private equity secondaries

Private Equity Secondaries in China — PEI Magazine Whitepaper

Secondaries

 

 

PEI Secondaries Cover

title2

 

 

 

 

Private equity dealflow continues to stall in China – but so far it hasn’t yet prompted the hoped-for explosion in secondary market activity

Secondaries specialists have been busy in Asia lately. While firms such as LGT Capital Partners and Paul Capital have been doing secondaries deals from Hong Kong since 2007, in the last 18 months other firms such as Greenpark Capital, AlpInvest Partners and Lexington Partners have all been enhancing their Asia presence.

So far, secondary market activity in Asia has been more of a gradual flow than a wave of deals. But the changing macroeconomic conditions are increasing pressure on GPs – and that could result in more opportunities, particularly in China. Asia’s largest and most attractive market is losing some of its shine, thanks to a sustained slowdown in annual GDP growth and a frozen IPO market that has left GPs holding assets that they need to exit.

“If you could do [secondaries] at this moment – wow,” says Peter Fuhrman, chairman and chief executive of China First Capital. “In this market, some LPs could sell out for 10 cents on the dollar. For LP secondary buyers, it is nirvana: a distressed exit market, portfolios with solid growing businesses inside of them, and a group of somewhat distressed LPs. A lot of these LPs, even bigger ones who have their money in China, have lost faith.”

Click to Read Full Article
Click To Read Full PEI Whitepaper Report on Private Equity Secondaries

China’s GPs search for exits — Private Equity International Magazine

Chinese GPs are running low on exit options, but the barriers to unconventional routes – like secondary sales to other GPs – remain high.

By Michelle Phillips

China’s exit woes are no secret. With accounting scandals freezing the IPO route both abroad and domestically, the waiting list for IPO approval on China’s stock exchanges has come close to 900 companies.  Fund managers have at least 7,550 unexited investments worth a combined $100 billion, according to a recent study by China First Capital. However, including undisclosed deals, the number of companies could be as high as 10,000, says CFC’s founder and chairman Peter Fuhrman.
CITIC Capital chief executive Yichen Zhang told the Hong Kong Venture Capital Association Asia Private Equity Forum in January that because many GPs promised high returns in an unrealistic timeframe (usually three to five years), LPs were already starting to get impatient. He also predicted that around 80 percent of China’s smaller GPs would collapse in the coming years. “The worst is yet to come,” he said.
What ought to become an attractive option for these funds, according to the CFC study, are secondary buyouts. Even if it lowers the exit multiple, secondaries would provide liquidity for LPs, as well as potentially giving the companies an influx of cash, Fuhrman says.

More

Direct Secondary Investment Opportunities in China Private Equity

 

As detailed follow-up to our report on the current challenging crisis of unexited PE investments in China, China First Capital has prepared a new research note. You can download the abridged version by clicking here.

This note provides far more detailed data and analysis on the unexited PE deals: by industry, original deal size, currency, round, and most importantly, “tier of PE”. This should give a more concrete understanding of the current opportunity in direct secondaries in China, as well as numerical challenges all GPs active in China will face exiting.

China First Capital is currently the only firm with this data and analysis. In addition to this note, we will also share in coming weeks three others research notes:

1. Secondary deals modeled on prospective IRR and hold periods
2. Risk-scoring metrics for primary and secondary deals in China
3. Portfolio analytics specific to primary and secondary investments in China

Beyond this work, shared as a service to our industry, to help facilitate the development of an efficient and liquid exit channel of direct secondaries in China, everything else will remain our confidential work product to be deployed only for clients that retain us. An introduction to our secondaries services is available by clicking here.

 

Private Equity Slows in China as Investors Can’t Find the Exit — Institutional Investor

II

Download complete text

12 FEB 2013 – ALLEN T. CHENG

China’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 country’s economic boom.

“You had an industry that grew very quickly but is not yet fully matured,” says Peter Fuhrman, chairman and CEO of China First Capital. “The 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,” Fuhrman says. More…

 

China Private Equity Secondaries — the new China First Capital research report

 

In the current difficult market environment for private equity in China, secondary transactions provide a valuable way forward.  Staging successful IPOs or M&A will remain severely challenging. This is the conclusion of a proprietary research report recently completed and published by China First Capital. An abridged version is available by clicking here.  You can also visit the Research Reports section of the China First Capital website.

Secondaries 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 yet these secondary deals still remain rare. As a result, General Partners, Limited Partners and investee companies, as well as China’s now-large private equity industry,  are all at risk from serious adverse outcomes.

This new CFC research report is a data-driven examination of the potential market for secondary transactions in China, the significant scope for profit on all sides of the transaction, as well as the no less significant obstacles to the development of an efficient, liquid, stable long-term market in these secondary positions in China.

The report’s conclusion is that secondaries have the potential to benefit all three core constituencies in the China PE industry — GPs, LPs and investee companies. The universe of deals potentially available for secondary exit is large, over 7,500 unexited investments made in China by PE firms since 2000.

However, the greatest potential for both PE sellers and buyers across the short to medium term is in a group of select companies CFC terms “Quality Secondaries“. These are PE investments that fulfill four criteria:

  1. unexited and not in IPO approval process, domestically or internationally
  2. investee companies have grown well (+25% a year) since the original round of PE investment, and have continuing scope to expand enterprise value and achieve eventual capital markets or trade sale exit in 3-6 year time frame
  3. businesses are sound from legal and regulatory perspective, have effective corporate governance, and a majority owner  that will support secondary sale to another PE institution
  4. current PE investor seeks secondary exit because of fund life or portfolio management reasons

CFC’s  analysis reveals that the potential universe of “Quality Secondaries” is at least 200 companies. This number will likely grow by approx. 15%-25% a year, as funds reach latter stage of their lives and if other exit options remain limited.

At the current juncture, in this market environment, and assuming “Quality Secondary” deals are done at market valuations, these investment represent some of the better values to be found in growth capital investing in China.  DD risk is significantly lower than in primary deals, and contingent risks (opportunity costs, and legal risks of pursuing other non-IPO exits) are lower.

Despite the current lack of significant deal-making activity in this area, secondaries will likely go from current low levels to gain a meaningful share of all PE exits in China.

The secondaries market in China will have unique factors compared to the US, Europe and elsewhere. There will likely be limited investor interest in any secondary deal involving a Chinese company or a portfolio that has underperformed since PE investment, or could otherwise be characterized as a  “distress” situation.

Quality Secondaries transactions in China will involve PE investors “cherry-picking” good companies at fair valuations.  The primary motivation for selling PEs is misalignment between its remaining fund life and the time required and risk inherent in achieving  domestic or offshore IPO or trade sale exit during that shortened time frame.

In contrast with secondary deals done outside China, we do not expect to see much activity involving the sale of all or most of a PE firm’s portfolio of investments. Specialist secondary firms operating elsewhere (e.g. Coller Capital, Harbourvest) do not currently have the experience or manpower in China to take on the complexities of managing and liquidating all or most of an existing portfolio of minority investments.

Rather, we expect those PEs with strong operating performance in growth capital investing in China to exploit favorable market conditions by becoming active buyers of Quality Secondaries.   GPs that prefer larger deals, (+USD25mn/Rmb200mn), should be particularly interested in Quality Secondaries, since company scale and investment amount will likely be larger, on average, than primary deals in China.

Selling PEs can pursue exit strategies based on option of selling either part or all of a successful unexited deal. A part liquidation in Quality Secondary transaction can mitigate risk and return capital to LPs while still retaining future upside. A full exit through secondary can increase fund’s realized IRR and so assist future fundraising. Importantly, a selling PE needs to act before pricing leverage is transferred mainly to buyers — generally this means secondary deals should be evaluated and priced in market when fund still has minimum of two years left of active period.

While clearly the most acute need for exit will be investments made before 2008, more recent investments need also to be assessed based on current market conditions. Many GPs are adopting what looks to be an unhedged strategy across a portfolio of invested deals waiting for capital markets conditions to improve.

In particular, much of this “wait and see” approach is based on the hope that Hong Kong’s once-vibrant, now-moribund IPO market for Chinese companies returns to its earlier state. The US stock market will certainly remain off limits to most Chinese companies for a long time to come. Exit through China’s domestic stock market is now seriously blocked by bureaucratic slowdowns and an approval backlog that even under optimistic scenarios could take three to five years to clear.

The need for diversification is no less paramount for exits than entries. Many of the same PEs 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: the Hong Kong IPO.  By itself, such dependence on a single exit path is risky. In the current environment, it looks even more so.

The flood of Chinese IPOs in Hong Kong basically came to a halt a year ago.  When they do resume, it may prove challenging for all but the best and biggest Chinese companies to successfully issue shares there. What will become of the other deals? How will GPs and LPs profit from investments already made? That’s the focus on this new report, titled, “China Secondaries:  The Necessary & Attractive Exit For Private Equity Deals in China“.

 

China Private Equity Secondaries — New York Times, Bloomberg, CNNMoney

Dual

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 the private equity 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…

 

Private-equity funds in China are still holding 82 percent of the companies they’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. 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.  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 In China – Time For A New Exit?

Article from Wall Street Journal January 8, 2013

China was once one of the few bright spots globally for private equity. Now it’s a quagmire – and investors are going to have to change the way they approach the market.

That’s the finding of a new report by Shenzhen-based private equity advisory China First Capital (pdf). According to the company’s own research, there have been about 9,000 private equity deals completed in China over the past decade, but in more than 7,500 of those instances – or $130 billion worth of investment – investors still haven’t managed to cash out.

“Over the last 18 months, first the U.S. capital markets, then Hong Kong’s and finally China’s Shanghai and Shenzhen domestic stock markets have dramatically lowered the number of IPOs of Chinese companies,” writes Peter Fuhrman, China First Capital chairman, in the report. “It seems more likely than not that the golden age of Chinese IPOs, when over 350 companies were listing each year across public markets in the U.S., Hong Kong and China, is now over.”

It’s not a turn of events that will be easily remedied. A wave of fraud allegations leveled by auditors and short sellers against a number of small Chinese companies listed in the U.S. has destroyed investor confidence in the sector and all but frozen new IPOs. Listings in Hong Kong dropped off in 2012 owing to that market’s poor performance, but even if it recovers many private-equity-invested companies are too small to clear the Hong Kong bourse’s listing requirements. And in mainland China, the regulator has all but stopped new listings in Shanghai and Shenzhen for fear that new offerings would divert liquidity and drive lower two of the world’s most underperforming markets.

Analysts tip China’s domestic IPO market to come back to life this year. PricewaterhouseCoopers expects a combined 200 IPOs raising between 130 billion yuan ($20.7 billion) and 150 billion yuan on the Shanghai and Shenzhen stock exchanges in 2013, it said in a report. But that’s not going to clear the private equity backlog.

About 100 companies have already been cleared by the China Securities Regulatory Commission to list their shares, but are waiting for the market to improve. A further 800 companies have already filed IPO applications and are waiting for regulator’s nod. And according to Mr. Fuhrman, an additional 600 or 700 companies could be ready to apply as soon as the regulator signals it’s fully ready to take new applications. With many funds needing to return cash to their investors in the not-so-distant future, waiting for an IPO slot to open up is looking like the financial equivalent of a Hail Mary.

Traditionally, IPOs have been the preferred way for private equity investors in China to get their money out of companies they invested in. That’s in part because during the golden years of 2006 and 2007, sky-high IPO prices would result in a killing for investors that got in early. But it’s also because finding another company willing to buy the company you’ve invested in – a popular exit for private equity investors in developed markets – is seldom an option in China. Private equity investors usually take only a minority stake in Chinese companies, often because the entrepreneur who founded the firm is unwilling to relinquish control.

“To achieve [a] trade sale exit, the [investor] would need to persuade the majority owner, usually the person running the company, to sell out,” said the report. “Even in cases where that is possible, there is not an active market for corporate control in China. Few deals have been successfully concluded where a private entrepreneur, alongside a PE minority investor, has sold the business.”

The answer to this investment exit quandary might be secondary deals, whereby one private equity fund sells its stake in a company to another private equity fund, or in some cases sells its entire stable of companies to another fund. So far there have been very few such deals in China, but Mr. Fuhrman thinks they could be the way of the future.

“Despite the current lack of significant deal-making activity in this area, secondaries will likely go from current low levels to gain a meaningful share of all PE exits in China,” says the report.

Secondary deals are usually unpopular among investors that give their money to private equity funds. Large investors who have allocated money to a number of private equity shops see them as a waste of their money, particularly if one fund they’ve invested in sells to another fund they’ve invested in – all the more so if it’s at a higher price.

Secondary deals overseas often involve distressed assets – the kind a private equity fund is willing to sell at a loss just to be rid of them. But the deals Mr. Fuhrman foresees coming to the table in China would be of much higher quality, with funds forced to sell because they’re due to return cash to investors rather than because of any underlying problem with the investment.

The current quagmire is a problem that’s been building for some time, and private equity funds have so far proven reluctant to embrace secondary deals as an exit. But with the chances of getting an IPO done looking less like a bottleneck and more like the eye of a needle, major changes might be forced upon funds and the way they do business.

– Dinny McMahon