There is strong optimism among major participants in the Chinese private equity (PE) market, with 79% of respondents expecting a rise in investment activities over the next 12 months, according to Deloitte's latest "China Private Equity Confidence Survey."
The survey says that market confidence is driven by a number of factors, including the economic growth trends, recovery of the public market, and growing interest on the part of companies to turn to PE as a source of funding. Most important is the recent surging proliferation of domestic RMB funds. The survey clearly indicates that the development of RMB funds is dramatically changing the PE landscape in China.
"All the factors are pointing to a positive outlook for the Chinese private equity market," says Chris Cooper, Head of Private Equity of Deloitte Northern China. "The market is starting to recover from the economic downturn and we have also seen improved sentiment in the stock market, coupled with the resuscitation in IPO activities – one of the viable exit routes for private equity. If the economy continues to recover, investment activities will continue to grow as we enter 2011 along with deal size and valuations."
In terms of deal type, 91% of respondents believe that "Development Capital" will remain the most popular in the next 12 months, reflecting the growth stage of many Chinese firms that need capital to fund their business expansion. Pre-IPO (21%) and PIPE investments (3%) are seen as less popular in this year's survey. Responses are also not positive towards buyout deals in the coming year. While economic growth may drive volume from the current low levels, respondents remain concerned that business owners will be reluctant to sell their businesses, and regulatory constraints will inhibit the growth prospect of buyout deals.
Despite optimism in the Chinese PE market, just over half of the respondents (52%) expect deal sizes to rise, backed by the abundance of capital, club deals and ongoing privatization of state-owned enterprises. In terms of industries, 27% of the respondents cited consumer and retail sector as having the most deal activities over the next 12 months, followed by the power/ energy/ mining sector (16%) and pharmaceutical/ biotech/ healthcare sector (15%).
Sector interests expressed by respondents are roughly in line with government priorities for FDI and private investment data. There has not been significant change in their sector interest as compared with last year's survey, except that deal activity is expected to be more active in financial services. Geographically, respondents believe that PE activities will spread out beyond the tier-one cities, with second- and third-tier cities showing a significant growth in popularity since last year.
"In the past, PE activities tended to focus on the coastal regions, with Shanghai and Beijing being the key hubs," says Danny Tong, Head of Private Equity of Deloitte China. "However, with the escalating maturity in the PE market in China, we are likely to see greater penetration of investment activities into the second- and third-tier cities inland from the coast, including the far western provinces. A related trend -- 82% of respondents believe that deal competition will become more intense in the Chinese Mainland due to the increase in the number of home-grown or RMB funds and new foreign entrants."
The survey shows that 58% of the respondents expect valuation multiples to stay the same this year, with price expectations moderating to a more realistic level; even after the rise in valuations since the recession. Similarly, most respondents (61%) expect that returns from PE exits will be flat over the next 12 months given that some public market growth forecasts appear unrealistic and continued macro uncertainties. The impact of RMB fund competition will also serve to keep returns flat.
Seventy-six percent of respondents believe that exit activity in the Chinese PE market will increase over the next 12 months, helped by a healthy mixture of supply and demand. The launch of the ChiNext exchange and the growing maturing of many portfolio companies will also boost exit activities in China's market.
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