China Private Equity Market Report: Relatively active trading volume and abundant "dry powder".

Recently, Bain & Company released a report on China's private equity market, and the company's partners explained the current situation of various primary markets at the report conference.

After reaching a high point in 2021, China's private equity market will basically decline sharply in 2022 and 23 in terms of deal size, number of financing, and exit scale. But this is not a problem for China alone, and the global private equity market is the same, so the whole market is still in the process of adjustment. In terms of deal structure and exit form, the primary market is very challenging.

"Of course, there are still some bright spots in these dark spots, for example, in the whole process of China's adjustment, there is a very significant feature, the direction of the US dollar fund and the RMB fund are different. RMB funds are very strong from the perspective of financing and investment, and compared with RMB fund financing and investment in 23 and 22, there has been a slight increase, including the first quarter of 2024, if you look at the trend, in fact, the same. Therefore, on the whole, due to the promotion of the national fund, the RMB fund has been stabilizing. Zhou Hao said.

On the other hand, US dollar funds will present a situation of "ice and fire" in 2023. In the first half of the year, the US dollar fund was very cautious from the investment point of view, and in the second half of the year, from the third and fourth quarters, after October, it was found that the market transactions were becoming more and more active, including large-scale transactions at the beginning of this year.

For the prospect of the private equity market, Zhou Hao believes that investment activity is picking up, but there will be no "V-shaped" reversal in which everyone is in it, but in the next two to three years, showing a relatively flat development.

The reason for this is that there is no shortage of funds in the market this year, and Bain & Company's research found that the stock of "dry powder" (the amount of money raised but not invested) in the market is large, and it has increased compared with '23 and '22. Some of the newly raised RMB funds have not yet been invested, and US dollar funds are increasingly inclined to or focus on investing in large-scale mergers and acquisitions in the later stage, but there are not many such targets for sale in the market.

Zhou Hao also pointed out in the meeting that it was found that the PE multiple of the transaction had declined. There has been a 20% drop in the last two years. Although the transaction multiple has fallen, buyers and sellers are still expected to need some time to run in in terms of valuation, which also causes the transaction completion time to be extended, and the number of transactions is also slowly climbing.

According to Bain & Company's statistics, more than 60% of all private equity fund transactions have not been exited in the past 16 years. From this point of view, the next two to three years, especially for US dollar funds, will be very challenging.

Finally, Zhou Hao gave two suggestions to private equity investors and GPs: First, what many clients have done in the past two years is strategic sorting and fund transformation. Every fund should think clearly about how to find investment opportunities in the future in the context of changes in the entire investment environment and investment logic, including the macro environment. In the future, the logic that China may generally rely on the rapid growth of the market is no longer valid, and whether it is ready to do more RMB funds in the future, or focus more on certain specific tracks, or focus on certain specific investment themes, all require careful thinking and polishing of each fund.

Second, 60% of the invested companies have not yet exited, how to maximize the value of these companies, help them exit as soon as possible, or how to help the invested companies improve their performance through means before exiting, which is the most important question in the hands of every GP. Big GPs have about 3 to 5 portfolio companies that need to exit, and the rhythm of exit is actually very important, including where and how to exit, whether to IPO or sell to other funds, these are all issues that need to be considered holistically.

"We feel that there is one more thing that GPs need to do: don't "wait for the rabbit", but "take the initiative". History tells us that finding exclusive trading opportunities can create the most value, don't sit back and wait for the opportunity to come out and several companies bid together, but use your existing resources and capabilities to find exclusive trading opportunities. This is the key issue to be covered after the fund has solved the exit problem. Zhou Hao said.

Judging from the active trading of investments, 2023 will fall to a ten-year low, and compared with the high point in 2021, it will fall in 2022 and 2023.

There are several reasons for this: First, it is true that macroeconomic growth has slowed down to a certain extent, which is fundamental. Second, the overall IPO exit is relatively slow, so the exit dilemma still exists. Many investors will also consider this factor in the investment process.

In addition, as mentioned above, the amount of "dry powder" to be invested is rising, and everyone wants to have higher efficiency, so they tend to look for larger projects. But the number of these projects is not so large, so this has led to a decline in the overall investment activity. Coupled with the transaction multiple, although it has declined to a certain extent, the differences between the two sides still exist, and we have also seen that there is still a certain gap between the expectations of many buyers and sellers, and there is no way to facilitate this transaction. Therefore, combined with these factors, investment activity is relatively low in 2023.

However, from a longer-term perspective, 2023 is in a relatively active range compared to 2005 to 2013. So it's a low point compared to the last decade, but trading is still active.

Looking at the composition of the deal, there are also several types: growth investment still accounts for the largest share, which is basically similar to the situation in the past few years, and still has a share of almost 60% in 23 years. Public market investment has increased, while start-up investment has remained high, which is the overall picture.

In terms of specific industries, compared with the investment in the past five years (2017-2022), e-commerce, technology, and online services have shrunk, but semiconductors, biomedicine, and automobile travel have continued to increase, and they account for a relatively large amount of transactions. Because many RMB funds are industry-guided, they look more at semiconductors and automobile travel, while US dollar funds will relatively look at more traditional medicine and so on, which is the difference between them.

Let's look at the types of players invested: compared to 18 to 22 and 23 years, we see that the global GP is relatively reduced, not as active as before. However, domestic GPs and government agencies are more active than before. At the same time, in the US dollar fund, the global GP pan-Asia-Pacific GP decreased, and Middle Eastern investors became more active to a certain extent. Therefore, it is mainly RMB funds and Middle Eastern investors that will continue to be active in 2023, and they will be more active than before.

At the meeting, several partners answered some important questions, which are sorted out by Titanium Media venture capitalists.

Q: Which industries will be more active in 2023?

A: The proportion of semiconductors, automobile travel, and biomedicine has indeed continued to increase, and the main reason is that RMB funds and industrial funds have promoted more such industries, and these industries continue to be active and will remain like this in the short term.

Q: Fundraising in 2023 will continue to be at a low point, but RMB fundraising will be relatively active, with many RMB, including industrial funds, raising relatively large amounts, and relatively few US dollar funds. Please tell us about the direction of fundraising in the market and policy trends.

A: At present, many leading US dollar funds have begun to consider RMB business, including registered onshore entities, in order to prepare for further long-term development in China. As for the direction of investment or fundraising in the US dollar and RMB, it must be very different. The majority of the sources of RMB fundraising are the government, as well as insurance funds, high-net-worth individuals and financial institutions, which are relatively large. U.S. dollar funds are a relatively stable source of fundraising, and there are basically many pension funds, including sovereign funds. The difference between the two is that the source of RMB fundraising will change a little more every year, but the US dollar is relatively stable.

We still see that US dollar funds are more actively trying the RMB, which opens up a different path for them in the future, on the one hand, they can get different sources of funds, and on the other hand, they can also invest in some industries that they could not invest in through US dollar funds before, which will generate more investment transactions.

Q: What are the new opportunities and transaction opportunities for PE/VC cross-border going overseas, what are the opportunities that are optimistic, and what are the lessons learned?

A: In recent years, everyone has been paying attention to going overseas, and in terms of statistics, this involves transactions that occur overseas, and there is no statistics on this part of the data in the China private equity report. From a directional point of view, transactions and mergers and acquisitions in North America, Latin America or Oceania are on the rise, and the industries are advanced manufacturing and the Internet. Among them, there are several enterprises going overseas, such as trade going to sea, supply chain going overseas, etc., these are the themes of investment, and the overall supply chain may be placed overseas. Chinese companies have been successful in China in the past, and they have been copied overseas, such as live streaming-related industries in North America, and everyone will continue to pay attention. In terms of the industry, everyone will pay attention to the advanced manufacturing or consumer electronics, photovoltaics, Internet, etc. just mentioned.

Q: More and more M&A cases have appeared this year, but some investors believe that M&A is not an easy thing, especially for early- or mid-stage projects that are not easy to price, is there any solution in the later stage?

A: This is the same as asset trading between funds, and the main reason for the price is that the price is relatively expensive when buying, of course, he does not want to exit the transaction too low when he withdraws. At the same time, from the perspective of enterprises, in such a market environment, they do not want to pay too high a premium. This problem will still exist in the short term, and we have slowly seen that from 22 or 23 onwards, the valuation of the whole transaction has returned to rationality, and if it is pushed back for another three years or so, the transaction after that period will become easier, and both the seller and the buyer can reach a better agreement on the price.

Second, from the perspective of the fund, if I buy a company and want to sell it to another company, I must pay attention to post-investment management and value creation in the process of buying, and I must make the company more valuable before I can sell it to the next company at a higher premium. Generally speaking, we have the same advice for fund customers, how to help the invested company reduce costs and increase efficiency, we should spend more time and energy on post-investment management, rather than buying it and letting it do it by itself, so we should intervene more in post-investment management, and after managing the company better, if the company is sold to other companies for M&A transactions in the future, this value will be better reflected.

Q: I mentioned earlier that China has a lot of money that has not been invested, what is the reason?

A: Although the overall fundraising in 2023 is low, the RMB fund still raised a lot of money. Last year, there was a significant decrease in investment transactions, which simply means that the money was not spent, so the amount of investment to be invested continued to rise. In the loop, the more money you want to invest, the more you want to invest a large amount, but the more you want to invest a large amount, the greater the difference between the two sides, and the number of targets is limited. There is also a possibility that because of valuation reasons, everyone has not invested, so there are more and more amounts to be invested in and out. We think this is likely to continue to be the case in the future, but with active trading volumes, such as a few large transactions in the first quarter of this year, it will gradually move to a healthier level.

Q: Why does everyone want to invest a large amount now?

A: The amount to be invested is large, if the workload is not so big and a large order is not so big, so it is best to hope to be able to invest a large order at one time, otherwise it will not solve the problem of high amount of investment. On the other hand, the threshold for larger transactions is also raised. I hope it has a very stable cash flow, has a certain amount of dividends, has a certain growth, and does not need to grow so fast. These are two factors contributing to the increase in large transactions. (This article was first published in Titanium Media Venture Capitalist, Author|Zhang Yinan, Editor|Tao Tianyu)