
China in six trends
Key themes in China private equity fundraising, investment, and exits
1) Soft-tech to hard-tech
A surge in growth-stage tech investment activity in China underpinned the region’s private equity revival in the fourth quarter of 2020. China accounted for 62% of all capital deployed in Asia and half of the China total went into the technology. This trend ended abruptly in the second quarter of this year on the back of mounting concerns about a sector-wide clampdown. Early and growth-stage tech investment fell from $14.8 billion in the first quarter to $8.4 billion in the second and it stayed at roughly that level in the third. But activity hasn’t dried up, rather it has been redirected. This trend became visible as early as mid-2019, in terms of deal count, as VC investors shifted focus from services to non-services – a crude way of capturing the transition from B2C to B2B. It is now reflected in dollar value as well. The non-services share of minority tech investment was 70% in the third quarter, compared to 40% in the final three months of 2020. Capital is targeting less sensitive areas, typically deep-tech hard-tech plays like artificial intelligence, semiconductors, and autonomous driving. Tangential sectors are also benefiting, notably electronics and consumer, with the rise of robotics and technology-enabled brands.
2) Beyond technology
Overall private equity investment in China gradually declined over the first nine months of 2021, a consequence of the growth-stage technology malaise. While the 2020 full-year total of $102 billion is unlikely to be surpassed, investors have already deployed more than the $67.4 billion put to work in 2019. The largest announced transactions comprise a mixture of US take-privates (51job), corporate carve-outs (Reckitt Benckiser’s China infant formula business, Zhaopin), corporate spinouts (Svolt, JD Property Management), and consumer technology momentum plays transacted earlier in the year. The sectoral picture is arguably more insightful, demonstrating that investors are generally trying to invest in line with government policy. Electronics (industrial value-add), healthcare, consumer retail (mass-market accessibility), and transportation (logistics) are holding firm or gaining, though technology remains the biggest show in town. Healthcare is now comfortably the second-largest sector, buoyed by substantial investments in telemedicine and biotech. Digitally enabled drug discovery has emerged as a key theme within biotech, led by the likes of Insilico Medicine and Xtalpi.
3) VC leads the way
Ince Capital returned to market with its second China VC fund in May, less than 18 months after closing its first. A first close of $450 million – matching the overall target for the vehicle – came in July. Ince pursues a consumer internet strategy, which means its portfolio companies might appear in the crosshairs of regulators as part of the ongoing technology sector purge. While much of the fundraising work predated some of the more draconian measures, Ince’s progress reflects a broader trend in China fundraising. US dollar-denominated China VC was one of few strategies across Asia that attracted more capital in 2020 than in 2019. The momentum, though not as pronounced as last year, remains. China-focused managers raised $32.5 billion in the first nine months of 2021, which means the 12-month total of $57.9 billion in 2020 is unlikely to be eclipsed. However, the picture doesn’t look so grim if renminbi funds are stripped out. Approximately $16.4 billion has been raised, more in 2020. Boyu Capital’s $6 billion fifth fund accounts for a large chunk of that, the VC contribution is still $6.1 billion. In addition to Ince, the likes of 5Y Capital, Source Code Capital, Long Hill Capital, Future Capital, Vitalbridge Capital, ZWC Partners, and Glory Ventures have reached incremental or final closes.
4) Location, location, location
China-based online-to-offline (O2O) home services provider Daojia filed for a US IPO in early July, not long after ride-hailing giant Didi saw its stock sink within days of debuting on the New York Stock Exchange. Regulators said that Didi was under investigation for violating rules on personal data collection. They later clarified that companies holding data on more than one million domestic users must undergo a security review prior to an offshore listing. In the first half of 2021, 18 PE-backed Chinese companies raised $12.7 billion through US IPOs, more in dollar terms than the previous two years. Now the pipeline has dried up. Daojia is said to have abandoned its planned IPO, with the likes of Ximalaya, Linkdoc, and Xiaohongshu doing the same. It remains to be seen whether these are postponements or cancelations. Even if the approval process in China is navigable, there remains the prospect of Chinese companies being delisted from US exchanges over audit compliance. Hong Kong is expected to be the key beneficiary of these trends, with regulators apparently more comfortable with listings closer to home (and, for brand owners, closer to their main consumer bases).
5) From boom to bust?
Regulation is an enduring – although sometimes underestimated – risk in China. However, few industries have been turned on their head as comprehensively as education. At the end of last year, the large class K-12 space was the scene of a brutal attritional battle: online providers were plowing money into marketing campaigns even as customer acquisition costs mounted. Of the $16 billion raised by the industry in 2020, across public and private markets, 80% went to the top five players. Government disquiet rose during 2021, culminating in comprehensive and ruthless action in July. The key takeaways: for-profit tuition in core school subjects must stop, with operators subject to strict approvals; pre-school children can no longer participate in online training of any kind; overseas-based foreign personnel are barred from running classes, threatening one-to-one English language tuition; and public listings or any other capital-raising activity is prohibited. Yanfudao and Zuoyebang raised nearly $6 billion from the likes of Sequoia Capital China, Hillhouse Capital, SoftBank, Warburg Pincus, and FountainVest Partners. The path to exit is unclear.
6) All about the wheels
One of the peripheral casualties of Evergrande Group’s difficulties servicing a $300 billion debt pile appears to be its PE-backed electric vehicle (EV) unit. As the parent heads towards what would be China’s largest-ever restructuring, the subsidiary canceled a planned secondary listing on Shanghai's Star Market and warned investors of a cash shortage. The fact that Evergrande, a real estate developer, is even in the EV space speaks volumes for investor appetite for mobility. Private equity firms and strategic players have pumped capital into EV, and they are doing the same with autonomous driving. China’s robotaxi pioneers Pony.ai, Weride, Deeproute.ai, and Didi Autonomous Driving have received more than $3 billion between them. Momenta, which supplies autonomous driving technology to carmakers rather than develop its own vehicles, recently took its total fundraising past the $1 billion mark. Capital has also flooded into autonomous truck specialists Inceptio, Plus, and TuSimple, with the latter going public, and into various semiconductor manufacturers who serve the industry. Meanwhile, Evergrande’s troubles have not deterred strategic activity with smart phone maker Xiaomi planning to invest $10 billion in EVs and buying VC-backed autonomous driving technology developer Deepmotion.
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