China Private Equity Chilled by ’Old Days’ Asking PricesCathy Chan
When Bob Partridge of Ernst & Young LLP was advising a global private-equity firm seeking to buy half of a Chinese kitchenware maker in December, due diligence revealed the company’s net income to be a third less than expected. Still, the founder insisted on his asking price, 23 percent higher than publicly listed peers.
The $75 million being sought, which the owner said reflected “China’s future prospects,” valued the company at almost 20 times its earnings, according to Partridge, an Ernst & Young partner covering China, Hong Kong and Taiwan. Comparable stocks in the MSCI China/Consumer Discretionary Index, which tracks 17 Chinese consumer companies listed in Hong Kong, are trading at 16.2 times earnings. In other markets, including the U.S., private-equity valuations are typically lower than similar listed companies.
“People are still of the mindset of 2010,” said Partridge, who wouldn’t identify the parties involved citing confidentiality. “They don’t have the sense of urgency driving them to change their valuations expectations.”
Many Chinese private companies are seeking prices dating back to a time when the nation’s economy was growing at more than 10 percent, compared with 7.8 percent last year. They aren’t budging even as the number of private-equity deals in China fell an unprecedented 43 percent last year and domestic initial public offerings, which private-equity firms count on to exit the investments, tumbled 70 percent. There have been no domestic IPOs this year, and new deals are virtually halted.
“China’s private-equity market is no longer the dreamland that many people inside and outside China had taken for granted over the past five to 10 years,” said Frank Yu, a former Goldman Sachs Group Inc. banker who founded Themes Investment Partners, a China-focused private-equity firm in Hong Kong.
The value of China’s private-equity deals fell 27 percent to $21.9 billion in 2012, the biggest drop ever, while the 473 transactions were at the lowest level since 2005, according to Asian Venture Capital Journal, which tracks the industry.
China’s economic growth last year was the weakest since 1999, after having peaked at 14.2 percent in 2007, according to data compiled by Bloomberg. In 2010, the number of private-equity deals jumped 60 percent and the value of the transactions rose 65 percent. The next year, investments hit a record $30 billion with 825 deals recorded.
“We’re still in a bit of a down cycle in China, but some entrepreneurs are still asking for prices from the old days,” said Martin Mok, a Hong Kong-based partner at EQT Partners AB that manages $535 million in China, Hong Kong and Taiwan for its global private-equity funds in Stockholm. “The gap is just too big.”
Private-equity funds in China are still holding 82 percent of the companies they’ve invested in since 2007, according to a report from China First Capital, a Shenzhen-based advisory firm. Funds typically seek to cash out of their investments within three to five years, often through IPOs.
“It is not always easy to deal with strong-minded entrepreneurs in China as a minority shareholder,” said Vincent Huang, a Hong Kong-based partner at private-equity firm Pantheon, based in London. Before 2005, closely held industrial companies were asking prices in the mid to high single-digit earnings multiples, he said.
Blackstone Group LP, the world’s biggest private-equity firm, hasn’t made an investment in China outside the property sector since the start of 2011, according to Asian Venture Capital Journal. Antony Leung, Blackstone’s chairman for Greater China, said in October that “being conservative sometimes may not be a bad thing.”
Another Ernst & Young client, based in the U.S., was trying to buy a Chinese food and beverage maker in December and was told the seller wanted to hold back with the hope that the IPO market would improve, Partridge said. That deal, along with the bid for the kitchenware maker, “appear dead” for now, he said.
“Many of these private owners are expecting prices in domestic markets to make another rally,” said Jeff Yao, a managing partner at Prax Capital Inc., a private-equity firm in Shanghai. “Plus, there are still too many renminbi funds seeking to buy stuff, and that’s stopping prices from coming down meaningfully.”
Domestic and overseas Chinese share sales slumped 46 percent to $59 billion last year, according to data compiled by Bloomberg. China’s domestic IPO market has slowed as regulators delayed reviewing new offerings. The number of listings fell to 79 last year, compared with a record 337 in 2010, the data show.
Investors in the U.S. also spurned Chinese companies following the finding of misstated corporate earnings and delisting of a number of firms from Hong Kong’s exchange. The market value of overseas Chinese listings dropped 47 percent to $6.6 billion from 2011, the data show.
Private-equity firms in China, including those denominated in yuan, also known as renminbi, have raised $137.7 billion since 2007, including a record $48.1 billion in 2011, according to Asian Venture Capital Journal.
Price multiples for Chinese companies have gradually risen with each fund raised from 2005 to 2009, said Sam Robinson, a partner at SVG Advisers (Singapore) Pte., a unit of London-based SVG Capital Plc, citing figures from funds he’s invested in.
“If a manager was paying eight times on average from their fund raised in 2005, the average might increase to 10 times from their fund raised in 2009,” he said in an interview. “It is very difficult to be precise on multiples paid as it’s never ‘apples to apples,’ but I would say that generally I have seen PE multiples rise.”
As a result of the high valuations and dim IPO prospects, private-equity funds are looking at cheaper publicly traded Chinese companies in Hong Kong and the U.S. to do deals, including take-private opportunities.
While buyouts dominate U.S. and European private-equity markets, they’re relatively new to China, where most equity stakes have focused on pre-IPO investment.
China’s biggest leveraged buyout so far involved Focus Media Holding Ltd., a U.S.-listed, Shanghai advertising company, which on Dec. 19 agreed to be bought for $3.7 billion by a consortium of investors led by Carlyle Group LP. The ad company, which short seller Muddy Waters LLC said in 2011 overstated its network, joins Chinese companies seeking to withdraw from U.S. exchanges after corporate governance concerns cut valuations.
In a development that could endanger the deal, Focus Media said last month that the U.S. Securities and Exchange Commission is probing potential violations of securities law regarding its purchase and resale of companies. Jing Lu, a media manager for Focus, didn’t answer two calls to the Shanghai office today.
The announced buyout doubled the value of take-private deals in China to $4.2 billion last year, although the number of deals fell to six from 10, according to the Asian Venture Capital Journal.
Before private-equity funds proliferated in China starting in 2006 and the domestic stock market became a viable exit channel for their investments, Chinese private companies were valued at “a significant discount” to listed companies in China, as funding for private companies was limited and state banks would only lend to government-run entities, Huang said.
Signs of a return to more-rapid growth are appearing in China. The International Monetary Fund is projecting China’s gross domestic product to grow 8.2 percent this year. The Shanghai Stock Exchange Composite Index has risen 24 percent from last year’s four-year low on Dec. 3 compared with a 6 percent rise in the MSCI AC Asia Pacific Index in the same period.
Partridge of Ernst & Young said he expects pent-up demand to keep building, resulting in deals starting in the second half of this year.
“This can’t continue indefinitely,” he said.