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Seeking a silver lining as deals ebb
By Jon Parker |
September 17, 2012, Monday
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Print Edition
Print Edition
IT'S been a difficult year for mergers and acquisitions so far in China, but a rebound may be around the corner.
China-focused private equity funds, which raised US$17.7 billion in the first six months of 2012, have not been able to raise the same amount of funds as in the past. The half-year total is 10 percent lower than the same period a year go and 23 percent down from the second half of 2011, based on information provided by AVCJ.
This drop includes domestic China private equity funds. They are finding it more difficult in the current environment, given the lack of significant returns in the domestic IPO market and the emergence of other investment platforms, including the use of trusts as a form of high-yield loans to real estate developers.
Falling steadily
Private-equity-backed initial public offerings in Shanghai, Shenzhen and Hong Kong have steadily fallen, from 164 in 2010 to 147 in 2011 and to 57 in the first half of this year. Hong Kong has been the hardest hit, with only four private-equity-backed IPOs in the first half of 2012, compared with 25 in 2011 and 34 in 2010. Shanghai has fared only marginally better, with that category of IPOs totaling six in the first half of 2012, versus 17 in 2011.
Of even more concern is that investors are not seeing steady returns, on average, from these IPOs one or more years after their initial offering. Although a number of industry sectors managed positive returns from their 2009 IPOs after one year of going public, every industry sector, apart from basic materials and technology, had across-the-board decreases, on average, in 2010 and 2011 IPOs, one year after their offer date.
The current prices of these 2009-2011 Hong Kong, Shanghai and Shenzhen IPOs are down between 20 percent and 50 percent on average for every industry sector.
Average returns have consistently fallen each year from 2009, causing pre-IPO investors to consider whether expected returns after lock-up periods were really a sure thing anymore.
For example, prices in the first seven days of trading increased more than 60 percent on average for 2009 IPOs backed by private equity in the sectors of communications and consumer products, and they held at more than 40 percent after three months of trading.
However, price increases for comparable IPOs in 2010 rose only between 25 percent and 40 percent in the first week of trading and were up between 17 percent and 31 percent in the first three months.
This comparison gets even worse when looking at 2011 vintage private-equity-backed IPOs. Average prices for communications and consumer products IPOs rose only 4 percent to 15 percent after the first seven days of trading, holding at 6 percent to 8 percent in the three months after the initial offering date.
Other opportunities
However, with the slumping IPOs and market volatility come the other opportunities.
Private equity funds have been finding ways to both invest in companies and create exit positions. From an investments standpoint, privatization has become increasingly popular for the management of China-based, US-listed companies to take advantage of low share prices.
Private equity funds have looked to back management where they see strong underlying metrics and future growth potential. There are a number of benefits to this type of investment.
For example, the stringent rules of reporting on an exchange typically mean that a company should have at least a base level of reporting - both management and financial reporting - because they face stricter reporting requirements when compared with private companies.
Therefore, as long as a valuation is acceptable, having stronger reporting already in place can decrease the amount of time private equity funds need to implement certain strategies for change once a company is taken private.
Downward valuation
In addition, investment opportunities have been on the rise recently as slower China growth and continued economic uncertainty in Europe and the US have resulted in downward valuation pressure for certain Chinese businesses, helping to narrow the differences between valuations of sellers and investors.
From an exits standpoint, private equity funds have increasingly found alternatives to IPOs for the time being. They include sales to strategic buyers and sales to other private equity funds or institutional investors.
Certain of the more successful exists recently have actually been partial exists in which a private equity fund disposes of a portion of the business and continues to improve the remaining portion that is held for future sale.
It's undoubted that this downward cycle will not last forever, but when global markets will show sustainable growth is still unclear. Meanwhile, China still has a lot of upside for private equity investors as valuations realign and markets continue to consolidate.
China-focused private equity funds, which raised US$17.7 billion in the first six months of 2012, have not been able to raise the same amount of funds as in the past. The half-year total is 10 percent lower than the same period a year go and 23 percent down from the second half of 2011, based on information provided by AVCJ.
This drop includes domestic China private equity funds. They are finding it more difficult in the current environment, given the lack of significant returns in the domestic IPO market and the emergence of other investment platforms, including the use of trusts as a form of high-yield loans to real estate developers.
Falling steadily
Private-equity-backed initial public offerings in Shanghai, Shenzhen and Hong Kong have steadily fallen, from 164 in 2010 to 147 in 2011 and to 57 in the first half of this year. Hong Kong has been the hardest hit, with only four private-equity-backed IPOs in the first half of 2012, compared with 25 in 2011 and 34 in 2010. Shanghai has fared only marginally better, with that category of IPOs totaling six in the first half of 2012, versus 17 in 2011.
Of even more concern is that investors are not seeing steady returns, on average, from these IPOs one or more years after their initial offering. Although a number of industry sectors managed positive returns from their 2009 IPOs after one year of going public, every industry sector, apart from basic materials and technology, had across-the-board decreases, on average, in 2010 and 2011 IPOs, one year after their offer date.
The current prices of these 2009-2011 Hong Kong, Shanghai and Shenzhen IPOs are down between 20 percent and 50 percent on average for every industry sector.
Average returns have consistently fallen each year from 2009, causing pre-IPO investors to consider whether expected returns after lock-up periods were really a sure thing anymore.
For example, prices in the first seven days of trading increased more than 60 percent on average for 2009 IPOs backed by private equity in the sectors of communications and consumer products, and they held at more than 40 percent after three months of trading.
However, price increases for comparable IPOs in 2010 rose only between 25 percent and 40 percent in the first week of trading and were up between 17 percent and 31 percent in the first three months.
This comparison gets even worse when looking at 2011 vintage private-equity-backed IPOs. Average prices for communications and consumer products IPOs rose only 4 percent to 15 percent after the first seven days of trading, holding at 6 percent to 8 percent in the three months after the initial offering date.
Other opportunities
However, with the slumping IPOs and market volatility come the other opportunities.
Private equity funds have been finding ways to both invest in companies and create exit positions. From an investments standpoint, privatization has become increasingly popular for the management of China-based, US-listed companies to take advantage of low share prices.
Private equity funds have looked to back management where they see strong underlying metrics and future growth potential. There are a number of benefits to this type of investment.
For example, the stringent rules of reporting on an exchange typically mean that a company should have at least a base level of reporting - both management and financial reporting - because they face stricter reporting requirements when compared with private companies.
Therefore, as long as a valuation is acceptable, having stronger reporting already in place can decrease the amount of time private equity funds need to implement certain strategies for change once a company is taken private.
Downward valuation
In addition, investment opportunities have been on the rise recently as slower China growth and continued economic uncertainty in Europe and the US have resulted in downward valuation pressure for certain Chinese businesses, helping to narrow the differences between valuations of sellers and investors.
From an exits standpoint, private equity funds have increasingly found alternatives to IPOs for the time being. They include sales to strategic buyers and sales to other private equity funds or institutional investors.
Certain of the more successful exists recently have actually been partial exists in which a private equity fund disposes of a portion of the business and continues to improve the remaining portion that is held for future sale.
It's undoubted that this downward cycle will not last forever, but when global markets will show sustainable growth is still unclear. Meanwhile, China still has a lot of upside for private equity investors as valuations realign and markets continue to consolidate.
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