China GPs wary of public market volatility, regulation - AVCJ Forum

The Shanghai Composite Index is closing in on the 5,000-point mark, having languished below 2,300 in late October. The Shenzhen Composite Index and Chinext have both more than doubled in value over the same period. For PE investors, it represents a remarkable turnaround from the suspension on new share offerings that lasted until late 2013, but volatility and bureaucracy remain concerns.

The certainty of exit is just as important as the valuation at which one can exit, noted Lihong Wang, managing director with Bain Capital. A buyout-focused investor like Bain may have to wait three years before applying to list due to change-of-control regulations. The application process itself could also be lengthy and then the private equity firm's shares would be subject to a three-year lock-up.

"I don't know if you can be confident that the market will still be at the current valuations three or more years from now," Wang said. "We cannot be dependent on A-share exits. The best channel is a Hong Kong listing or a trade sale."

Even primarily minority investors have been forced to seek alternative exit channels. Yao Duan, managing director at Shenzhen Co-Win Venture Capital, said that her firm had completed 20 M&A exits in the past two years. "The returns compared with IPOs are not as high but we can get a really quick exit," she explained.

Meanwhile CICC Private Equity, the PE division of China International Capital Corporation, has seen one full and one partial M&A exit in the last 12 months and a number of companies have listed in Hong Kong. The full exit was announced in January as two CICC renminbi-denominated funds agreed to sell their positions in Jiangyin Tianjiang Pharmaceutical as part of a $1.34 billion deal that will see Hong Kong-listed China Traditional Chinese Medicine buy a majority stake in the business.

Cathy Zhang, managing director at CICC, said her firm and Jiangyin Tianjiang's management agreed to seek out a strategic buyer because the IPO process would have taken too long. The transaction has still been time-consuming: the decision was taken in early 2014, and nearly 18 months later, final approvals from the Chinese regulators and shareholders in the buying company have yet to come through.

"It is a very long process and the return will not be as good as if we had listed the company directly on the A-share market. But when you factor in all the other considerations that was the best option for us," Zhang said.

There is optimism for what the New Third Board offers as a listing destination for smaller companies that have not achieved the financial and operational milestones required by China's other bourses.

Co-Win's Duan noted that liquidity should improve towards the end of this or early next year, while CICC's Zhang sees the market's strong start as a catalyst for reform in other areas. "The New Third Board is a real registration-based capital market in China right now and it is putting pressure on the A-share market and the CSRC [China Regulatory Securities Commission] to fast track reforms," she said.

However, it is not the answer for all private equity-backed companies. As the market matures, investors will increasingly seek a broader range of exits, with trade and secondary sales expected to gain traction. Bonnie Lo, a partner at NewQuest Capital Partners, observed that GPs can capitalize on the willingness of A-share companies to make acquisitions through share-swap arrangements, although it can be challenging for a minority investor to bring about this outcome.

"The one-year shutdown in the domestic IPO market has made GPs realize that exit opportunities need to be grasped and the public markets are not always open," Lo said. "If a company goes public it should generate the highest returns but there are other considerations. We see GPs maturing and looking at a diverse range of exit paths."

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