China PE: Exit issues

There have been seven private equity-to-private equity trade sales in China so far this year, already more than the 12-month total for 2017. It is tempting to link this statistic to the slowdown in domestic IPO approvals – suggesting that entrepreneurs and investors, having grown tired of waiting or recognizing they are unlikely to meet the regulatory requirements, are looking at other options – but it is rarely as straightforward as that.

Leyou, the seventh of these transactions, pulled the plug on an IPO, but it was for a US listing and the withdrawal had nothing to do with red tape or misbehavior. According to one of the investors, CDIB Capital, the mother-and-baby products retailer wanted to stay cash flow positive and recognized this wouldn’t be possible given public market shareholders expect rapid online growth, even if it means high cash burn. CDIB and The Carlyle Group ended up selling to Warburg Pincus.

Other companies – some of which fall into the high cash burn category while others do not – continue to attack the US bourse with gusto. Between July 2016 and June 2017 there were three listings in the US by private equity-backed Chinese businesses. Over the following 13 months, the total came to 22, with aggregate proceeds of nearly $8 billion.

Contrast that with the domestic market. For the same two periods, the number of IPOs fell from 254 to 140, although a few very large listings meant there wasn’t much change in the amount of capital raised. Nine out of every 10 applicants for A-share listings – this is all companies, not just those with financial sponsors – won approval in the first quarter of 2017; the rate was down to just over four in 10 by the first quarter of 2018. The number of applicants in the pipeline fell from 511 at the end of 2017 to 388 as of March 2018.

Increased scrutiny is no bad thing if it is applied consistently and excludes candidates with poor internal controls, questionable accounts, uncertain sustainability of earnings, or suspect plans for their IPO proceeds. There is also evidence to suggest that suitably qualified companies are getting listed at a faster pace. Should this herald the eventual introduction of a registration mechanism for IPOs in place of the current approvals system, which is cumbersome and can lead to abuse of power, all the better.

Private equity investors would benefit from a clean and efficient market, but they may find their more immediate plans for expedited liquidity events go awry. While it is reasonable to suggest that trade sales will become increasingly prevalent, AVCJ Research’s records do not point to the emergence of this phenomenon.

Proceeds from trade sales reached an absurdly high $10.3 billion in the second quarter, but for that thank Ele.me and Mobike, PE-backed start-ups that were acquired by Alibaba Group and Meituan-Dianping, respectively. The number of transactions in the first half of 2018 came to just 33, roughly half the six-monthly average for the preceding two years. Questions are being asked about the health of China’s economy, irrespective of whether trade tensions intensify. Are buyers getting spooked?

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• Topics
• Greater China
• IPO
• Trade sale
• Exits
• China