There is a problem, however. “The lack of transparency and of quality management teams means that the investable universe is small,” says Chris Lerner, partner in the Shanghai office of Eaton Partners, the fund placement agent. This leads to a rise in valuations, depressing profit opportunities. “There’s a sense out there that there’s a lot of capital chasing a limited number of deals,” adds Lerner.
In the high-growth sectors, such as ecommerce and healthcare, companies are sometimes being bought at as much as three to five times sales, says Lerner, with, in certain cases, stakes in companies changing hands at as high as 40 times price to earnings. In businesses not enjoying the same rapid growth, however, he still sees pricing at high single digits to EBITDA.
Another solution is to invest sooner. “Groups are investing at an earlier and earlier stage,” says Lerner. Even though early-stage returns have also fallen, they are still potentially higher than for later-stage investments.
The backlog is so large, says Prasanna, because of a 14-month suspension in 2012-13. This caused problems for private equity investors since IPOs account for the majority of exits every year. “It coincided with the point when a lot of investors were in the harvesting period for funds begun in 2006-08,” says Chris Lerner, of Eaton Partners. “This depressed the distributions of a lot of China funds during a time when there were unprecedented levels of distribution in the US.”
Another concern cited by investors is the sometimes less than helpful role of the state. Lerner, of Eaton Partners, advises investors to steer clear of companies whose revenue depends largely on selling to the state, because this revenue stream is subject to the vagaries of government budgets. Another complication is assessing the role of China’s “princelings” – the sons and daughters of leading Communist Party officials, who have formed a powerful and corrupt business class – when making private equity investments. In some ways, however, the government’s ongoing corruption clampdown may be making things easier. “There’s been a lot of change in the ability for private equity firms to leverage connections,” says Lerner. As a result, “a lot of the princelings associated with private equity funds have fallen back into the shadows or left the business altogether”.
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