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  • Private Equity Insights, September 2013

    Asia Private Equity Institute (APEI), SMU


    Asia Private Equity Institute (APEI) Private Equity Insights Q3 2013


    • An Introduction to the APEI • The Private Equity Deal Landscape in China by Lily Fang and Melvyn Teo • Update on the Institute’s Activities

    An Introduction to the APEI The vision of the Asia Private Equity Institute is to be the premier research and knowledge hub for private equity and venture capital activities in the Asia Pacific region. According to Preqin, “Asia PE funds raised $62 billion in 2011, double the $31 billion raised in 2010. This 100% growth rate was approximately twice that of the global PE fund raising market, and Asia funds have now taken over Europe as the 2nd largest fund-raising market after North America.” Despite the surge in interest for private equity in Asia, most academic and practitioner research on private equity remains focused on US and Europe. As the first Asia- focused academic research centre on private equity and venture capital, APEI seeks to fill this knowledge gap. To do so, APEI will be an integrated platform that (i) conducts high quality academic and applied research on private equity and venture capital (ii) educates practitioners and disseminates new ideas and methods, thereby raising the standards and level of professionalism in the industry (iii) elevates the profile of the private equity and venture capital industry in Singapore and Asia. Some of the activities of the institute include a quarterly private equity insights newsletter that parlays academic findings into key lessons for general partners and limited partners, a closed door quarterly investment roundtable which facilitates an exchange of investment ideas between key industry players in an intimate setting, and an annual private equity conference where academics, general partners, limited partners, and industry experts discuss and debate topical issues that resonate with the industry.

  • Private Equity Insights, September 2013

    Asia Private Equity Institute (APEI), SMU


    The Private Equity Deal Landscape in China Lily Fang and Melvyn Teo1 Executive summary We explore the private equity landscape in China using a large transactions database with 17,585 transactions and US$367.50bn total capital flows. Private equity activities increased rapidly in the last two decades, from virtually non-existent in 1991 to a peak of US$92.59bn in 2011. Initially, entry transactions are driven by growth capital, although in the more recent years, we see a surge in venture, pipe, and buyout activity. Exits have concentrated in 2006, 2010, and 2011. General partners tend to invest in companies in finance, machinery, services, mining, food, and real estate. The average investment multiple for deals in China is an impressive 5.58 but the performance distribution is highly skewed. On one hand, 66.23 percent of the deals are either write-offs or have yet to deliver distributions to their investors. On the other hand, 21.38 percent of targets acquired deliver multiples in excess of three times initial capital. Moreover, the average deal multiple when weighted by initial investment falls to 1.39 suggesting that the larger deals substantially underperform the smaller ones. Significant variation in performance exists between industries, with machinery and finance outpacing mining and real estate for the average dollar invested. Finally, the duration of Chinese private equity investments has changed over time. The mean time to exit for deals initiated between 2001 and 2005 is less than two-third that for deals initiated prior to 2001. However, the investment cycle appears to be lengthening again after 2005, which is indicative of a more difficult exit environment. Introduction In recent years, China has been one of the hottest destinations for private equity funds. According to Washington-based EMPEA (Emerging Market Private Equity Association), for example, China accounted for 45% of all private equity fund raising for emerging markets in 2011. China’s rise in the global private equity scene is perhaps inevitable, given the country’s rapid economic development, vast population, burgeoning middle class, and steady transformation from an investment and export driven economy to one that is driven more by internal demand and consumption. Against this macro- economic backdrop, private equity investing in China has focused more on growth than on harvesting efficiency gains or unlocking shareholder value, as is often the case in mature markets like the U.S. or Europe. The data presented in this newsletter bears out the growth-centered theme of Chinese private equity investments. However, in recent years, deal sizes have become bigger and more buyout type deals have taken place. Another critical factor behind the rise of China’s private equity industry—one that is perhaps less obvious or discussed—is the incomplete and underdeveloped nature of China’s capital markets. In China, banks (most of which are state-owned) are still the biggest allocators of capital, and capital is allocated overwhelming to the state-owned sector. While the private sector now generates over 60% of the country’s GDP and over 70% of total employment, it still gets only about 20-30% of the credit from banks. There is a vast funding gap working against China’s small and medium private sector firms, which are the key drivers of China’s

    1 Lily Fang is Associate Professor of Finance at INSEAD. E-mail: Phone: +65-6799-5376

  • Private Equity Insights, September 2013

    Asia Private Equity Institute (APEI), SMU


    economic growth. By providing capital to these enterprises, and in many cases, by providing expertise as well, private equity has played a significant role in capital allocation and wealth creation in China. Anecdotally, virtually every private sector “success story” from China that one can think of—Haier, Alibaba, Focus Media, etc.—all have benefitted from private equity backing. In the long run, private equity in China can do extremely well by filling in the gaps in China’s capital markets. However, these long-term factors underpinning the growth of China’s private equity market are, in the short-term, challenged by a number of adverse conditions. One of the key challenges for China’s private equity industry is that it has been easier to raise and invest money than to exit and realize returns. This is a point that is clearly borne out by our data. In our dataset, we observe 11,724 private equity transactions2 made over the past two decades. Overall, the total dollar amount of investments is 168.93 billion in our sample, which spans 1991 to 2012. The total dollar amount of exits is 198.57 billion. Thus the industry has, on aggregate, just about returned all the capital to LPs. This overall statistic however masks a huge amount of heterogeneity in performance. In particular, over 60% of the investments are either capital losses or unexited. At the same time there is a long (and thin) right tail in the performance distribution. Out of the total sample of deals initiated before 2010, 23.54% of them have multiples between 3 and 100. The extreme heterogeneity in deal performance presents a significant challenge to an “average” LP who might be grappling with capital allocation and manager selection decisions regarding China private equity. The challenging exit environment may not have any quick fixes. It is driven by a confluence of factors: the continued uncertainty in the global economic outlook, the IPO ban in China since Oct 2012, and the relatively small M&A market. Thus in some sense there is a lot of money “stuck” in the private equity ecosystem. Ultimately, exit conditions will only improve if the domestic A share market recovers, foreign investors increase their appetite for Chinese listings, or the M&A market for Chinese firms grows. Thus it can be said that the overall performance of China’s private equity has been lackluster, especially in contrast to the rapid GDP growth over the last decade. Raising funds have been relatively easy while exiting from deals have been relatively difficult. This has resulted in the huge asymmetry in deal performance with a large mass density at capital loss and a small right tail. Ultimately, this suggests that one of the key bottlenecks in China’s private equity is also a lack of human capital: talented, experienced private equity managers with the right skills. When investors are enticed by China’s growth prospects, capital flowed into China’s private equity funds. Without sufficient talent and investment expertise, the “money-chasing-deals”3 dynamic played out on a market-wide scale, hurting aggregate performance. In the last two years, private equity activity in China has cooled relative to its 2011 peak. In the long run, we think that a slower, more moderate pace of fund raising and investing could be the start of a healthier cycle for the industry. A slower pace of growth will allow human capital, market infrastructure, and capital markets time to develop and catch up. Data and Analysis The data used in our analysis comes from the VC/PE database compiled by ChinaScopeFinancial. The VC/PE database covers more than 3,000 LPs, more than 5,000 GPs, and 6,000 funds. After data cleaning, such as removing funds for which we have no investment information, we are left with 2,140 funds and 11,724 deals in our sample, from 1991 to 2012. For many of our deals, we have cash flow information,

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