Two Leading Asia-focused Investors Report on the Prospects and Pitfalls for Private Equity Investments in China

Shannon Beeman
October 13, 2015

The days when private equity investors could reap high returns on their investments in China are long gone, said two Asia-focused investors at the 2015 Michigan Global Private Equity conference on October 9. The two experts said private equity firms must dig harder and deeper to find attractive, legitimate investment targets amid uncertainty and tumult in the world’s second largest economy.

“The golden era has passed for private equity in China,” remarked Yi Luo, senior managing director in the Private Equity Group at Blackstone. “Now high-quality investment opportunities are very difficult to find, and there’s a lot of anxiety about exactly where the country is heading.” While this shift doesn’t necessarily mean North American PE firms shouldn’t invest in China, Luo added, it does indicate they are no longer assured of getting outsized returns on their investments, as his former employer, the Carlyle Group, did from 2005 to 2013.

David He, partner and managing director of PAG Asia Capital, noted that China has experienced  a slump in its traditional manufacturing-driven growth model, and potentially faces headwinds for its exports if and when the Trans-Pacific Partnership ─ a proposed trade agreement involving the U.S. and 11 other Pacific Rim countries ─ is approved by the U.S. Congress and implemented. Private equity investors, he added, now face more competition for investment deals in China and need a laser-sharp strategy and focus to navigate through the country’s often-murky investment, regulatory and political landscape.

Luo and He were interviewed by Fox Business Network reporter Jo Ling Kent during the opening session of this year’s Global PE conference, which celebrated its 10th anniversary. Approximately 200 private equity investors, financial-services professionals, entrepreneurs and members of the Ross School of Business attended the event, which is hosted by the Center for Venture Capital and Private Equity Finance and the Zell Lurie Institute at the University of Michigan’s Ross School of Business.

During their informal discussion, He and Luo told their audience that private equity investors should be aware of changes taking place inside China which are impacting deal flow, company growth and exits from investments. These challenges include:

  • Slowing economic growth, with a 7 percent target for 2015
  • Stock-market turbulence
  • Recent devaluation of the yuan
  • Inability, thus far, to shift to a consumer-based economic model
  • Runaway pollution and environmental degradation
  • Fraud and corruption in the public and private sectors
  • Rising wages and labor-retention costs that are eating into company profit margins
  • Tightened government controls over the domestic Internet
  • Cybersecurity concerns

Luo and He emphasized the strategic advantage of recruiting local talent with strong connections to people, markets and resources when building out China-focused PE investment teams. “You have to have a local team that understands China’s way of doing things ─ that is just reality,” said Luo, who went to college in China and later enrolled at Michigan Ross, where he earned his MBA degree. He recommended recruiters look for Mandarin Chinese who have been educated in the U.S. rather than candidates from Taiwan or Hong Kong.

With 1.35 billion people, China represents a potential mega-market for global and domestic products and services. Increasingly, the emerging Chinese middle class is demanding higher quality goods and amenities similar to those they have observed in the U.S. and Europe. Among the most promising sectors for private equity investors seeking to capitalize on this trend, according to He, are pharmaceuticals, healthcare, media and entertainment. “There are still opportunities in the industrial and manufacturing sector, but you can’t depend on scale and market position alone,” he cautioned. “You need to consider a company’s core capabilities and whether it has the ability to emerge as a new leader and go beyond where it is today.”

He reported that 2014 was one of the biggest exit years for private investors. “If you invest in a good company with a good market position, then regardless of what happens, there is always a way for a private equity investor to exit,” he added.