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Weekend Analysis


WILL PE STILL FLOURISH AS CHINA TURNS INWARD?

By Andrew Woodman
October 21, 2022
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With the end of China's 20th Communist Party Congress in Beijing, there are
signs that a more insular country is emerging—it's a worrying development for
private equity, an asset class that thrives on international cooperation.

Chinese leader Xi Jinping used the event to confirm his unprecedented third
term. He has used his power to expand state control of the economy and crack
down heavily on parts of the country's giant tech sector. He has also, it
appears, begun to turn his country inward, emphasizing economic self-reliance
and asserting China's national interests on the global stage.

At the same time, the influence and power of China's private sector has
declined. According to reports, significantly fewer executives from private
groups were invited to this month's congress compared to previous years.

These are unstable times for China. The unraveling of the country's real estate
sector has triggered a financial crisis years in the making. Meanwhile, a
zealous commitment to its zero-COVID policy, enforced by regional lockdowns and
travel bans, has been ruinous for the country's fortunes. This month, the
International Monetary Fund downgraded China's growth forecast for next year to
4.4%. There is no indication that China will loosen the policy.

During this turbulent time, there are signs that PE's love affair with China may
be waning. Both deals and fundraising activity have fallen from recent peaks—the
country that is the jewel in Asia's PE crown has lost some of its sparkle. China
will still play a big role in the future of private equity in the region but the
nature of that role, and the extent of state's involvement, may change.
 

> This article appeared as part of The Weekend Pitch newsletter. Subscribe to
> the newsletter here.


I first started writing about private equity a decade ago, when I lived in Hong
Kong, one of China's two Special Administrative Regions, the other being Macau.
At the time, Greater China arguably represented PE's greatest Asia opportunity
with Hong Kong as PE's international gateway to the nation's fast-growing
economy and over 1 billion customers.

That still holds true today, but the city has lost some of its original cache.
Like the rest of China, it has suffered the impacts of a punitive lockdown
regime and the fallout of a national security law introduced in 2020 that
curtails important Hong Kong freedoms. The result is that some investors are
looking elsewhere in the region, most notably Singapore.

Among those that remain in Hong Kong, many have expressed dismay at the
political climate on the mainland. Weijian Shan, the head of PAG Group and a
figure that looms large in Asia's PE community, has been a particularly vocal
critic. Earlier this year, he was quoted by the Financial Times, saying his firm
has to be extremely careful about its portfolio in the country.

This year has so far seen $53.5 billion transacted across 573 deals in the
Greater China region, which includes Hong Kong, Macau and Taiwan. At the current
pace, the year will fall short of the 726 deals, worth $88.6 billion, completed
in 2021.

Fundraising has also taken a hit with fewer, albeit larger, funds reaching a
close. So far this year, 16 funds in the region have raised $26.2 billion. The
biggest among them was Baring Private Equity Asia's $11 billion regional fund;
the firm was acquired this year by Sweden's EQT, which already has a presence in
Hong Kong. By comparison, 2019 saw 73 funds raise $68.6 billion.

For funds based in China, there is still around $121 billion in dry powder. But
not all of that capital is necessarily being put to work in China itself, since
many of these vehicles will have a pan-Asia focus. Some Asia managers are giving
mixed reports on how they will handle their China exposure. Bloomberg reported
in July that The Carlyle Group would cut its China exposure in its $8.5 billion
fund, but the firm also said last month it would be leaning into the country.

Others appear to remain bullish—Temasek-backed firm Vertex was recently reported
to be seeking $500 million for a new China-focused vehicle. The buyouts are
still happening too. CDH and PAG have been mulling offers for Chinese data
center company Vnet Group, a US-listed business.

Yet, while the PE market will endure in China, the state could have great
influence. One way this has already materialized is through the growth of
government guidance funds. These are public-private investment vehicles that
look to further government policy goals, while generating financial return. Such
funds now account for a significant chunk of private markets activity. According
to figures cited in The Economist that came from Chinese research firm Zero2IPO,
around 2,000 funds collectively raised nearly $1 trillion between 2015 and 2021.

For investors, the Chinese economy will always remain too big to ignore, but so
will its government. The Chinese private markets industry may continue to play
host to the world's investors, but just like this month's Communist Party
Congress, it will be the government that decides who gets invited.

Featured image by Jenna O'Malley/PitchBook News
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