By Yunfei Gao, Research Analyst at King’s Private Equity Club
- Published as part of our ‘Deep Dive’ Section, promoting in-depth pieces which analyse underrepresented issues and challenge conventional narratives.
China’s investment landscape is in turmoil. Top investors have shunned the country after private companies faced a shake-up and the government clamped down on tech giants such as Tencent and Alibaba. At the same time, the suppression of listed Chinese companies by U.S. regulators, the continuation of the Russian-Ukrainian war, and the continued travel restrictions in Mainland China and Hong Kong have all added risks to the domestic investment landscape.
China is expected to replace the United States as the largest economy in the world in 2028. While the pandemic hit the global economy in 2020, China still achieved 2.3% GDP growth as the government took the lead in quickly restoring normal life and production order. As of September 2021, the AUM of China’s private equity industry totalled US$2.8 trillion. Despite the recent outbreak, severe lockdowns and supply chain disruptions in Shanghai, private equity AUM is expected to expand further as the government actively improves the relevant regulatory framework and promotes a more mature financial system.
Disruption and opportunities
Domestic epidemics have occurred more frequently in recent months across the country with the increased transmissibility of Omicron and many cities have adopted strict closure and control measures to deal with the variant. This, in effect, has led to consumption and related market players being significantly impacted. However, in the context of the epidemic, the dividends of the “Big Health” companies are still evident. Under the influence of various factors such as national policy support, demographic changes, and the spread of the epidemic, the demand for the health industry has exploded, and the enthusiasm for market investment is high. With an ageing population and the rapid development of science and technology, the “Big Health” industry will become a prominent track in 2022.
On the other hand, driven by the domestic economic recovery after the effective control of the pandemic in 2020 and changes in global capital markets, investments in China’s private equity industry continued to rise. The scale and volume reached a new high: As of 2021, there were 124,391 registered private equity funds in China, a year-on-year increase of 28.43%.
The overall recovery of the private equity investment industry is closely related to the increase in exit channels. For instance, the establishment and launch of the Beijing Stock Exchange in September 2021 played an important role in broadening the exit channels of private equity, promoting the liquidity of equity investment, and improving the capital utilisation rate and investment return of private equity funds. According to a Deloitte report, the number of IPOs in the Chinese Mainland market reached 492 in 2021, which equals RMB 537.2 billion, an increase of 14% in terms of proceeds raised over 2020.
However, in the first quarter of 2022, the continuous decline of the secondary market, especially the sharp decrease of technology companies had received much attention from investors. This resulted in many investment institutions in the primary market suffering. Since the end of 2021, the value of many new stocks has fallen to about 40% of the issue price. Some have even fallen by a whopping 60%. This would have been unthinkable for Chinese investors, as they expected the price of new stocks to always go higher as it is considered as the “guaranteed windfall” for those determined to stag.
In addition, according to a report by Deloitte China, in the first quarter of 2022, only a total of 85 new shares were listed on the Beijing, Shanghai and Shenzhen stock exchanges and raised RMB 179.9 billion. While in the first quarter of 2021, 100 new shares were listed in Shanghai and Shenzhen. Although the number of IPOs fell by 15%, the amount of financing in the overall IPO market increased by 136% due to the return of a telecommunications company for listing (China Mobile raised RMB 56 billion) in the Mainland A-share market. Most of the financing amount came from the Shanghai market, while the Shenzhen market recorded 41 financings, and only 7 IPOs were raised on the Beijing Stock Exchange. Listings might be even further delayed and under stricter scrutiny due to China’s continued “zero-tolerance policy” towards covid cases.
Incorporating ESG into investment assessments
In recent years, China’s private equity and venture capital funds have gradually increased their investment in ESG industries such as new energy and technological innovation. In the first half of 2021 alone, the new-energy vehicle sector in China’s primary investment market raised more than US$12.6 billion with more than 50 deals, a year-on-year increase of 42.5%. The financing of the new-energy vehicle sector hit an all-time high in 2021 and it took only one year for the total funding in the sector to rise to RMB 300 billion from RMB 100 billion in 2021.
The secondary market has also responded positively. Many fund management companies actively developed and sold ESG products and integrated ESG investment concepts and methods into the company’s overall investment framework. By the end of 2021, there were 181 domestic ESG-themed funds with RMB 382.8 billion and 1,002 pan-ESG funds with a scale of over RMB 1,773.2 billion. On both quantity and scale, ESG funds have shown significant growth compared to previous years.
However, in practice, China’s ESG market has not yet formed a unified rating standard, and different rating standards exist, making it difficult for investors to understand the intrinsic value of the bid. At the same time, the ESG rating system’s ambiguity also limits investors’ and companies’ involvement in ESG. As ESG continues to receive attention from regulators, the industry, and investors, its potential risks are being re-evaluated, and all parties are looking for possible solutions.
Geopolitical risks on the exit route
In the U.S., the Holding Foreign Companies Accountable Act (HFCAA) hit the market for Chinese companies to go public by the first quarter of 2022. Only one Chinese company from medical devices was able to go public in the first quarter of 2022, raising $39.4 million. In contrast, in the first quarter of 2021, shares of 20 Chinese companies were traded in the market, raising $4.37 billion.
In the second quarter and even the second half of 2022, the exit channel of venture capital funds may usher in a turning point. Chinese ADRs might need to consider being listed in Hong Kong instead for fear of being delisted in the U.S. for international financing. However, according to Deloitte China, IPOs in mainland China will continue to grow in 2022. The main boards in Shanghai and Shenzhen are estimated to have about 120-150 new shares, raising about RMB 200-230 billion. A large number of new shares are also expected to be issued on the Beijing Stock Exchange in 2022.
Conclusion
From the long-term perspective, China’s economy is still vigorous, its industrial and supply chains are resilient, and the country continues to optimise its economic structure. However, China’s private equity investment environment has become more cautious against an increasingly stringent outlook for Chinese internet and technology companies, especially for exit deals. Those Chinese companies headquartered in the U.S. need to explore other exit avenues other than U.S. IPOs. Investors’ assumptions about the fundamental market will face significant challenges. It might take time for them to rebuild confidence in the Chinese private equity market under the uncertain external environment.
King's Private Equity Club is a student society at King's College London, providing a high quality of networking, speakers, workshops and social events to the King's Community. Our goal is to improve our members understanding and employability.
