PE activity buoyed by more realistic valuations

The gap between the valuation that sellers are demanding and buyers are willing to pay is narrowing in the wake of China market turmoil.
PE activity buoyed by more realistic valuations

Entrepreneurs in China and across Asia have restarted negotiations to sell stakes in their firms to private-equity buyers on the back of stock market falls, observed Daniel Yeh of Ropes & Gray.

The private equity partner noted that during the seven months to June 12 this year, when the Shanghai Composite more than doubled to 5,166 points, potential sellers had abandoned such talks.

However, after a slump that saw the Shanghai index fall to a low of 2,927 points on August 26 and China’s IPO market being shut down, Yeh said sellers had grown more interested in pursuing buyers. The State Council, China’s cabinet, ordered an indefinite suspension of new listings in early July.

Yeh added this was a trend that was playing out across Asia generally, although in “less dramatic fashion”. Stock markets outside China had not generated the same kind of pipelines for IPOs. But market volatility saw many of those that had planned to list shelve their plans.

Listings planned for KKR-backed Weststar Aviation and Sime Darby’s automotive business in Malaysia were both put on hold, as was an IPO for Carlyle-backed PT Solusi Tunas Pratama, a planned Reit by Manulife in Singapore and an ASX listing for insurance distributor Greenstone.

Successful fundraisings last year meant the private equity industry was now much more cashed up, noted David Brown, China and Hong Kong transaction services leader for PwC.

He suggested that meant PE activity would continue this year, even given a marked slowdown in the fundraising environment. The amount of capital that PE firms have raised globally, but not yet deployed, exceeds $1.3 trillion, by Preqin data.

However, one potential dampener to PE firms putting capital to work in China is uncertainty about the viability of variable-interest entity (VIE) structures, said Brown.

These structures get around rules barring foreigners from owning Chinese companies that operate in certain sectors, such as the internet. Rather than owning a Chinese operating company directly, investors own shares in an offshore company that has VIE contracts, allowing it to receive income generated from operations in China.

But Brown said he had seen acquirers avoiding deals that required anti-trust approval, since China’s commerce ministry “doesn’t want to go near anything that has got a VIE structure in case they’re seen as giving a blessing to VIEs”.

Brown noted: “Would it [a VIE structure] actually hold [as legal] if it was tested in a Chinese court? A lot of people think perhaps it would not.”

There is a market expectation that Chinese authorities will provide greater clarity on VIE rules this year, although the range of dates for that is wide. According to a draft of the new foreign investment law released for consultation this January, VIE structures are due to be regulated for the first time.

However, few observers expect more than an indication of how VIE structures will be treated this year. But Yeh pointed out that uncertainty over VIE rules had not seemed to slow down deals just yet.

Brown was less certain, pointing out that company owners felt it was risky to keep listing overseas since they know something is going to happen around VIE structures.

Yeh agreed there was a less robust pipeline for take-private deals – where companies delist following a buyout often backed by PE firms.

He said there was optimism that deals where the company’s founder was part of a buyout consortium – and retained operational control but not necessarily majority ownership – would not be affected by VIE rule clarifications.

Both Yeh and Brown agreed that China outbound would be a focus for domestic Chinese PE firms and companies. “Outbound PE, I think, will pick up again,” said Brown, noting it had flagged in a buoyant stock market.

Yeh also anticipated more cross-border deals as PE buyers seek greater portfolio diversification. He pointed to firms in the West Coast of America as targets and developed markets more broadly operating across a range of relatively defensive sectors, such as health care and media.

Yeh joined Ropes & Gray’s Hong Kong office this week from Weil, Gotshal & Manges. That firm’s PE practice leader, Peter Feist, relocated to New York a few weeks ago. A new PE partner was hired earlier this year, as reported.

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