Fund focus: Forebright relies on its domain expertise

“This is the most challenging fundraising environment since the outbreak of the global financial crisis in 2008, exacerbated by multiple factors,” said Hongwei Chen, a partner at China-focused private equity firm Forebright Capital.

In addition to geopolitical tensions, he highlights pandemic-related disruptions to travel and business activities, historically high US interest rates dampening investors’ risk appetite – why target private equity when an annual return of up to 6% is available from government bonds with negligible risk? – and an end to the consumer-internet story that has underpinned much of Chinese GPs’ returns.

“The successful formula of relying on fast-growing consumer or internet platforms has ceased to yield good results,” Chen added.

About USD 21.5bn was committed to US dollar-denominated China funds last year, according to AVCJ Research. The running total for 2023 is approximately USD 6.1bn. US investors previously open to engaging with Chinese managers, even if it was just to track the latest trends, have pulled back. Many are holding off on new commitments; some are declining re-ups.

Nevertheless, Forebright closed its third fund slightly above target with USD 502m in commitments. New Opportunities Fund III is two-thirds larger than its predecessor, which closed on USD 285m in 2019. Most existing LPs returned, and a dozen new relationships were added, despite the process being disrupted by COVID-19 not long after it launched in late 2021.

The LP base – which includes pension funds, endowments, asset managers, fund-of-funds, and family offices – has a similar geographic flavour to its predecessors. Europe is best represented, with German development finance institution DEG among the participants. Several of the new LPs are from the US, while other participants hail from Asia, the Middle East, and Latin America.

Chen noted that investors still willing to back China funds have raised their qualification standards significantly. Oftentimes, external consultants are called on to conduct independent reviews ahead of investment committee deliberations. Candidates then join a larger pool of China GPs that are subject to stricter due diligence and performance comparison exercises.

“LPs have lots of opportunities to choose from. They would likely require solid evidence that supports what GPs claim as strategies. We have been focusing on advanced manufacturing and enterprise software opportunities for more than nine years. With a robust track record of realizations and returns in these sectors, our team earned the vote of trust from LPs,” said Chen.

Forebright’s median cheque size is around USD 25m and tends to back leading companies in niche markets. Privatisations of US-listed Chinese businesses have emerged as a sweet spot – the firm has completed five deals of this nature.

A prominent example is electric transformer maker Jinpan International, which Forebright delisted in 2016 at a valuation of USD 98m. The company relisted on the A-share market in 2021 and now has a market capitalisation of CNY 13.8bn (USD 1.9bn). Most recently, Forebright backed a USD 150m privatisation of NASDAQ-listed chip designer O2Micro International.

“Given they are out of favour, these kinds of opportunities could be acquired at attractive entry valuations, sometimes lower than that of a typical private market deal,” said Chen. “And then our team would have a clear path on how to collaborate with founders on value creation.”

Forebright sees limited competition for small to mid-cap take-privates. Companies with valuations of around USD 100m don’t meet the minimum size requirements of many US-based private equity firms. An inability to understand China is often another deterrent.

Chen also highlights cultural differences between US and Chinese investors. While replacing the senior management of a portfolio company is commonplace in the US, taking that course of action in China could lead to an entrenched fight and a lot of lost value. Forebright prioritizes winning the trust of the founding team and establishing a constructive working relationship.

The firm aspires to pursue more take-private deals, while also identifying cross-border opportunities – such as supporting overseas M&A by Chinese companies, bringing products and technologies to China from overseas, and spinning out businesses from multinationals.

One key point of differentiation comes in the post-deal phase. Consumer-facing companies – including the large consumer-technology platforms – often engage in battles for scale, burning substantial amounts of capital in the name of gaining market share. The business-to-business players that makeup Forebright’s portfolio must achieve pre-eminence through other means.

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• Topics
• Greater China
• Growth
• Buyout
• Fundraising
• GPs
• LPs
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• Industrials
• China
• Forebright Capital
• Fundraising