Fund focus: Firstred's advisory angle

Few independent Chinese managers hit the $1 billion – or RMB6.8 billion – mark with their debut renminbi-denominated fund. But Firstred Capital has done just that.

It helps to have a high-profile principal. Xiaodan Liu (pictured) established Firstred in 2019 after stepping down from her position as CEO and chairwoman of Huatai United Securities. Over the course of 20 years, she had become a familiar face in M&A circles and ended up leading Huatai United from a regional outfit to one of China's top three investment banks. It topped the domestic M&A advisory league table for five years in a row.

A RMB4.1 billion first close on Firstred’s fund came within two months of launch in January 2020. A day later, the city of Wuhan was locked down as Chinese officials sought to control the spread of COVID-19. “I was a little worried about whether it would affect the fund settlement. But all our LPs contributed the capital in time. Many of our LPs represent large listed enterprises, with a combined market value of over $260 billion” says Liu.

Those listed players include Yili Group and Haoxiangni, leaders in dairy and snack foods, respectively. Founders and senior management of other corporate giants made commitments directly or through family offices. Additional contributions came from insurance companies and fund-of-funds.

One insurance company decided to support Firstred because it found that traditional Chinese growth funds were too similar and unable to manage large amounts of capital. It ended up putting in RMB300 million. “If Firstred cannot be successful, then I don’t know who else will make it,” says the LP’s investment committee head.

Sequoia synergies

Sequoia Capital China is another key backer, also holding a 12% stake in Firstred’s management company. Liu explains that this represents the continuation of an historical cooperation. Sequoia previously invested in Huatai United’s direct investment arm, with a similar shareholding ratio. In addition, Liu is friends with Neil Shen – founding and managing partner of Sequoia China – having dealt with him frequently during her career in investment banking.

The two firms pursue synergies. Sequoia introduces its portfolio companies to Firstred, which in turn contributes M&A expertise. Shen sits on Firstred’s board, but the GP is independently run. It was through Sequoia that Firstred became one of few financial investors to get access to BYD Semiconductor, the chip-making arm of electric vehicle manufacturer BYD. The firm contributed RMB100 million to a funding round last May that attracted dozens of strategic investors.

Firstred describes its investment strategy as M&A, though not in the conventional sense – the objective is to empower Chinese companies with Firstred's M&A capabilities. There is a lot of flexibility as to the nature of equity participation in deals.

“For overseas PE funds doing buyouts in China, there are often many challenges. The US model doesn’t always work in China. For example, we define our M&A approach broadly and can cover minority investments in companies with the potential to pursue inorganic growth strategies. This is a unique opportunity in the Chinese market today, and I think this is the way for M&A funds to thrive here,” says Liu.

The new fund targets late-stage growth and buyout opportunities. On the growth side, Firstred focuses on companies that may have future upstream and downstream M&A needs within their industry value chains. Spinouts are likely to be a major theme.

For its debut deal, Firstred supported a spinout and restructuring of Hualan Vaccine – China’s largest flu vaccine producer – from Hualan Biological. It paid RMB828 million for an approximately 6% stake in Hualan Vaccine, which is preparing for an IPO on Shenzhen’s ChiNext board. Firstred is also working with the company on expansion into new verticals through M&As, leveraging its existing distribution channels.

As for buyouts, Firstred has no desire to be the sole large shareholder in target businesses. Rather, it will explore different structures with strategic partners, industry investors, and management teams.

The firm has completed six investments to date. In addition to Hualan Vaccine and BYD Semiconductor, it has backed new energy business Renogy, battery producer China Lithium Battery Technology, and unnamed companies focused on electrofusion and chip packaging and testing, respectively.

M&A or IPO?

Liu observes that navigating China’s M&A market involves understanding its nuances. Target companies usually have growth prospects, so there is no need for high leverage multiples. The financial models for China deals are often straightforward. Moreover, the pool of management talent is relatively shallow. If a GP fires a CEO, it might be hard to find a good replacement. “You can’t overstate the GP’s value in post-investment management in China,” Liu adds.

At the same time, she believes that China is on the cusp of an explosion in M&A activity. Reforms to the domestic IPO process have made it easier for companies to list but not all of them will receive a warm welcome from investors. Once problems with low trading volumes and limited liquidity emerge, some may decide the public markets are not for them.

“In the long run, IPOs may not be the most important path to exit; M&A will also play a major role,” says Liu. “Although IPO is still the mainstream approach today, we are starting to feel a shift towards M&A. For example, many of the recent deals I’ve been looking at are buyouts.”

In this respect, China may follow in America’s footsteps. The establishment of NASDAQ prompted a boom in technology IPOs, and then two or three years later, M&A volumes began to rise. Half of delistings in the US are realized through M&A.

“China’s IPO boom is starting now. I think the number of listings will peak at 8,000-10,000, including companies trading on the domestic markets, in Hong Kong, and in the US. At this scale, many companies will list each year and many others will delist through M&A,” says Liu.

Meanwhile, Firstred is looking to raise approximately $500 million for its debut US dollar fund. The renminbi and US dollar vehicles will be managed by the same team under the same strategy. Deals will be split between the two on a pro rata basis, apart from transactions that are only open to one currency due to foreign investment restrictions or entrepreneurs wanting to take their companies public on specific markets.

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• Topics
• Greater China
• Renminbi fund
• Fundraising
• China
• Firstred Capital
• M&A