China PE firms bet on mergers in the consumer sector to drive growth

China-focused private equity firms are eyeing mergers and acquisitions (M&A) in consumer staples and overseas expansion opportunities as the country’s slowing economy and escalating geopolitical tensions with the west put pressure on exits, several industry sources told the Post.

Investors are seeking to diversify their risk portfolio and prioritising “predictable growth” at times of economic uncertainty, said Sam Sun, partner at Beijing-based Atlay Equity Partners.

“That is why buyouts and consolidations in sectors such as consumer staples and advanced manufacturing are becoming more attractive,” he said. “These sectors tend to have very sticky customers, very predictable financials, and good cash flow.”

Buy and build, a strategy whereby PE firms acquire one company that has developed expertise in a certain industry, and use that company to acquire another company, is common for consumer deals, said another yuan buyout fund manager, who asked not to be identified due to the sensitivity of the subject.

Chinese companies tend to be smaller in size and have weaker cashflows compared to their US counterparts. Therefore, consolidations in the form of mergers and buy and build could help these Chinese companies explore synergies and create value, making them more attractive in the eyes of potential buyers, the source explained.

“In the wake of the US-China decoupling, China is focusing on developing the economic potential of its huge internal market to power consumption,” said US private equity firm Bain & Co in its regional outlook. “The government aims to support key industry sectors, lower barriers for investors, and seek regional trade pacts. As it implements that strategy, consumer confidence and export-based industries are likely to recover.”

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The idea that China’s PE industry could be going through a transition period from being growth-investment and venture capital-driven, to one that could see more buyout players, was also echoed by Eric Xin, managing partner at Trustar Capital, at the Asia Venture Capital Journal (AVCJ) Private Equity & Venture Forum China this week.

“The localisation of companies that were traditionally supported by foreign capital, that are now struggling to adapt to the Chinese market … is one area where we see [buyout] opportunities,” he said.

However, M&A could also face challenges when the market is down, as buyers are now more cautious about how they spend their money, warned Jui Tan, managing partner at BlueRun Ventures China.

China’s IPO applications slumped by a third in the first half of 2023, when Chinese exchanges accepted about 330 new applications, down from more than 500 a year earlier, according to exchange data. The decline came despite the roll-out of a registration-based system intended to make the IPO system more market-driven.

M&A also saw a decline, albeit to a lesser extent. The world’s second largest economy recorded a total of 347 deals worth US$29.4 billion in the first quarter of 2023, an 8.2 per cent drop from the same period last year. Volume-wise, China’s domestic and inbound deals decreased by 36.7 per cent, according to data from S&P Global Market Intelligence.

This deceleration is also reflected in a growing trend of longer fundraising periods and a decrease in the average target size, research firm Preqin said in a report that showed the average fundraising time increased to 21 months in 2022 from 11 months in 2021.

“This phenomenon was influenced by various factors, such as difficulty in fundraising, unstable valuations, and uncertainties in decision making after first-round settlements,” the report said.

Meanwhile, US dollar-fund managers are reducing their allocation to China, as dollar-based PE funds with at least half of their capital invested in the country raised just US$1.4 billion in the first half of 2023, a staggering 89 per cent decline from the previous year, according to the Wall Street Journal, citing data from Preqin.

“A lot of dollar funds that used to focus on China are now looking to diversify their geographical focus,” said Sun. “They are looking more towards Southeast Asia, Europe, and Australia, and that is another way to reduce risk.”

David Chang, founding partner at Hong Kong-headquartered MindWorks Capital, said he is very bullish on Southeast Asia as a potential destination for Chinese start-ups looking to expand globally, as the region is geographically very close to China and has a sizeable population of close to 700 million people.

“We prefer industries that are supported by the central government, that are less exposed to policy risks,” he said. “With that in mind, we like to invest in fintech, manufacturing, and logistics start-ups that can help move Chinese goods around the globe and enable [cross-border] payments.”

“Funds that just invest into sensitive industries that are banned by American investors, like quantum computing, semiconductors, and AI, are probably going to face challenges, because there’s still a lot of uncertainty around the executive order and more importantly, the [US] presidential election next year, which could lead to policy changes.”