China Daily

Private equity is proving its worth in China

Private equity is proving its worth in China

There are no billion-dollar blockbuster deals, no hostile takeovers, no big initial public offerings. Yet over the 10-year period since PE and venture capital players entered China, the industry has played a supporting role in economic growth, job creation, innovation and entrepreneurial success.

  • min read


Private equity is proving its worth in China

Private equity's (PE) quiet but significant role in China's economy doesn't get a lot of headlines. There are no billion-dollar blockbuster deals, no hostile takeovers, no big initial public offerings. Yet over the 10-year period since PE and venture capital players entered China, the industry has played a supporting role in economic growth, job creation, innovation and entrepreneurial success.

PE investors have accomplished this as a byproduct of what it has always done best: scouting out good companies in fast-growing markets and promoting best practices in operations and governance. To do this, they have had to overcome the initial skepticism from Chinese entrepreneurs. What's more, they have usually been minority investors with largely hands-off participation in management.

Indeed, PE has shown great adaptability to China's opportunities. For instance, it has shifted its focus to providing growth capital, not actively staging turnarounds with its own hand-picked executives. In that sense, the private equity industry in China shares characteristics more common to venture capital. The main reason for this change is that much of China's economy has been in high-growth mode. Limited access to expansion capital for smaller companies and new enterprises has led entrepreneurs to private equity investors for growth capital to fill the breach. As a result, more than 80 percent of private equity investments were in the form of capital to finance growth. For its part, PE has picked carefully and well.

Today, China has become a leading destination for PE capital in Asia, where it is solidifying relationships among Chinese stakeholders, including government officials, financial institutions, the general public and, particularly, with entrepreneurs and management teams.

These conclusions are drawn from a Bain & Company survey of mainland Chinese companies that received at least $20 million in financing from foreign or Chinese private equity funds between 2002 and 2006. The survey excluded deals completed after 2006 to permit tracking of post-investment performance for a period of at least two years. The analysis is based on data obtained on 100 PE-backed companies, accounting for more than 50 percent of the total value of private equity deals completed during the five-year period. These companies represent a broad range of industries, company sizes and geographies.

Among other major survey findings was that, simply put, PE helps create better-run companies. Indeed, firms with PE shareholders turned in annual revenue growth three percentage points higher than their publicly listed peers. In the year they first received PE investments, the companies posted total revenue of 535 billion yuan ($78.37 billion). Two years later, they generated 867 billion yuan, a 62 percent rise. Even as they increased spending for employee compensation and R&D, PE-backed firms booked substantially more robust profit growth than the benchmark companies. They posted an average earnings growth rate of 39 percent versus 25 percent for the publicly listed companies in the survey.

In the year that funding was received, the surveyed companies had net profits of 36 billion yuan. Two years post-funding, profits of the same group of companies had nearly doubled to 71 billion yuan. One factor is that PE-backed companies benefit from the transfer of management know-how. This higher profit growth is generally not achieved through reduced employment or lower salaries but by pursuing the right growth opportunities and through efficient management of costs, information technology and inventories.

Interviews with executives also revealed that they valued the role their PE partners played in improving corporate governance, such as improvement of accounting transparency and tax disclosure. The Chinese government gained, too: The data show that PE-backed companies yield higher tax payments, and that these have increased at a rate faster than taxes paid of publicly listed businesses since 2002. Total tax payments of PE-backed companies increased at a 28 percent compound annual rate, 10 percentage points higher than those of their publicly listed peers.

Another noteworthy effect of PE is that it has led the shift toward domestic consumption, a government policy goal. While PE investment in China increased by 58 percent since 2002, investment in the consumer goods and retail industries grew by 77 percent. PE investments in consumer and retail businesses now rival those made in the traditionally strong IT and media sectors. Accounting for less than one-third of the value of IT and media deals in 2002, consumer and retail investments reached parity with them in 2008. Not surprisingly, PE's increasing presence in the consumer goods and retail sector is having a positive impact on overall domestic consumption and sales. Retailers backed by PE investors booked a sales growth of 47 percent compared with just 16 percent for publicly listed retail companies. PE-backed consumer goods companies also booked sales growth of 30 percent compared with 18 percent for publicly listed peers. Along the way, PE has also been pushing investment into the inland provinces, another public-policy goal.

PE firms still face plenty of challenges as they work to build on their initial success. They will need to sharpen their due diligence capabilities to compensate for a lack of transparency in financial reporting and to navigate the complex regulatory and deal-approval process. Instead of scattering their energies by chasing too many opportunities, they will want to concentrate them on keeping the companies in which they invest focused on what they do best,

PE will be a player as China's economy continues rapidly to expand and evolve. As the nation's business challenges grow more complex, private equity's skills and management expertise will make it an increasingly valuable asset.

Michael Thorneman is the Managing Partner of Bain & Company Greater China, co-leads the firm's Private Equity practice in China. Weiwen Han is a Bain partner focusing on Private Equity. Both are based in Bain's Shanghai office.


Ready to talk?

We work with ambitious leaders who want to define the future, not hide from it. Together, we achieve extraordinary outcomes.