Chinese demand provides exit opportunity for UK PE

Bridget Walsh, EY
16 March 2015

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UK private equity has a huge opportunity to capitalise on the significant flow of Chinese capital into Europe and beyond, writes Bridget Walsh, head of private equity and Chinese trade routes at EY

Through my dual role as head of EY's PE practice in the UK and the firm's Chinese trade routes, I have been monitoring the flow of Chinese capital into Europe for some time. This is a trend that is unlikely to slow anytime soon.

There is a growing sophistication and reach of China-based funds. Where not long ago local funds were focused largely on the domestic market, today firms are increasingly seeking opportunities outside their local market that provide both scale and the potential for high growth. There are many smaller Chinese private equity firms that have local expertise but little in the way of international knowledge. To overcome this and to reduce risk, Chinese funds are co-investing with western private equity houses and also investing in publicly listed companies, as evidenced by Sanpower buying a stake in House of Fraser.

It is not just consumer brands that are attractive, such as Hony Capital's investment in Pizza Express. Chinese funds also have an appetite for infrastructure, real estate and medical devices companies, as well as TMT and healthcare.

Europe is seen as an attractive and accessible market with fewer restrictions to Chinese investors than others. European assets are also viewed as good value compared with many other markets globally.

Emerging trends
On advising some of the most prominent inbound Chinese deals in the UK, my team has seen some common factors playing out.

The first is the flexibility offered by the deal structure. Although some deals are 100% acquisitions, we have a number of Chinese clients seeking to forge joint ventures (JVs), particularly in the consumer products sector, with the objective of taking the brand back into the Chinese market to achieve significant upside from the deal. JVs provide UK and Chinese firms the opportunity to leverage local expertise and knowledge, as well as navigate cultural differences in their respective countries.

In terms of valuations, Chinese investors tend to focus on the net asset and net earnings value of a target as opposed to EBITDA. It is important the vendor is aware of this and presents results in a way that reconciles the difference between different multiples. It is also important to be aware that EBITDA is not the most popular valuation approach among many Chinese investors and as such vendors need to ensure they are talking like for like when discussing multiples.

Capital restructuring is also common among Chinese investors. After acquiring a target business, they tend to inject capital into the business to reduce financing costs. Chinese corporates are increasingly seeking to raise finance locally in Europe as opposed to China, where the financing costs are relatively more expensive.

An important consideration, not to be overlooked, is how Chinese investors like to engage and operate when acquiring assets. Chinese investors typically prefer to engage in private dialogue with vendors, rather than engage in an open tendering process, and may want to enter exclusivity agreements fairly early on in the process. Coming to terms with this different approach and learning from others who have advised on similar situations will make the process far smoother, with the likelihood of a more positive outcome.

Eating into the overhang
The exit overhang is one of the industry's biggest challenges, with the European private equity market having invested and realised capital at a rate that means it now holds a record number of investments. The reach and increasing sophistication of Chinese private equity to do deals in Western countries could aid UK houses to reduce their exit overhang significantly. There are plenty of portfolio companies currently sitting with UK houses that would be highly attractive to Chinese investors through a secondary buyout.

Despite a slower growth rate, China's economy retains the dynamism it has developed over the past decades. As it continues its shift from an export- to consumer-driven economy, Chinese private equity and corporate appetite for well-established European assets and brands will continue apace – giving the UK industry further opportunities to target and market their portfolios to Chinese acquirers.