China Crackdown Traps Private Equity Investors

The world's leading private equity firms are facing a growing problem in China: they can't sell their investments. As Beijing continues its crackdown on initial public offerings (IPOs) and the Chinese economy slows, foreign investors find themselves trapped, unable to exit their investments and recoup their funds, as reported by the Financial Times.

Industry data reveals a stark trend: none of the top 10 global private equity groups operating in China have been able to list a Chinese company or fully divest their stakes through mergers and acquisitions (M&A) this year. This marks the first such instance in at least a decade, though exit strategies have been hampered since Beijing imposed restrictions on offshore listings in 2021.

This inability to exit is creating significant challenges for private equity firms, who typically aim to sell or list companies within three to five years of acquisition to generate returns for their investors. With exit strategies severely constrained, these investors' funds are effectively locked in China, leaving future returns uncertain.

"There’s a growing sense among PE investors that China may not be as systemically investable as once thought," says Brock Silvers, CEO of Hong Kong-based private equity group Kaiyuan Capital, to the Financial Times. He attributes this to a confluence of factors, including a weakening economy and increased domestic regulatory pressure.

This situation stems from the significant investments made by global private equity firms in China's rapidly growing economy over the past two decades. These firms, including Blackstone, KKR, CVC, TPG, Warburg Pincus, Carlyle Group, Bain Capital, EQT, Advent International, and Apollo, have collectively invested $137 billion in China over the past decade. However, total exits amount to just $38 billion, while new investment has dwindled to $5 billion since the start of 2022.

The difficulty in cashing out is deterring new investments, with some pension funds expressing concerns about China's investability. "In theory, you could buy cheaply [in China] now but you need to ask what would happen if you can’t exit or if you have to hold it for longer," notes a private markets specialist at a major pension fund.

The slowdown in global private equity exits is also contributing to the problem, with a 26% decline in deals globally during the first half of 2023, according to S&P Global. However, the complete halt in China exits is particularly concerning, making pension funds hesitant to allocate capital to the region.

Foreign buyout groups previously relied on taking Chinese companies public in the US or other markets to exit investments. However, Beijing's crackdown on offshore listings, prompted by concerns over data security and regulatory compliance, has significantly slowed this avenue.

The dearth of exits is forcing private equity firms to explore alternative strategies, such as selling stakes to domestic and multinational companies, as well as to other buyout groups. However, these options face challenges, including US political scrutiny of investments in mainland China and a general reluctance among overseas buyers.