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Archive for January, 2009

IPO Market in China — Down in 2008, But Not By As Much as in the USA

January 14th, 2009 No comments

song-vase

 

Looking for confirmation of how much more vibrant China’s IPO market — and therefore private equity market — is than the US? Well, the numbers are in. China’s IPO market has stumbled. America’s is in a coma.  

As reported in the Shanghai Daily, the number of IPOs in 2008 on China’s domestic stock exchanges fell, both in number and amount of capital raised. The totals were 76 IPOs, compared to 118 in 2007. The total capital raised was US$15 billion (RMB 103.4 billion) on the Shanghai and Shenzhen stock exchanges, down 77% from a year earlier.

While hardly a banner year for IPOs in China, the situation in the IPO market in the US was nothing short of cataclysmic. IPO activity was basically at a standstill, touching lows not seen for a generation. The last two quarters of the year, there wasn’t a single IPO by a venture capital or private equity-backed business. The IPO window in China may have closed somewhat. In the US, it seems welded shut.

What does this mean? Well, for one thing, it’s not a predictor of future activity. The US markets are highly cyclical. IPO activity ceased, in large part, because of more general weakness in the stock market, which was down over 33% in 2008. As the stock market begins to recover, so will IPO activity. Meantime, however, many venture capital and private equity firms in the US are going to suffer. Badly. 

In China, stock markets fell more steeply than in the US, but that didn’t entirely undermine the public appetite for new issues. There are a lot of cultural factors at work here. But, one fact that’s often overlooked is that most shares in China are owned by individuals. In the US, over two-thirds (by valuation) are owned by institutions. Individuals tend to have a higher appetite for risk than institutions, whose managers are constrained by fiduciary responsibilities and a competitive need to outperform their peers.

So, when it comes to the IPO market, China enjoys a structural advantage over the US, at this point in history. Equally important, China’s continued high economic growth of over 8% underpins corporate profit growth that is among the fastest in the world. 

Each $1 of profit in China can still be sold for $15 or more at IPO. That’s why China looks even more attractive, comparatively, than it did before for many of the world’s private equity firms. 

In the global competition for capital, China now ranks as a genuine superpower. 

Distressing Times — China’s Weak PE Firms Look to Sell Out

January 7th, 2009 No comments

Ming Dynasty Ivory Luohan

 

Look up. Those are vultures circling over China’s Private Equity market. The vultures, in this case, are distress investors, including AIG and GE Capital. They have quietly begun shopping for the investment portfolios of hard-up private equity and venture capital firms who spent the last three to five years investing in China. The price they are offering: as little as five to ten cents on the dollar. In other words, a PE fund that invested $100mn in Chinese private companies could liquidate those investments for as little as $10mn in cash.

Who would be crazy enough to sell at that price?

Good question. It’s hard to see why any PE or VC fund would want out at that sort of price. After all, their investors (aka LPs) are locked in for the long haul, about 7-10 years on average. This is the signal difference PE and VC firms enjoy compared to hedge funds, whose investors usually can redeem either quarterly or annually. A PE or VC fund has better balance of assets and liabilities: its illiquid investments are matched by liabilities to its investors that are similarly long-term. 

This means a PE or VC firm can ride out any market turbulence, even one as severe as what we’re experiencing now. China’s stock markets are off 60% over the last 12 months, and IPO activity (the usual exit route for PE and VC investments in China) has all but dried up.   

And yet, you can be sure there are PE and VC firms that will sell out in coming months to distress investors. Why? It’s not because these funds will be legally or contractually or even morally obliged to sell. It’s more a matter of confidence – or lack thereof. While LPs can’t withdraw their money, they can make life very tough for PE or VC partners whose investments are in deep trouble. 

Another reason, PE or VC partners don’t much like the prospect of nursing investments for many years, during a difficult period, with no strong likelihood of a successful exit. VC and PE partners like to say they’re long-term investors. But, the reality is, they like to get in and out within two to three years, collect their share of profits, use this success as a selling point to raise more money from which they can collect even higher management fees. And so the wheel spins. At least in good times. 

Well, the good times are over. 

I’ve run a VC firm through the last down-cycle following the crash of the internet bubble in 2000. It takes a different kind of mindset than that of many PE and VC investors, especially ones who had a relatively easy time during the boom years, when some very mediocre companies can achieve successful exits. 

China’s PE market today is quite reminiscent of Silicon Valley venture capital after the 2000 crash. A lot of Silicon Valley VC firms (generally those with the weakest ability to make winning investments) sold out to distress investors back then. A similar pattern is emerging in China – the weakest will perish.   

The good firms know how to keep the vultures at bay. They are the ones who know how to manage in lean times, and how to work harder, faster and smarter with their portfolio companies to improve operations and cash flow.