China PE challenge is micro, not macro - AVCJ Forum

“Whatever uncertainty you think there is, one thing cannot be more certain: China has the largest and fastest-growing middle class in the world, which is expected to grow from 250 million to 500 million people over the next five years. These people are looking to consume better products and services,” said Hugh Li, co-founder and managing director at GenBridge Capital. “You just have to make sure you are investing in the right segments of the economy.”

The complexities come in two forms. First, intense competition and high valuations, with private equity not only facing competition from their peers but also from corporations and high net worth individuals typically participating in the asset class through renminbi-denominated funds. Second, the fact that many industries are evolving so quickly, which means the opportunities – and the skill sets GPs must apply to realize them – are not what they once were.

Dan Zabrowski, a venture partner with healthcare-focused GP Decheng Capital, noted that even if term sheets come in, it doesn’t necessarily mean deals get done. “We always ask ourselves, ‘Is the science differentiated? Is the management team good? And can we get the return we need?’ We have seen companies where the first two boxes have been ticked positive but the valuation was too high so the investment never happened,” he said.

GenBridge addresses the valuation issue in two ways. It leverages relationships with Chinese technology companies such as JD.com and Tencent Holdings – Li’s two co-founders previously worked in JD.com’s investment and strategy department – to generate deals that would not ordinarily be available, particularly if the company in question doesn’t actually need capital. The firm also seeks to differentiate itself through post-investment value-add.

Even then, the operational requirements of portfolio companies change in tandem with the broader industry evolution. CDH Investments is a case in point. The GP backed shoe retailer Belle International in 2005 at a valuation of less than $100 million and took it public two years later. It is now involved in a proposed $6.8 billion privatization of the company – and the rationale for the deal is not so much enabling growth as engineering a turnaround.

“Experience and track record are important but adaptability is critical as well because of the changes we are going through,” said GenBridge’s Li. “We see the emergence of a new generation of brands and services and it requires a different set of capabilities to identify, evaluate and empower those brands.”

In this sense, the abundance of capital in China won’t solve the problems companies face, which means there is still scope for private equity firms that are able to differentiate themselves in terms of value-add.

“There has never been a lack of capital in China. The scarcity value is in the micro, in the people who can create value,” said Stuart Schonberger, a managing director at CDH. “Why do people say there is not enough deal flow in China and too much money chasing too few deals? I think it’s because it is difficult for a US investor that has figured out a paradigm that works in developed markets to shift that paradigm to China.”

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• Topics
• Greater China
• Consumer
• Buyouts
• Expansion
• China
• AVCJ Events
• CDH Investments Management
• GenBridge Capital