DC Advisory analyses the opportunity for Western sponsors With Cath Kidston and Pizza Express following Punch Powertrain as the latest European targets to secure backing from Chinese private equity investors, DC Advisory analyses the key drivers of this growing trend… The Great Wall of Chinese private equity money Over 1,000 different Asian private equity funds have closed since 2009, raising over US$230bn of capital. This, coupled with the slowdown in Asian private equity dealmaking over the period, has led to a significant increase in available firepower, with Asian private equity estimated to have almost US$130bn of so called ‘dry powder’. ChinesePE Key characteristics driving the Asia opportunity The main driver of Asian private equity interest in Western businesses is the potential to leverage an established brand or technology in Asian markets. This is particularly the case with the developing consumer market in China, driven by the growing middle class population, increased purchasing power, continuing urbanisation and consumers ‘trading-up’ to higher quality products. For Punch Powertrain – a leading automatic transmission manufacturer for the automotive industry – this opportunity arose from the company’s proprietary clean powertrain technology. This positioned the company to benefit from the increasing focus on fuel efficiency and emission reduction in global automotive markets, particularly in the growing urban traffic in China’s cities. For Pizza Express and Cath Kidston, the opportunity to roll-out established brands across a growing market of 1.4bn consumers provides an avenue for accelerated growth, at a time when their domestic markets have reached saturation point. Tosh Kojima, Head of DC Advisory’s Japan-Asia Focus Group, noted that: “Asian private equity investors – through their access to management talent, proximity to government decision makers and ‘boots on the ground’ – are often better placed to deliver on these opportunities than their Western counterparts.” Lack of domestic deal opportunities Another driver for Asian sponsors looking overseas is the lack of quality opportunities in their domestic markets. Most of the domestic Chinese opportunities are minority transactions, and concerns over governance and quality of financial reporting are widespread, thus increasing the risk profile of investing in Chinese private companies. In addition, a lack of Asian IPO activity has closed off the ‘pre-IPO’ investment strategy of many Asian funds. This has driven Asian funds to seek other opportunities where their unique value-add can deliver emerging market returns with developed market governance. Main players in Asian private equity The Asian private equity market is characterised by three main groups of financial sponsors: (i) the offspring of Western private equity firms (eg, KKR, Carlyle); (ii) private equity arms of integrated Asian investment banks (eg, CICC, CDIB); and (iii) local Asian private equity investors (eg, New Horizon, CDH Investments). With the Asian arms of the Western players focused on originating deals in the local region (although a few have geographically flexible investment mandates as long as the angle is ‘Asian’), it is the latter two groups that have driven the latest trend. The integrated investment banks are inclined to focus on opportunities that allow them to put their full range of products into use, particularly leveraging their Asian ECM and DCM capabilities. Local Asian private equity groups generally have relatively limited experience investing outside China, but their deal teams in many cases comprise sophisticated international corporate financiers and industrialists. The opportunity for Western sponsors Whilst some Western sponsors may see the emergent Chinese private equity groups as a threat, creating a new universe of rival bidders for a limited pool of mid-market deals, they also represent significant opportunity. In the case of both Cath Kidston and Punch Powertrain, the transactions involved Asia-focused investors taking a substantial but non-controlling stake alongside the existing investors. This provides a cash-out opportunity for the incumbent sponsor, de-risking their investment and improving IRR through an early partial exit. It also introduces a new partner able to support the next phase of growth and drive returns on the residual stake of the incumbent. Crucially, it also broadens the potential exit opportunities for incumbent investors. As well as the potential to sell out in full to the new partner, many Asian sponsors have extensive experience in divesting companies through Asian IPOs or Asian trade sales, particularly to state owned enterprises. Both of these are avenues where Western sponsors, particularly in the mid-market, have limited expertise. Tosh Kojima added: “It is a perfect partnership of Asian ‘smart’ money looking for Western ideas that can be rolled out in Asia, and the Western seeds that need Asian help to blossom.” The pitfalls Co-ordinating a process to attract Asian private equity investment requires significant skill and judgement, not least in identifying situations where such a transaction is deliverable. Timetables, process steps and logistical co-ordination require a different approach to a conventional Western auction. In addition, the complexities of negotiating shareholder agreements, where incumbent and new shareholders necessarily have different ‘in-prices’ and time horizons, requires significant expertise. Whilst the rewards of such a transaction can be attractive, the pitfalls require a judicious approach, drawing from a sound understanding of how Asian investors operate from both a cultural and professional perspective. Michael Mariaz, Managing Director at DC Advisory commented: “Strong presence on the ground and deep understanding of cultural differences are key to successfully navigating through the specifics of cross-border M&A with Chinese private equity funds. It is thanks to our colleagues in Beijing, Shanghai and Hong Kong – and access to the key market participants – that we are uniquely positioned to assist our European clients who are looking to tap into the Great Wall of Chinese private equity money.” -Ends-