Greater China Private equity briefing - 3Q 2021

The private equity (PE) market in the Greater China region is compelling for investors looking to capitalize on the region’s growth. Despite the global economic disruption, China posted a GDP growth of 2.3% in 2020. Moreover, its private capital sector has total assets under management (AUM) of US$1.3t, which is expected to expand further with proactive government efforts to strengthen regulatory frameworks and establish a formal financial system.

The Greater China region is becoming increasingly accessible to private investors:

• The introduction of Foreign Investment Law, Catalogue of Encouraged Industries, and the launching of various free trade zones provided attractive ways for foreign investors including PE to access the broader fast-growing industry sectors.
• Hong Kong’s Limited Partnership Fund Ordinance adopted in Aug 2020 has facilitated the establishment of funds onshore in Hong Kong in the form of limited partnerships. This is expected to boost Hong Kong’s standing as an asset management and PE investment centre in Asia. In addition, the Hong Kong SAR government has introduced the tax concession regime for carried interest in early 2021 to enhance attractiveness to PE investors.

However, while the PE opportunities abound, China’s changing regulations on a few industries as well as the impact on Chinese companies to list on overseas stock exchanges are critical challenges industry players face.

Key emerging themes impacting Greater China’s PE landscape include：

1. The new regulations launched by Chinese Government has undermined business model of certain industries and suspended overseas listings by domestic companies.

In Jul 2021, the Cyberspace Administration of China (CAC) proposed draft rules calling all data-rich tech companies with over one million users to undergo security reviews before listing overseas. Chinese regulators‘ scrutiny and new legislation could be a headwind for companies attempting to list on overseas stock exchanges and will likely push more high-profile offerings onto domestic and Hong Kong-based exchanges. Concurrently, U.S. Securities and  Exchange Commission (“SEC”) has required Chinese issuers to disclose material risks related to their operations in China, further adding complexities and creating uncertainty over exit timelines.

Notably, the Hong Kong Exchange (HKEx) has outlined rules for IPOs by Special purpose acquisition companies （“SPACs”）and Beijing opened new Stock Exchange (“Beijing Stock Exchange”) to be a major base serving innovative small and medium sized enterprises.  Both provide alternative exit opportunities to PE portfolio companies in the region.

2. Investors expected to shift focus to sectors less prone to regulatory impact and identify opportunities in the sectors that are aligned with China’s regulations

Technological innovation is in the spotlight of the 14th Five-Year Plan (2021-25).  Investors are expected to shift focus to the core technologies, covering key sectors such as semiconductors, 5G applications, the Internet of Things, and autonomous driving. 

3. China’s blueprint for national development is pushing Environmental, Social Responsibility and Corporate Governance (“ESG”) into the mainstream investment focus

In 2020, China announced its climate targets to be carbon-neutral by 2060. According to BNP Paribas, to achieve the goal of economic transformation to sustainable development, an investment of approximately US$247-468b will be required each year, and 90% of the capital may be from the private sector.

4. Artificial intelligence/machine learning (AI/ML) and 5G expected to garner continued PE interest in the region

The ubiquity of mobile payment systems and the advent of advanced digital infrastructure have paved the way for companies focused on next-generation technologies such as 5G and AI/ML. According to GSMA Mobile Economy Report 2021, Greater China alone will account for nearly half of the total 5G connections (48%) by 2025, way ahead of the global average of 21%.

Notes: *Analysis includes PE funds which are closed, fully invested, liquidated or in the divestment phase. It includes funds with an investment mandate to deploy capital in the Greater China region.

Source: AVCJ, EY analysis

• PE invested US$62.0b across 533 deals throughout Greater China in YTD21*.
• Aggregate deal value increased 28% from US$48.4b from YTD20*, while volume increased by 5% from 510 deals.
• The average deal size witnessed an increase of 31% to US$175m in YTD21* from US$134m from an year ago.
• Technology remained the preferred sector for investments, garnering 49% of the total deal volume and 50% of the total deal value.
• Many investors are now shifting focus to sectors that are less vulnerable to regulatory and policy changes, such as semiconductors, automation, sustainable products, etc.
• The region could witness increased investments in ESG-linked assets. The government is working towards increased sustainability efforts.
• Recently the China government committed to achieving complete carbon neutrality by 2060 and, in the 14th Five-Year Plan, it has set a target to reduce carbon dioxide intensity by 18%, thereby providing the private sector with significant opportunities to invest in clean energy and e-mobility.

• PE exited 48 assets worth US$15.0b in YTD21* throughout the Greater China region.
• Aggregate exit value increased 60% from US$9.4b to YTD20*, while volume fell by 34% from 73 deals.
• The average exit size witnessed an increase of ~2.7x to US$417m in YTD21* from US$165m from anPE year ago.
• In the largest exit of YTD21*, RRJ Capital and Joy Orient Investments along with other investors, sold their US$2.1b stake in China Logistics Property Holdings Co. to JD.com.
• The technology and healthcare sectors offered remarkable opportunity to realise value and together garnered a share of 52% of exits volume during YTD21*.
• During YTD21*, sale to strategic acquirers dominated the exit activity (82% of total number of exits), followed by secondary sale.
• Cyberspace Administration of China have proposed new regulations that would require all data rich tech firms with over one million users seeking to list in overseas stock exchanges to undergo a cybersecurity review. This is expected to deter portfolio companies looking to exit via IPO route by listing on overseas stock exchanges
• This move is expected to re-route the PE-backed IPO listing plans of some China-based portfolios to domestic stock exchanges.
• The uncertainty over exit timeline remains.  Notably, the Hong Kong Exchange (HKEx) has outlined rules for IPOs by SPACs and Beijing opened new Stock Exchange to be a major base serving innovative small and medium sized enterprises.  Both provide alternative exit opportunities to PE portfolio companies in the region.  

• Fundraising activity came roaring back in 2021, as economies reopened and healthcare crises started to stabilize.
• Greater China-focused funds raised an aggregate amount of US$72.5b across 47 funds during YTD21* as compared with US$49.2b across 46 funds in YTD20*.
• The average fund size increased 44% to US$1.5b in YTD21*from US$1.1b in YTD20*.
• The region witnessed the final close of 13 mega funds (more than US$1b) during YTD21* compared with seven mega funds in YTD20*.
  • US-based KKR achieved the final close of its KKR Asian Fund IV, with a close size of US$15.0b, and a mandate to invest in the APAC region.
  • China-based Boyu Capital achieved a final close of its Boyu Capital Fund V, with a final close size of US$6.0b.
• Regulatory developments in the PE space in the region ensure that Hong Kong SAR remain a leading jurisdictions for offshore funds to establish their regional platforms.
• In Feb 2021, Hong Kong set forth a legislative framework for granting concessionary tax treatment to carried interest received by or accrued to PE fund managers and their employees. This move would create the right conditions to encourage increased critical mass in the onshore PE funds industry, and to develop Hong Kong as a premier PE fund hub in the region.

In the past few months, several regulations have been passed by Chinese regulatory bodies to govern the economy, including placing restrictions on certain industries such as private education, conducting cybersecurity reviews of China-based companies to be listed on overseas stock exchanges, and launching antitrust scrutiny of investments made by internet giants. PE have responded by realigning their strategies and aligning their investment mandate to the policy changes.

Despite the challenges and uncertainties presented from the pandemic and regulatory scrutiny, as a key part of China‘s “dual circulation” strategy, China will further push forward opening-up and focus on quality growth, which still favour PE assets in the region for higher quality growth, better governance structures, and value enhancing opportunities.

The introduction of Foreign Investment Law, Catalogue of Encouraged Industries, and the launching of various free trade zones provided attractive ways for foreign investors including PEs to access broader and fast-growing industry sectors.

Summary

We believe that China will further push forward opening up, which is compelling for PE looking to capture the growth of domestic demand and create value by technology and innovation.