PE must prove value credentials to China targets - AVCJ Forum

"It's no longer a rising tide floats all boats. Sectors go through different characters of growth - some are already mature and have no growth while others will keep growing fast for many years to come. Choosing the right sectors is more important than before," said Frank Tang, CEO and managing partner of FountainVest Partners.

Management teams are also far more sophisticated in terms of their own operations and their awareness of what private equity has to offer. This places the onus on would-be investors to emphasize how they can add value to what might already be a strong-performing business.

Tang added that private equity has been commoditized in the eyes of some entrepreneurs, simply because they receive so many plain vanilla pitches. But where there is interest in bring on board outside investment there is often a particular problem that needs solving, whether it is a succession planning issue, a need for assistance in entering new markets, or a dispute between existing shareholders.

Speaking of his own experiences investing in China, David Liu, country head for KKR, divided the past 20 years into three phases. The first, which ran from the early 1990s to 2000 was characterized by a general lack of familiarity with the asset class. Executing deals was difficult and so too were exits, given A-share listings and the red chip restructuring route that led to Hong Kong IPOs were not available.

Phase two, from 2000 to 2010 or thereabouts, saw significant capital markets development and a sustained period of returns for private equity investors that is unlikely to be repeated. Finally, in the last 3-4 years, the environment has become more challenging with performance increasingly dependent on strategies that are operationally-focused and value-oriented.

"Making 20% IRR is a very difficult game but there are much larger deals and the market is becoming more mature," Liu added. In the light of these changes, KKR's approach to China has evolved - one third of the firm's employees in China are now operational executives who might spend a year or more working on specific projects with portfolio companies.

However, Homer Sun, CIO at Morgan Stanley Private Equity Asia, observed that PE-driven operational improvement, while increasingly appreciated by companies in China, is still in its nascent stages.

"There is a contrast with big buyouts in developed markets where there is transparent price discovery and almost by definition, because you made the highest bid, to make money you need to lead with operational value-add," he said. "Our view is that China in the next 5-10 years will be a minority investment market rather than a control investment market."

The AVCJ China Forum continues tomorrow in Beijing. For more information, go to www.avcjchina.com.

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