Private Equity Investors Still Keen on China

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He will also set up a yuan-denominated fund in collaboration with Suzhou Ventures Group.

This easing in the regulatory environment is taking place alongside a concerted effort to develop domestic private equity firms. The move is pioneered by the Bohai Industrial Investment Fund (see "Tianjin: A PE breeding ground").

The Bohai Fund is joined by large SOEs, which have become major players through strategic investments in non-competing companies. Meanwhile, domestic financial institutions have lobbied the government to take things further.

Last September, China International Capital Corp and CITIC Securities became the first domestic brokerages to receive private equity licenses. China Life proposed in March that insurers be allowed to diversify into private equity.

Below the radar

Then there is a rising numbers of informal private equity funds set up by small groups of wealthy individuals.

"Close friends provide the money. They trust me so all I have to do is give them a call," was how one Shanghai-based deal-maker, who specializes in buying stakes in firms and guiding them to initial public offerings (IPOs), explained it to CHINA ECONOMIC REVIEW.

These "clubs" traditionally operate more like hedge funds, investing in listed securities, but there is a growing appetite for direct equity investment. Unlike the Western private equity model, these funds operate on a deal-by-deal basis and are not committed to investing a certain amount within a specified time frame.

"A lot of company owners in China have become cash-rich and so an industry has emerged to take care of these people with money," added Maurice Hoo, a partner in the Asia private equity group at law firm Paul Hastings.

The additional capital provided through the expansion of existing sources and the introduction of new ones has created a much more competitive—and more expensive—market for all concerned.

The aforementioned Shanghai-based deal-maker, who asked not to be named, recalled striking a deal with the founder of a silicon company under which he agreed to list the firm at six times its book value. The founder phoned back a day later to say that another private equity firm had come calling and offered to secure a valuation of 12 times book value.

"It was a blue sea and now it's a red sea," the deal-maker reflected. "Three years ago nobody did this kind of thing but now everyone wants to get involved."

Shelly Singhal, CEO of Crestpac, an Asia-focused alternative investment group which currently has 40% of its private equity pool invested in China, has also noticed the growing pressure, particularly in major cities.

"Companies used to have two or three private equity firms come talk to them," Singhal said. "Now it's more like 30."

Challenging times

Talk of tougher deal-making conditions appears to be borne out by the numbers. According to the Asian Venture Capital Journal (AVCJ), new funds raised for investment in China came to US$10.55 billion last year, up 93.6% on 2006. The average growth for Asia as a whole was 23.4%. However, new investments rose by just 3% to US$10.62 billion compared to 33.3% region-wide.

"Most of the PE firms raised a lot of money in 2006 but they did not invest much last year," said Andy Xie, an independent economist who also participates in small-scale PE investments through his offshore firm Rosetta Stone Capital.

It could be argued that the competitive environment is exacerbated by the limited scope of deals on offer.

A total of US$84.32 billion in private equity money exchanged hands in Asia last year, the AVCJ claims. Buyouts accounted for US$39.84 billion, or 47.3% of this. Growth capital and private investment in public equity each took about 20% with 3.2% for pre-IPO investment.

In China the balance is very different. Buyouts made up just US$802.8 million, or 7.1% of the total pot. The lion's share of the market was taken by growth capital and pre-IPO investment, on 41.1% and 20.5% respectively.