Third Quarter 2011: Venture capital deals steal the spotlight as buyouts wane

1) The rise of venture capital

Private equity investments in Asia continued to dwindle in the third quarter of 2011, coming in at $12.6 billion, down 37.8% year-on-year. This came as fundraising followed the opposite arc, reaching $14.1 billion for the quarter, a level not seen since April-June of last year.

Comparing investment activity with its most recent peak, in the fourth quarter of 2010, the most visible difference is in the buyout share. These transactions accounted for half of the $22.2 billion committed in October-December last year, but only 18.3% of investment in the most recent quarter. Rather than buyout-dominated, activity is now split more evenly between the major segments, buyouts, growth capital, venture capital and other transactions.

The big winner is undoubtedly venture capital. From $200 million and 1.1% of total investment in the fourth quarter of 2010, it accounted for $3.1 billion and 24.2% in July-September. Early- to mid-stage investments - venture capital and growth capital - made up approaching 60% of the transaction pool for the first time since the second quarter of 2010, and then growth capital was responsible for over 50%.

The investment breakdown by industry confirms the prevalence of venture capital. There were 281 transactions in the quarter, down from 358 a year earlier, but information technology, the traditional mainstay of VC players, was the only industry to see a substantial increase in activity. Sixty-nine deals were completed compared to 53 a year ago.

Information technology deals accounted for 25% of all transactions in the quarter, up from 15% a year ago. Computer-related deals also rose from 7% to 11%, leapfrogging heavy manufacturing, medical and non-financial services to become the second-largest category overall. Electronics also posted a small year-on-year increase, while most other major saw their share of overall transactions decline.

One plausible explanation for this trend is a "flight to early stage" in response to rising competition and prices in the growth capital space. Industry participants confirm it has become an established strategy among China players.

A number of firms that made their names in venture capital in the last decade found they were able to raise larger funds on the back of strong track records. As a result, they went after larger, growth-stage deals. Now that space has become overpopulated - pre-IPO investments hit $7.8 billion in 2010, up 238% from two years previously - these firms are moving back to VC, although they still have to move quicker than before to complete deals.

Harry Man, a partner at Matrix Partners China, told AVCJ in June that his company has moved away from Series C funding into the Series A and B rounds. Matrix concluded that it could offer the most value by getting involved earlier in a company's development process.

2) How sustainable is China fundraising?

It comes as little surprise that China continues to lead the region in terms of fundraising. China also bucked the trend that saw most countries raise less capital in the third quarter than in the same period a year earlier.

PRC funds received commitments of $10.7 billion, up 227% on July-September 2010. India and Japan were the only other nations to see growth in activity. However, this massive increase in fundraising was not matched by a proportionate rise in new vehicles. A total of 32 China-focused funds achieved closes in the third quarter, just five more than a year earlier.

Six funds accounted for $8.5 billion of the total raised. This is not altogether unusual - China has seen its fair share of super funds - and several of the firms involved are established private equity platforms: PAG, which reached a first close of $1.7 billion on its $2.5 billion Asia buyout fund; CDH, which achieved a $1.1 billion second close on Tianjin CDH Equity Investment Fund II, despite having set a full target of $762 million; Orchid Asia, which raised $327 million for its fifth vehicle; and GSR Ventures, which closed its fourth venture fund at $350 million.

Together, that comes to less than half the $8.5 billion. The remaining capital was committed to two funds. The Innovation Industrial Investment Fund, a vehicle to be managed by a consortium of Shanghai government agencies and funds, as well as bit-part players including Sequoia Capital, received $4.2 billion. And China Cultural Industrial Investment Fund, another government-linked operation, reached a first close of $927.9 million against a final target of $3 billion.

China fundraising isn't in danger, but there are mixed signals. When two thirds of the capital goes to state-linked entities and a large collection of small renminbi funds that are relatively new to private equity and only in it for short-term returns, there are grounds for asking whether the recent stellar growth can be sustained. On the other hand, gradual regulatory easing should facilitate the entry of brokerages and insurance companies, adding more depth to the market.

3) Trade sales up, IPO exits down

Public equity markets took a beating in the third quarter, with the MSCI AC Asia Pacific closing at 113.119 points on September 30, having lost 16% over the three-month period. The gains made since late May-early June of last year are nearly wiped out.

In this climate, IPO exits have struggled. There were 33 private equity-backed listings between July and September, which raised a total of $6.3 billion. Exit volumes continued a quarter-on-quarter decline that dates back to the last three months of 2010, when 125 offerings raised a collective $44.2 billion.

The top 12 offerings accounted for 70% of all funds raised, with China-related listings occupying nine of these slots. All of these China IPOs were on mainland exchanges, with exception of Sun Art Retail Group, which raised $1.7 billion in Hong Kong, the largest offering of the quarter, and Tudou Holdings, whose much delayed NASDAQ listing generated $174 million.

Of these 12 largest offerings, seven ended the quarter below their IPO prices and only two were trading at a significant premium.

Trade and secondary sales stepped in to fill the liquidity void. There were 67 transactions, down slightly on the previous quarter, but the value more than doubled to reach $14.9 billion. This level of activity hasn't been seen since the final three months of 2010, when IPOs generated more than twice as much as trade sales.

Trade sales in Australia's consumer sector generated much attention as private equity firms began to exit investments made during the boom period of the mid-2000s.

On the M&A side, Pacific Equity Partners (PEP) and Unitas Capital agreed to sell New Zealand beverage firm Independent Liquor to Japan's Asahi Group for $1.27 billion, while China's Bright Food Group agreed to buy a 75% stake in CHAMP Private Equity-controlled Manassen Foods.

Bain Capital was responsible for the leading secondary buyout, paying Archer Capital and HarbourVest $1.25 billion for accounting software firm MYOB.

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• Topics
• Venture
• Buyouts
• Fundraising
• Greater China
• Exits
• Venture
• buyout
• Fundraising
• China
• Exit
• Trade sale
• IPO