Private equity firms revise Chinese strategy as regulatory crackdown intensifies

HONG KONG, Aug. 9 (Reuters) – Private equity firms rethink their strategies in China as a growing regulatory crackdown on some of the country’s hottest sectors forces investors to seek bets in sectors other than they hope less vulnerable to sudden changes in policy.

Private Equity (PE) and Venture Capital (VC) funds are turning away from data-rich, consumer-centric internet companies to industries such as semiconductors and renewables, industry executives have said .

The shift comes as investors reeling from a barrage of regulatory controls and sweeping rule changes in recent months targeting large domestic companies, primarily in the internet, private education and real estate industries. .

The move last month to ban private tutoring companies from profiting from teaching basic school subjects and raising capital, for example, is expected to trigger a rush among private equity investors to find an exit. after paying billions.

The unexpected crackdown will not only cast a shadow over the return prospects of private equity investors, but also reduce investment opportunities at a time when many of them are sitting on billions of dollars in capital.

“We face the most severe regulatory environment for over a decade, when market competition is fiercest and capital is most abundant,” said Richard Ji, chief investment officer and managing partner of All-Stars Investment.

“With increasing regulation, good companies become fewer and more expensive. Overall, future returns for venture and private equity investors may decline,” said Ji, whose Hong Kong-based fund focuses on leading companies in the new economy sectors.

Forty-three China-focused funds have raised a total of $ 49 billion this year, nearly the annual amount of $ 50 billion in 2020, according to data from Preqin. Hillhouse Capital Group alone raised $ 18 billion in Asia’s largest non-state-backed fund in May.

The number of funds raised this year, however, is less than a third of last year and a sharp drop from peak fundraising in 2016 and 2017, when more than 1,100 funds were raised each year, according to the data.

According to Chinese data firm Zero2IPO, in 2020 angel, venture capital and private equity investments totaled 887 billion yuan ($ 137 billion), up 14% year-on-year, of which 384.3 billion yuan for computing, Internet and semiconductors and electronics. sectors.

In the first half of this year, investments totaled 470 billion yuan, up 50% year-on-year.

INVESTMENT POTENTIAL

In the wake of the crackdown, many investors are turning to industries less prone to antitrust and data-related controls, such as semiconductors, automation, renewables, healthcare, and technology-focused services. businesses.

These sectors are also considered by some leaders to be in line with China’s strategic goals because, according to investors, Communist Party leaders are putting socialism before shareholders and reshaping certain sectors to reduce cost pressures and serve people better. ordinary.

“Chinese demand for homemade chips and the trend towards vehicle electrification and autonomous driving will also create many new companies with investment potential,†said Henry Zhang, chairman of Hong Kong-based Hermitage Capital. .

The tech crackdown has cooled the valuations of internet companies and online education groups, investors said. However, they pointed out, in popular sectors such as retail, businesses remain expensive.

Investors are also looking for technology companies that focus solely on the Chinese market to avoid potential regulatory risks with their overseas operations, said a senior Beijing-based investor with a private equity fund.

Having been caught off guard by the regulatory crackdown, some investors have said they will now conduct a more in-depth policy analysis when assessing a potential investment.

Some have started reading The Governance of China, a multi-volume book written by Chinese President Xi Jinping, for political guidance. Others said they would read more state media for political clues.

“We need to stay one step ahead of what the country thinks,” said Choon Chong Tay, managing partner and director of Vertex Ventures China, a venture capital firm backed by Singaporean state investor Temasek.

Reporting by Kane Wu and Julie Zhu; Editing by Sumeet Chatterjee and Stephen Coates

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