet established themselves as a routine method of exit in China. But, in our view, they must become one. Secondaries are, in many cases, not only the best, but perhaps the only,  option available for a PE firm with diminishing fund life. “Buyers of these direct secondaries will not avoid or outrun exit risk,” the report advises. “It will remain a prominent factor in all China private equity investment. However, quality secondaries as a class offer significantly higher likelihood of exit within a PE fund’s hold period. ”

The probability and timing of exit are key risk factors in China private equity. However, for the many institutions wishing to invest in unquoted growth companies in China, a portfolio including a diversified group of China “Quality Secondaries” offers defensive qualities for both GPs and LPs, while maintaining the potential for outsized returns.

Returns from direct secondary investing are modeled in a series of charts across a hold period of up to eight years. In addition, the report also evaluates the returns from the other possible exit scenario for PE deals in China: a recap/buyback where the company buys its shares back from the PE fund. The recap/buyback is based on what we believe to be a more workable and enforceable mechanism than the typical buyback clauses used most often currently in China private equity.

Please note: the outputs from the investment return models, as well as specifics of the buyback formula and structure,  are not available in the abridged version.