PE’s positive role in China

An important new source of development in China, private equity-backed companies are outperforming the market in revenue growth, rising an average of 21% in each of the past two years-an impressive gain from just 3% in 2009. By comparison, listed companies saw their revenues grow 14% in the same period. Private equity firms also posted 7% higher profit growth than their publicly traded counterparts.

These are just a few of the findings from our second survey of private equity's economic, social and environmental impact in China - a joint effort by Bain & Company and the European Union Chamber of Commerce in China.

While PE is still is a relatively new phenomenon in the country, the industry continues its rapid development. China now is one of the world's leading destinations for private equity capital amid continued global economic turbulence. It accounted for more than 5% of the total invested globally in 2011, a significant jump from just 1.5% in 2007. Like many fast-growing industries, the changes set in motion by an influx in new capital raise questions about whether or not PE enriches Chinese society and economic development.

To help answer those questions, we examined trends, data points and other indicators pertinent to evaluating economic performance and social and environmental development. And, in this context, the performance of PE-backed firms was compared with that of publicly listed companies. The survey covers deals announced from 2004 to 2008, with information from companies that represent 40% of the total value of private equity deals from that period worth more than US$20 million.

Our analysis also involved in-depth interviews with executives representing 25 PE-backed companies.

The value proposition

We learned the dimensions of private equity's economic impact. For example, PE investors provide critical support for smaller companies, now a powerful engine of growth. The results show that investors helped smaller companies outgrow listed competitors, tripling the revenue growth rate of comparable listed firms.

Private equity investors also increase financial performance by offering valued guidance. The majority of executives of PE-backed companies reported they benefited from the role their partners play as management and financial advisers on a range of issues: strengthening corporate governance, creating more open and transparent decision-making processes and reallocating working capital to support growth.

However, private equity firms received mixed reviews from some survey participants who welcome more hands-on support and increased industry operational knowledge from their investors, even after taking the company public.

PE-financed firms support the expansion of China's domestic consumer goods and retail industry, with more investors shifting their attention to this area. In 2010, consumer goods and retail deals represented 13% of total PE deal value, a marked increase from 4% in 2004. Retailers backed by PE investors booked sales growth of 59%, compared with just 19% for publicly listed retail companies - consistent with what we observed in the first survey, conducted in 2009.

Private equity investments also appear to be aligned with China's "Go West" policies that encourage investments in the country's underdeveloped hinterlands, primarily in western and central China. After a decline in 2008, investor interest has rebounded. Since 2009, more than half of all PE investments have been in companies headquartered in the western region, surpassing backing for businesses located in the more affluent coastal provinces.

The findings show that private equity has made a significant social impact, too, demonstrated by improved job opportunities and innovation. PE-backed firms pay higher salaries even as global economic uncertainty continues, generating full-time jobs at an annual rate of 8%, on a par with the market over the period of our study. But the pace has slowed since the 2009 survey, when job growth at PE portfolio companies increased by 16%. Even so, wages are continuing to rise - salary growth rate is 7% higher at PE portfolio companies than at listed companies, contributing to an improved standard of living for employees.

As another sign of the industry's growing social impact, private equity-backed firms have increased R&D investments. Measured as a percentage of revenue, portfolio companies now spend almost twice as much on R&D than their publicly listed counterparts, showing a sustained emphasis on innovation.

Environmental shortfall

When it comes to environmental protection, however, PE-backed and publicly traded companies have opportunities to do more. For both groups, corporate commitment to environmental initiatives is still in the early stages. Only about 40% of the companies surveyed had released an environmental protection report detailing spending and green initiatives; even fewer disclosed their expenses for environmental protection.

Looking ahead, several evolving trends could affect China's private equity industry. They include the rise of local competitors with the introduction of RMB-denominated funds, closer alignment of domestic regulations with international principles, collaboration with global funds to diversify portfolios and higher levels of participation by domestic institutional investors and fund-of-fund investing in PE.

All these shifts point to even stronger role for private equity in China, adding weight to its existing contribution to economic and social growth.

Michael Thorneman is a partner and head of Greater at Bain & Company. Weiwen Han is a partner and Hao Zhou is a project manager. All three are based in Shanghai.

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• Topics
• Greater China
• Performance
• Investments
• China
• Growth capital