Fund focus: Re-ups underpin FountainVest's Fund IV close

FountainVest Partners had become accustomed to swift fundraising. Its first three US dollar-denominated funds each took no more than eight months to achieve final closes on progressively large totals: USD 950m, USD 1.35bn, and USD 2.1bn. All three hit their hard caps.

Fund IV continues the upward trend in size, closing on USD 2.9bn, but it took 20 months and extensions to the fundraising period to get there. FountainVest raced to a first close of about USD 1bn in October 2020 and it had locked in around USD 2.2bn by mid-2021. Then an unfortunate series of external events ensued, starting with a USD 1trn sector-wide tech stock sell-off triggered by regulatory uncertainty.

“In the third quarter, people were shocked and put their pens down. In the fourth quarter, they recovered a bit and started working again, but then there was omicron, which dominated November, December, and January,” said Frank Tang, FountainVest’s CEO, who established the firm in 2007 by leading a spinout of the China investment team at Temasek Holdings.

“It wasn’t until late January and early February that they got comfortable. Then Ukraine happened and omicron hit China, with lockdowns in Shenzhen and then Shanghai.”

This account is reflected in the broader China fundraising picture. A total of USD 20.1bn was committed to US dollar vehicles last year, consistent with the average for the previous five years. However, more than 70% of the capital was raised before the end of June. Clampdowns on after-school tuition and offshore IPOs, which precipitated the sell-off, began in late July.

Prior to FountainVest’s final close, fundraising for 2022 to date was USD 7.2bn, according to AVCJ Research. In addition to specific China concerns, LPs are now grappling with the implications of a broader macroeconomic weakness and a global technology sell-off.

LPs in FountainVest’s third fund account for USD 2.1bn of Fund IV, which launched with a target of USD 2.8bn. Not everyone re-upped, but those that did upsized their commitments from the previous vintage. Most of the 10 largest LPs opted for double-digit increases.

“We’ve seen a real bifurcation,” said Tang. “LPs generally are focusing on re-ups, especially given the lack of ability to travel, and shying away from finding new GPs. At the same time, certain LPs didn’t come back in, but we had new ones come in from Asia, the Middle East, and Europe. They are willing to take a contrarian view. Some had never invested in a Chinese GP before.”

US investors account for about one-quarter of the fund corpus, the same as in Fund III, as dropouts were counterbalanced by larger allocations from those that re-upped. Washington State Investment Board (WSIB), for example, has invested USD 250m in Fund IV, up from USD 200m in Fund III.

Tang declined to comment on specific LPs. In addition to WSIB, significant investors in Fund III included Ontario Teachers’ Pension Plan (OTPP), Canada Pension Plan Investment Board (CPPIB), and California State Teachers’ Retirement System (CalSTRS), AVCJ Research’s records show.

WSIB has backed FountainVest from the outset. As of December 2021, Fund I had delivered a 1.4x multiple and a 6.71% net IRR, according to performance data disclosed by the pension system. This compares to 1.6x and 14.32% for Fund II and 1.3x and 13.69% for Fund III.

Fund II marked the firm’s switch to a more concerted buyout strategy. Control transactions represent two-thirds of the Fund III corpus and four-fifths of Fund IV, which is over 33% invested. Tang noted that minority deals “complement the buyouts and ensure we have proper sector knowledge and ecosystems set up” across consumer, healthcare, and industrial and business services.

Minority investments in tech start-ups since 2020 include community group buying platform Xingsheng Youxuan, self-driving truck developer Plus, and education provider Zuoyebang. The most recent of these was in the first quarter of 2021 and none of them is in immediate need of funding, Tang said.

On the buyout side, FountainVest has been active in casual dining, pet food, nutritional supplements, and logistics with acquisitions of China F&B Group, a master franchise operator for Papa John’s and Dairy Queen in mainland China, New Zealand-based Ziwi, Langdi Pharmaceutical, and Rokin Logistics.

While all were sourced through sector-led screening exercises, the first was a secondary acquisition, the second a succession planning situation, and the last two were carve-outs. Take-privates, industry consolidation, and corporate carve-outs – from Chinese as well as international companies; Langdi was acquired from an A-share company – are expected to be key themes.

“In the next few years, many companies will review their strategies and portfolios, choose to focus on what is core and divest the non-core. This will create opportunities,” Tang said.

Ziwi, which was announced in September 2021 and closed in March, is the most recent transaction. Since then, FountainVest – and, it would seem, most of the firm’s peers – have exercised caution. Private equity investors have deployed USD 30.8bn in China so far this year. The first-half totals for 2020 and 2021 were USD 36.8bn and USD 56.3bn, according to AVCJ Research.

China exit activity has also been muted, notably among the strategic players most likely to pick up control positions from FountainVest. Less than USD 1bn has been transacted in trade sales in 2022, compared to USD 5.3bn and USD 10.2bn in the first six months of 2020 and 2021. Tang noted that the firm is engaged in discussions over certain assets but admits that generally there are obstacles.

“There are three major uncertainties for this year: general geopolitics; the regulatory situation in China, and uncertainty here will probably ease as the government realises that sudden changes have ramifications they didn’t expect; and the zero-COVID policy in China, which is a human-driven unpredictability that impacts supply chains, revenue, and cash flows,” said Tang.

“Over the next 2-3 months, I think people will be very cautious about doing deals and how to structure them.”

UBS served as placement agent for FountainVest Capital Partners Fund IV.

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• Topics
• Greater China
• Fundraising
• Buyout
• GPs
• LPs
• China
• Fundraising
• Fountainvest Partners