Grant Thornton: Vibrant outlook for Chinese Private Equity industry bolstered by a more comprehensive “Belt and Road Initiative” and emerging Guangdong-Hong Kong-Macau Bay Area

Hong KongGrant Thorntons latest Asia Private Equity Insight 2018 (The “Insight”) finds that Asian private equity (“PE”) industry shows optimism on PE-backed Merger and Acquisition (“M&A”) activities despite the slowdown of overall M&A activities following the record high achieved in 2015. While funding appears to be more accessible against the backdrop of a bullish stock market, China posed a new restriction on overseas acquisitions, hindering the outbound direct investments related particularly to the real estate and entertainment sectors. In addition to ongoing regulatory uncertainty, the rise of protectionism around the world and the “American First” foreign policy in the US are viewed as obstacles for cross-border investments made by Chinese companies. Nevertheless, Beijing’s global trade strategy, the “Belt and Road Initiative”, not only plays a momentous role boosting the Chinese and Asian economies at least over the medium term but also brings knock-on benefits to the Asian PE market.

“Belt and Road Initiative” hastens Chinese PE growth

“Guangdong-Hong Kong-Macau Bay Area” brings in advanced manufacturing industries

In 2017, global fundraising continued to boom, dry powder at PE firms remains high and valuation has gone up. Fund-raising activities are expected to remain robust for Chinese PEs in 2018, which have become one of the biggest beneficiaries of a prolonged easy monetary policy, with financial institutions, government-backed sector funds and state-owned enterprises continuing to be the leading fund sources.

Chinese PE industry has undergone a recovery of cross-border deals since 2H2017 and this trend is expected to continue given the imbalance of a supply and demand of qualified underlying targets in the domestic market, especially for opportunities that tie with the Belt and Road Initiative. The development of the Guangdong-Hong Kong-Macau Bay Area also opens up new horizons and plays an important role in building the Belt and Road Initiative to drive the growth of Chinese PE firms. Under China’s innovation-driven development strategy, the Bay Area is shaped as a cluster, which gathers international talents and resources, to cultivate the advanced manufacturing industries and support investment activities.

Barry Tong, National Head of Transaction Advisory Services at Grant Thornton, said, “The outlook for the Chinese PE industry shall remain vibrant in 2018, growth is expected to be generated from the innovative emergence of Chinese technology start-ups which are favoured by both venture capital as well as PE funds. There is also no sign of a slowdown in fundraising as new capital commitments to private equity are likely to remain positive in 2018. ”

Increase in Asia PE-backed buyout despite the drop in global market

Contrary to the drop in the overall global market and other key markets like the US and Europe, PE-backed buyouts in Asia increased by around 129% to US$48 billion in the first 9-month of 2017, comparing to the same period of 2016. Major recent developments in Asia, including the more comprehensive strategy enacted for the Belt and Road Initiative, fast-growing Indian economy that focused on digital solutions and technologies, and raised confidence in South Korea’s political stability, have contributed to this upward trend.

Mr. Tong continued, “2018 may see a further increase in PE-backed buyouts, contributed by the US tax reform and the crystallisation of China’s upcoming economic development plans following the 19th Party Congress in Oct 2017. Despite the capital outflow restriction from the Chinese government, outbound buyouts are now getting clearer about what types of transactions that would win government support.”

Increasing investment opportunities in industrials and healthcare sector

The Industrials and Chemicals sector continues to be attractive to PE firms due to its breadth and diversity of business. The demand for Industrials and Chemicals deals is running ahead of the supply of quality assets. Particularly, China-oriented special PE firms are becoming more active in acquiring assets from the West.

Meanwhile, the growth in demand for quality healthcare services is driven by an ageing global population and rising income levels. PE firms and hedge funds are investing heavily in the healthcare industry, especially in China where valuation multiples stay high as PE firms are anticipated to compete against strategic investors that can pay for synergies. Sectors such as TMT, healthcare, education and advanced manufacturing are expected to attract investors including PEs and other industrial players.

Historic high dry powder to drive secondary buyout in 2018

Trade sales ranked the top PE exit strategy from 2013 to Q3 2017 and accounted for over 54% of all exits in those periods while secondary buyouts accounted for 33% of all exits in 2017. Secondary buyouts across Asia and around the globe decreased by 11% in volume during the first 9-month period of 2017 compared to the same period in 2016. Selling portfolio companies to other PE firms that were likely specialised in the portfolio companies’ industry via secondary buyouts helped PE sellers realise investments in ageing portfolio companies more efficiently. However, a historic high of US$954 billion of dry powder as of September 2017 will create incentive to drive more secondary buyouts in 2018.  

In the first 9 months in 2017, the total number of exit in the PE-backed exit market declined by 14% comparing to the same period in 2016. The decrease was possibly due to turbulences in the overall economic market and uncertainties in the global political environment. Asia accounted for 8% of the global percentage of the number of PE-backed exits in 2017, similar to that of 2016.

In addition, funds raised by Hong Kong IPOs were recorded at HK$128 billion, a decrease as compared to HK$195 billion in 2016. The cutback on funds was attributable to the absence of sizable IPOs on the market and the rescheduling of large-scale offerings for 2018. The active China A-share IPO market as an increasingly preferred exit route is another challenge hindering the overall performance of the Hong Kong IPO market. Yet, such effect is limited to the tightened regulatory control and IPO approval in mainland China during 2017.

Mr. Tong concluded with his view on the prospect of the PE sector, “Despite stringent regulations and challenges, PE firms that are optimistic about investing time and resources into driving new eras and investment strategies throughout their portfolios look set to come out ahead in 2018. Intensified competition for attractive investment opportunities will be common over outstanding targets that are highly sought after. PEs may accelerate the IPO process for portfolio companies in light of its fund life, which in turn might bring some downward pricing pressures. In view of this, secondary deals amongst PEs and MBO could become viable and valuable alternative exit options.”

PE Exit Trends

Global Number of PE-Backed Exits by Type between 2013 and Q3 2017