In striving to compete for your investment dollars, private equity funds seek to differentiate themselves from their competitors. Thus, it is hypothesized, LPs will be more readily able to choose this or that firm over another. Having an investment strategy in PE thus achieves two purposes: the first, to differentiate your fund from others in hopes of achieving higher fundraising targets and second, to effectively aid in the process of screening investments, as being a generalist fund possibly drains resources away from your focus.
We have also seen PE firms morph into ‘alternative asset managers ,’ a la Blackstone and Carlyle may prove to become a trend. After all, diversification is an investor’s friend. This almost is the antithesis of the ‘specialization = differentiation’ thesis other firms are pursuing and in fact becomes a diversification = differentiation’ play, looking at it one way. While I cannot exactly place myself in Rubenstein’s or Swartzman’s shoes and try to re-create a corporate strategy discussion, I do imagine that the diversification play dovetails with every asset manager’s aspirations of differentiation to secure investment.
But what about PE shops in China? What are they doing these days with regards to differentiation?
There are a few trends going on, but will briefly summarize them below for those who are interested:
• Controlled buyouts are SLOWLY gaining traction, so some firms are moving their focus in that direction. While right now 80-90% of private equity deals in China are minority investment, the buyout climate is becoming more and more ripe. Family-owned companies are seeing the benefits of partnering with buyout firms and financing is becoming smoother for such processes. However, the government still has the right to quash a buyout attempt in sensitive industries.
• Princeling funds are losing their luster. There was a time 5-10 years ago, where if you were the son or relative of a Politburo Standing Committee member, it was pretty much a sure thing you were going to source some good looking deals. Over the past few years though, this has shifted. In 2011, for instance, Wen Jiabao’s son, Winston, left New Horizon Capital for a job at a state-owned enterprise within a year of the firm closing a $700 MM+ fundraise. LPs are becoming more wary about investing in funds with one central player and are opting for looking for funds with a deep bench.
• Affiliate funds are becoming more attractive to LPs – by this I mean those funds that are associated with a larger body, such as a bank, insurance firm, or multi-national corporation. This move to differentiate from pure play private equity funds has proved attractive to those LPs who are looking to invest in China but want to de-risk slightly.
But what is the trend that may be around the corner?
It’s this monkey’s humble opinion that what may be next for private equity firms in China is diversification into asset management, but only in selected fields. For example, a firm that does minority investments and buyouts (most firms will say they will operate in this way) that also does cargo ship leasing. Or infrastructure advisory work. Or medical device registration. Or what have you.
This could be a way for independent funds (not affiliates or princelings) to continue to differentiate in the market, especially if they are not a big name bad boy. PE in China is already wildly operationally-focused, so it could follow that the firms decide to pursue an approach that differentiates themselves from other funds and also adds to their bottom line, through a stream of auxiliary revenue services that also dovetails with their area of investment expertise.
Further, for PE firms to get involved in China’s ‘shadow banking’ industry, which basically includes all ‘off country book’ financing activity, could prove to be profitable, as it’s been estimated at over 50% of the country’s GDP. After all, PE is a game based on asymmetric information…
Just a theory for now… but would love some critiques/questions from the other monkeys out there to flesh this one out a bit. Whatcha got for me?
"for PE firms to get involved in China’s ‘shadow banking’ industry, which basically includes all ‘off country book’ financing activity, could prove to be profitable" Have you seen any Chinese PE firms getting into the shadow banking space? How do they structure their deals?
Lots of the more... flexible.. PE firms got involved in the shadow banking space in 2011-2012 - not a lot of decent deal flow, and lending to property developers at 20-30% made a lot of sense. It has died down a little, but there are a bunch of funds that still do something similar. I have also seen a number of firms, DAC is one that comes to mind, that buy up defaulted loan portfolios and try to recover.
I don't know about the end of the princelings though - Boyu seems to be doing pretty well, and it looks like big money is still happy to make that bet. I thought the whole New Horizon issue was more politics involving his father than anything else. I'd be interested to hear if you are seeing other princeling funds struggling. To be honest, from where I am standing, it looks like the funds who are still willing to put their money into play are the ones who are winning, a lot of people just sitting on their hands at the moment.
BSR, I was hoping to see a post from you here :)
From a discussion I've had with someone who formerly was with KKR, a sizable investment of theirs in China is Far East Horizon, which invests in real estate leasing and financing SMEs. After doing a quick search, it appears that FEH has had a CAGR of over 50% for the last three years. (Asia VC Journal) Not all of their investment work is shall we say 'by the book,' but KKR can still get a piece of the shadow banking action by being one step removed. It offers an attractive risk/return profile after all.
According to the same source as above, TPG backs one of Far East's competitors, UniTrust. UniTrust leases equipment to SMEs for construction.
In both cases, these leasing operations really open the door for more bespoke financial services under the guise of 'leasing.' It's definitely a niche market, but perhaps something larger firms are going to become more interested in as the overall growth of China tempers a bit.
As far as how they structure their deals, it looks like the PE firms take a minority stake in these leasing companies and allow them to continue business as usual, in essence underwriting the risk of leasing. The leasing industry in general is more opaque and regulations are far more relaxed than other financial services industries, thus it is commonly included in the shadow banking discussion. At the risk of having this turn into a discussion about what defines shadow banking, let's just leave it at 'PE firms are intrigued by leasing opportunities because there is perhaps less oversight in the space and therefore an opportunity to reap greater rewards.'
Thoughts?
lunar capital has been doing really well, buyout firm and near the top if not at the top of the cambridge associates surveys. i met their team recently and it seems like they really have it together. extremely operations focused and they're about to raise their fourth fund.
Yep, Lunar has been a really successful firm in the consumer space. They seem to 'stick to their knitting' by targeting companies that focus on the growth of the middle class. In fact, their most recent monthly report was titled 'Burgeoning Bourgeois,' if I remember correctly...
Highhater, are you familiar with them in particular?
Sounds like they're doing gods work, by you know, creating value, not outsourcing it and plundering it like most buy out firms do here
interviewed with them recently. not sure if its what i really want to do but if i get an offer id seriously consider. theyre a really young team and seemed like there was a lot of energy there
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