Q&A: CITIC Capital's Eric Xin

Q: What has led to the weakening of China’s economy?

A: Several factors have come together at the same time – it is almost like the perfect storm for China. Three years ago, it was all about deleveraging and deregulation. There was too much leverage in the economy after the global financial crisis: first, they loaded up debt on the government; then they loaded up debt on corporates; and then in the last three years, they loaded up debt on consumers. This debt must be managed, which led to the deleveraging policy. The government took some forceful action in attacking shadow banking, cutting back on lending to SOEs [state-owned enterprises]. Deleveraging is painful, it normally comes with bankruptcies and a shrinking economy. The government’s view was that there might be some pain, but they would have more control and maybe the global economy – external markets, the One Belt One Road (OBOR) initiative – would help.

Q: Where does deregulation come into it?

A: Deleveraging was slowing down the economy and deregulation was supposed to speed it up, but this hasn’t happened to the extent people were expecting. Another factor is the environmental protection drive, which has resulted in the closing of a lot of factories. It’s absolutely the right thing to do, but it has impacted business. On top of it all is the trade war. Together these factors have caused consumers to lose confidence. They accumulated a lot of debt buying houses and cars, but now they are more conservative, they are holding back.

Q: How have your existing investments been impacted?

A: Most of our portfolio companies are doing all right. We have invested a lot in the services sector, which isn’t as vulnerable to the downturn because it is underdeveloped. McDonald’s has experienced some challenges in terms of single store sales growth, but it will come back. In areas such as automotive services and beauty products, we still see strong growth.

Q: What kind of policy response do you expect to the downturn? Credit expansion and a fixed-asset investment drive might undermine the longer-term rebalancing of the economy…

A: It’s very difficult. The government must find a balance – they can’t just let the economy crash, there needs to be a soft landing. At the same time, the priority is getting leverage under control, and hopefully, they will continue to do that, even if it does cause some pain this year and next year, and not take short-term medicine. I am still optimistic for the long term. Chinese people are hardworking, they are money savers, and they are motivated, and then the government still has a lot of resources. There will be more reforms. Part of the problem between the US and China is that China promised to open up the services sector on joining the WTO. On paper, they said private investors could come in, but it is has proved more difficult. Still, the new growth engine of the economy is deregulation plus innovation, so there will be change in this area.

Q: Why has reform been slow to come?

A: China is transforming from a manufacturing economy to a service economy, which involves a change in mindset. The regulation of manufacturing is relatively simple. Services is not. How do you allow private enterprise to drive growth while at the same time safeguarding consumers? If you look at the areas that need to be deregulated, like education and healthcare, everyone is talking about investing in those areas. But there are some ideological barriers and SOE barriers. In healthcare, for example, should they promote public hospitals or private hospitals? The services sector needs deregulation, but there was been a lot of debate, a lot of back and forth.

Q: How big an opportunity is healthcare deregulation?

A: The potential is enormous. We believe the current system can’t work because everything is paid for by public insurance. There isn’t enough money to cover everyone. China has to develop a commercial insurance system, provided by private companies for private companies. You are going to have a have a multi-billion-dollar private clinic healthcare industry and then another multi-billion-dollar health insurance industry. And it will save the government billions of dollars. It’s the same with education. Parents have more money and they are willing to pay children’s education. This could help subsidize the public education system and save the government billions of dollars.

Q: Where else is there potential in the services sector?

A: There are many other industries that are fragmented in China while globally you have multi-billion-dollar companies. We see a lot of potential in areas like business-to-business services, automotive services, and facilities management. Last year, we bought a facilities management company [SkyFM] and it’s doing really well. Labor is getting expensive, so companies are more willing to outsource.

Q: What are you looking at apart from services?

A: We are very much focused on services and consumption upgrades. There is a lot of deal flow from corporate carve-outs. We did seven last year, including one from an H-share listed company [pallet and packaging business China Merchants Loscam] and another from a Japanese listed company [Amoy Food, a Hong Kong-based producer of cooking sauces controlled by Ajinomoto]. Corporates tend to divest during downturns, and it’s usually the wrong time to sell. We can go in, buy at a reasonable price, and then when the cycle comes back we do well.

Q: Loscam was acquired from China Merchants Group. How is a SOE carve-out harder than a normal corporate carve-out 

A: SOE carve-outs are very different animals. Those deals require all the skills of a typical carve-out – developing the management team, putting in place independent systems – but you also need to understand SOE culture. Most SOEs stay involved after a divestment, so it’s important to manage that relationship and find a way to be partners.

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• Topics
• Greater China
• Buyouts
• Buyout
• GPs
• Consumer
• China
• CITIC Capital