AVCJ Awards 2021: Special Achievement: Weijian Shan

Q: How do you get comfortable with the notion that 20x is the new 15x in terms of EBITDA multiples?

A: I don’t think we’ve ever invested at 15x, let alone 20x. For very stable, growing, high cash flow businesses, you can pay higher valuations because interest rates are low, and a lot of leverage is available. But those transactions are rare. Many years ago, a Europe-based private equity firm was kind enough to reveal its portfolio to me in detail. One revelation I came away with was that the companies they got for low valuations weren’t doing well, but where they paid higher valuations, the companies were doing better. I came back and discussed it with my team, and we recalled what Warren Buffett once said: It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price. The quality of the business really matters. A mistake we have made in the past 10 years is to have been very disciplined on valuations and consequently, we have missed some new economy deals. But discipline is important. If it’s too high a valuation and there’s too much debt, you will run into trouble when the economy turns.

Q: What is the level of competition for new economy businesses in China?

A: It seems to me the situation is getting better. Until last year, we competed for deals with the likes of Tencent and Alibaba. They have deep pockets, and they weren’t as sensitive to valuations as we were, so it was difficult. Following the introduction of the antitrust measures and other regulations, I see fewer big tech companies competing with us for deals.

Q: How do you explain the regulatory barrage of 2021?

A: If you look at the regulatory measures and policy initiatives one by one, in each case there is arguably a socially desirable purpose. With after-school tutoring, they genuinely want to reduce the burden on children and parents. The antitrust and data privacy measures were probably long overdue. In the property sector, the goal was to squeeze out the price bubble and the debt bubble. Most countries go through economic cycles, but China hasn’t experienced a recession in 40 years because it can squeeze out systemic risks – like price and debt bubbles – before they do real damage. Having said that, the way they have gone about it, without much guidance for the market, is clumsy. They came in suddenly and there were unintended consequences, second or third-order effects. Investors were spooked. There were questions about whether China is too unpredictable and whether it is investable. That is damaging to the market. I hope lessons have been learned, the regulators have done most of what they intended to do, and we have a calmer year. With economic growth slowing so significantly, I hope also that the government eases macroeconomic policies.

Q: Tencent Music Entertainment (TME), a former PAG portfolio company, had to give up its exclusive label rights following an antitrust investigation…

A: Thankfully, we got out in time and made good money out of it. Having exclusive copyrights was a huge competitive advantage. There were 800 million unique monthly subscribers; only in China would you have such a business. Before the company was required to sub-license copyrights to competitors – which is how it works in the US; Spotify, iTunes, and Amazon have equal access – there was no chance for the likes of NetEase Music and Alibaba Shrimp. Now they are doing well.

Q: Have technology companies in China grown so fast that regulation couldn’t keep up with them?

A: Yes, but when you look globally, many of the same complaints about technology companies exist. Some countries are better at dealing with them than others. Europe is typically one step ahead of the US, and then China is quite far behind. The initial intentions of new economy companies are good. Why did TME have exclusive copyrights? Until we invested in China Music Corporation [which ultimately merged with TME], copyrights weren’t protected. Universal Music and Sony were happy to license to anyone who wanted to pay. TME and others played an important role in upholding international copyrights in China. Now, though, the market is more mature, everyone respects copyrights, and it makes sense that you need to take antitrust measures for the good of consumers.

Q: PAG has existing exposure to education through Golden Apple Education Group and Lily English. How have they been impacted by regulatory action in the industry?

A: Golden Apple is a profitable and high-quality kindergarten operator; it’s not after-school tuition, so it hasn’t been impacted. While the stock of all education companies has fallen, the fundamentals are still strong. Lilly English is not a big investment, it doesn’t need much money, and the business remains in good shape. It used to be an offline business, but we started migrating online because of COVID. It sells canned programs to parents who teach their kids when it is convenient – unlike some other English teaching businesses, which pair children with overseas teachers and it happens live.

Q: What about the exit prospects for these businesses?

A: For kindergartens, the exit options changed shortly after we invested. Companies were barred from listing domestically or overseas. It doesn’t prevent you from doing a trade sale, and as a majority shareholder [in Golden Apple] that might be preferable. Valuations changed when it was announced that more education companies cannot do public listings, but we are not as affected as others. One area we did get out of earlier, for regulatory reasons, was consumer finance. We saw the regulatory regime was changing, with interest rates being lowered and capital requirements increased, so we exercised our put.

Q: Is there anything you now do differently because of the events of the last 12 months?

A: It has heightened our sensitivities, but it hasn’t changed the way we do business. We have always been careful on ESG [environment, social, and governance]. The tricky part is social responsibility. We stay away from gambling, smoking, and gaming. But recently we were evaluating a business involved in hiring blue-collar workers and one of the questions posed was whether it would be consistent with the policies promoting common prosperity. We concluded that the business helps these workers rather than create social security issues, so from an ESG perspective, it got a pass. Previously, private equity investors weren’t so sensitive about paying social security, healthcare benefits, and giving employees time off. Now, though, you must ensure the companies you invest in are compliant.

Q: How do you feel about the surge in “policy-aligned” sustainability-related investments?

A: Whenever there is policy support for a sector, people try to take advantage of the tailwinds. We’ve seen this over the years in areas like solar panel manufacturing. It’s good that electric vehicles and clean energy are getting support, but there are risks to piling into businesses that are one of many. There is no lack capital in China or Asia. If you adopt me-too strategies, it leads to overcapacity and corrections. We’ve seen this happen repeatedly because China’s growth story is a story of overbuilding in almost every industry. You need differentiation and competitive advantage.

Q: Would the same apply to emerging consumer brands?

A: Yes. This happens in the food business from time to time. How sustainable is the brand? How sustainable is the business? Consumers go from one fad to another. It something does well, everyone wants to imitate. It comes down to where you have a differentiated product, not just a brand, and you keep innovating.

Q: How has the China-other Asia split in PAG’s funds changed as you’ve put more resources in markets like India?

A: Our funds have always been labelled as Asia funds, but with our brand name, team, and track record we have an advantage in China. At the same time, China is three times the size of Japan and more than five times the size of India. More than 50% of the private equity capital deployed regionally goes into China. All our funds have been two-thirds China, one-third rest of Asia, so we are slightly above average. This is not by design; we don’t do capital allocation by geography. If there’s a good investment opportunity, we try to capture it, one deal at a time.

Q: How does this influence fund size?

A: The market has become bigger. Fund I was USD 2.5bn and the largest investment, Universal Studios Japan, was USD 250m. TME was about USD 130m. In Fund II, which was USD 3.66bn, the largest deal was Yingde Industrial Gases at USD 1.5bn. In Fund III, which was USD 6.1bn, the largest investment was USD 2.8bn. That was Wanda Commercial Management. Ten years ago, it would be a stretch to find an investment opportunity where you could deploy USD 500m. Now you can deploy USD 1bn. As the market has grown, fund sizes have grown just to stay in the game. Our underwriting hasn’t changed in any way at all.

Pictured: Weijian Shan (centre) accepts the special achievement award from AVCJ's Tim Burroughs (left) and Allen Lee (right)

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• Topics
• Greater China
• GPs
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• China
• Asia
• PAG
• Weijian Shan
• AVCJ Awards