Guangdong-Hong Kong-Macau Bay Area initiative to drive private equity deal momentum

Hong Kong – Grant Thornton’s latest Asia Private Equity Insights 2019 finds that Asian private equity (“PE”) industry appears cautiously optimistic about the PE market across the region for 2019 amid looming uncertainties over the global economy. While Asia has increasingly become one of the most attractive markets for PE investors due to their gradual opening up to investments and global trades, US-China trade tensions and extreme market valuations are amongst the top concerns for investors. Uncertainties and concerns over the changing tariff policies as well as measures imposed against investment in sensitive sectors such as telecommunication and semiconductors by the US and China have led to increasing cost of funding and soaring market valuations. China’s new asset management rules also make it tough for certain Chinese PE firms as the rules put stricter requirements on evaluating qualified investors and limits cooperation between PE funds and commercial banks. Nevertheless, China is gradually opening up more opportunities for cross-border enterprises to access to its market. The easing of restrictions imposed on foreign investment within its Free Trade Zones and relaxation of curbs on sectors including automobiles, banking, agriculture and heavy industries would increase the market competitiveness of China and sustain the inbound deal momentum.

“Guangdong-Hong Kong-Macau Bay Area” accelerates economic growth and draws growing interests from PE firms

China’s Greater Bay Area Initiative, as a massive economic cluster, is expected to accelerate the development and cooperation between nine most affluent cities in Guangdong province as well as Hong Kong and Macau. By 2030, the Greater Bay Area is expected to play a leading role in advanced manufacturing, innovation, shipping, trade and finance.

With supportive government policy, the Greater Bay Area is set to open up cooperation opportunities and new horizons for technology related sub-sectors such as hybrid electric vehicle. Given information technology is the least affected industry under the US-China trade war due to the industry’s high correlation with local markets, the segments associated with information technology such as big data, cloud computing and artificial intelligence are expected to attract growing interest from PE funds to provide growth capital in the area.

Barry Tong, Joint APAC Head of Transaction Advisory Services at Grant Thornton, said, “In China, being the most popular market for the global institutional investors, we have observed a trend of Chinese PE investors partnering with foreign PE firms to fund investments in order to capture the synergy of accessing industry relationship and technical expertise to bring the investment to the next level of growth.”

Evolving venture capital financings for startups

Against the backdrop of an increasingly vibrant startup scene in mainland China and Hong Kong, the region has seen an uptrend of funds specialising in early stage with the increasing participation from venture capital funds. Those early-stage venture capital funds target investors who seek PE stakes in startups and small to medium-sized enterprises with strong growth potential. Biotech is one of the hottest sectors for venture capital funds.

Thanks to the move towards economic liberalisation and the trend towards the removal of barriers to foreign investment by Asian governments, Asia has become an increasingly fertile environment for venture capital. Mr. Tong said, “Opportunities could be further unlocked for Asian companies by going into sub-sectors such as education and healthcare. The sub-sectors are expanding rapidly on the back of the rising adoption of innovative technology and growing consumption power fuelled by the unprecedented expansion of the middle class.”

New dual-class and biotech companies listing regime provides an extra exit option

The Hong Kong Stock Exchange (“HKEX”) last year changed its listing rules to allow the companies with dual-class share structure to debut in the city and opened the door to biotech firms that have yet to generate revenue. As the dual-class share structure helps start-up founders focus on the long-term growth of the company instead of immediate financial returns and the new listing regime enables the biotech companies to go public easier, PE firms are motivated to invest in these companies and gain higher returns through exiting the investment via IPO.

Mr. Tong continued, “While the new listing rules is designed to attract innovative companies with dual-class share structures and up-and-coming biotech companies to launch IPOs in Hong Kong, the IPO valuation and the post-IPO share price performance would be the important factors of consideration for the emerging companies when choosing between Hong Kong and the US for IPO destination.”

Record-high level of dry powder poses challenges for capital deployment

Trade sale ranked the top PE exit strategy from 2014 to Q3 2018 and accounted for over 50% of all exits in those periods while secondary buyouts accounted for 33% of all exits from Q1 up to Q3 2018. Secondary buyouts (“SBOs”) across Asia and around the globe increased by approximately 13% in volume during the first 9-month period of 2018 compared to the same period in 2017. A record-high amount of dry powder, totalling US$1.14 trillion, was recorded as of September 2018. The vast amount of dry powder will continue to be the major driver for potentially more SBOs in near future.

In the first three quarters of 2018, a total of 1,308 PE-backed exits were recorded, increased by 88 in number comparing to the same period in 2017. Asia accounted for 7% of the global percentage of the number of PE-backed exits in 2018, a slight decrease from 2017 in terms of percentage while the proportion for the rest of the world slightly increased. In general, the global proportion remained fairly stable over the last 2 years.

In addition, funds raised by Hong Kong IPOs totalled HK$287 billion as of Q4 2018, an increase of 124% as compared to HK$128 billion in the same period in 2017. HKEX recorded 218 newly listed companies in 2018, an increase of 25% from 174 companies in 2017. This was mainly driven by the new listing regime introduced in April 2018 for emerging and innovative companies. The positive effect of the new listing regime is expected to last into 2019.

Mr. Tong concluded with his view on the prospect of the PE sector, “2019 is set to be another challenging year, the biggest concern for PE investors is that too much money is used to pursue too few attractive deal opportunities. Abundant liquidity could lead to inflated asset prices and overvaluation, which could damage future returns. As such, PE firms are encouraged to navigate their exposure to impending macro-economic shifts and evolutions in global trade measures while at the same time proceed cautiously when selecting industries and locations to invest, so as to better position their portfolios and be able to recognise reasonable deals from the pool.”