Lower valuations, less leverage could drive China PE returns - HKMA Forum

“In the US, if you look at the last 20 years, a significant part of returns were driven by leverage ... Now interest rates are back up, so a major source of return is gone,” Yichen Zhang, chairman and CEO of Trustar Capital, said at the summit, which was organised by Hong Kong Monetary Authority (HKMA).

“On the other hand, this is the first time in 40 years that interest rates in China have been lower than the US, and because there is a lack of inflation in China, they are likely to remain low. We could see more returns out of private equity from China than from the US.”

Chip Kaye, CEO of Warburg Pincus, noted that his four decades at the firm have been characterised by 25 years of declining rates and 15 years of low rates. With rising rates dampening the impact of leverage and multiple expansion proving much harder to achieve than before, it places more emphasis on what investors can do to enhance a company’s underlying earnings.

“That’s the sorting out that’s going to take place in the US, creating real businesses that are genuinely profitable,” Kaye said.

Investment in China is complicated by slowing economic growth and an assortment of other factors – ranging from geopolitics to regulatory uncertainty – have dialled up the perceived risk. According to Zhang, “basic consumption is by and large intact” but it will take time for the economic drag created by a trouble-hit real estate sector to ease.

Lei Zhang, founder and chairman of Hillhouse, added that the best companies are usually built in the most challenging times. Lei Zhang said he drew inspiration from a passage in “Winning the Loser's Game,” a book co-authored by Charles D. Ellis, founder of Greenwich Associates, that observed the most successful athletes aren’t necessarily the strongest, rather those who make the fewest unforced errors.

“In this environment, I am telling my management, you don’t need to be super smart. All you need to do is be consistent – think long term, keep a steady hand, do the right things,” Lei Zhang said. He added that Asian companies are generally well-positioned because they tend to have strong balance sheets and reasonable growth prospects, and they are run by an increasingly competent management cohort.

Yichen Zhang said that he sees plentiful investment opportunities in China. Corporate carve-outs are an active channel with multinationals looking for partners to assume majority control of their China business units. Divestments by overleveraged Chinese companies and founder succession situations are also rich sources of deal flow.

“The Chinese market, on the private equity side, was on a great run. You overlapped factors like tremendous economic growth, cheap capital from international investors, and great entrepreneurs. All the stars were aligned to create that sort of return,” Yichen Zhang said. “But all good things come to an end. We are seeing now is a maturation of the Chinese market.”

In this context, he expects buyouts – which currently account for about 20% of the Chinese private equity market, compared to 70%-80% in developed markets – to emerge as the main play.

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• Topics
• Greater China
• Buyouts
• GPs
• Performance
• China
• Hillhouse Capital Management
• Trustar Capital
• Warburg Pincus Asia
• Hong Kong Monetary Authority (HKMA)