No one doubts that last year was an extremely tough one for Chinese private equity investors. And “Cautious” is the word that most investors mention when talking about their investment strategy for the Year of Pig. There are still many uncertainties ahead, they say.
The whole private equity market has embraced a “capital winter” as fundraising slows, both for startups and for funds. For the latter, only those with a proven track record are able to get enough money while the rest find it hard to attract limited partners.
Capital is concentrating on China's leading players. The number of PE and VC firms raising money declined almost 12% to 941 last year, while the total capital that they raised increased by 15% to $652 billion. For startups and companies which need money, first and foremost they need to prove their value in the market before they get their hands on funds.
The slow-down in the private equity market is likely to continue this year, as investors wait for clearer signs of a recovering market.
The US-China trade war is undoubtedly the biggest uncertainty that lies ahead. To what extent both sides can reach an agreement is still an unknown. There is no doubt that an agreement between the two largest economies will affect people’s faith in the Chinese market.
At the same time, the Chinese economy is undergoing a domestic structural change, as the country deleverages all major sectors. The market is still adjusting to the tightening and loosening up of Chinese fiscal policy.
The influence on the equity market is obvious. The value of companies dropped in the primary market and, in some cases, their pre-IPO valuations fell below that of their previous fundraising. Many investors point out that this might continue this year and even into 2020.
Private equity investors are likely to be more prudent if not as conservative as last year said Chen Shuang, executive director and CEO of China Everbright Limited (CEL). Large state-owned asset management funds like CEL are likely to be more cautious with new investments and decisive when divesting. They will continue to be progressive in fundraising to hedge the risk and uncertainty.
DEFENSIVE INDUSTRY
More investors are adapting to a defensive strategy. “One of the biggest adjustments we’ve seen right now is the focus on advanced manufacturing business,” said Wang Ran, founding partner and chief executive of CEC Capital. Advanced manufacturing, along with corporate internet services and healthcare will become the hedging sectors this year.
Unlike many consumer plays, advanced manufacturing is a policy-oriented market, as China wants to use high-tech to transform production lines. Due to the special policy-oriented investment character in China, such investment falls in line with the state policy of “Made in China 2025” and is comparatively safer with predictable growth.
Currently, most private equity investment in advanced manufacturing is for rear-end production, which is closer to the final application of the product, Wang said. There are also projects which involve front-end research and development in advanced manufacturing materials but, for financial investors, they are not suitable as front-end R&D has a longer investment cycle and requires a better understanding of technology.
OPPORTUNITIES OVERSEAS
As the uncertainties and deleveraging in China continues, investors have been looking overseas for both investment and fundraising.
Chen, for example, said that CEL intends to strengthen its overseas assets allocation. The company’s current mix is about 30% overseas with a balance of 70% in China. He said that he wants to increase the overseas asset allocation to 45% and hopes to complete this adjustment as soon as possible.
In terms of regions, investors tend to go further to avoid collateral damage in the trade war. CEL intends to expand its Singapore platforms.
“We have acquired Kinergy, a semiconductor manufacturer, in Singapore,” Chen said. “Together with a current investment platform, we aim to build up our Singapore operation as a global M&A platform.” CEL is looking at several potential projects in Southeast Asia, specifically in the high-tech field.
Private equity fund activity in Southeast Asia aims to grasp the same opportunities in the region that they did in China 20 years ago.
A ROLE-CHANGE
Private equity and venture capital funds have changed their role in investments too. No longer happy to be cash cows for startups, they now want to be the mentor, the partner and the platform for their invested projects.
“We’ve seen more interest in going earlier-stage than before with the hope to be able to pour in more capital down the road,” said CEC Capital's Wang. The boutique investment bank has historically advised more in late-stage capital raises. This is partially because of the recent valuation correction in the primary market, as investors start to question the basic rationale of a “venture stage, pre-IPO valuation” opportunity.
Even with the slowdown in the second half of last year, early-stage investment numbers increased 5% to 6,052 cases. Early-stage investment was also supported by the government as Beijing is currently policy-promoting Angel and Series A investment.
Chinse investors have begun to rationalise their activity in early-stage investment. To invest early means that they can participate at a reasonable price while getting the chance for follow-up investment in the next three years - they can grow together with the company.
Aside from being the mentor of the startups, investors are themselves now building platforms to create an ecosystem for invested projects. CEL-backed Terminus is an artificial Intelligent-of-things startup that builds smart cities. The company has received investment proposals from other China Everbright investees which include AI computer vision company SenseTime and AI service provider 4Paradigm.
“Our investees now want to participate in our investment,” said Chen. “This is what we do now - build an ecosystem and spur investees to grow and prosper together.”
IMF has predicted that China's GDP growth will slow down to 6.2% in 2019; not an entirely optimistic view for the Year of Pig. It is inevitable that investors look for a steadier approach in investments. But it is good news for the market, as it could prick the valuation bubble and filter out the unqualified companies. After all, slow and steady wins the race.
