Private equity-backed M&A in China stalls as investors put off deals amid trade war
Bankers and deal advisers see US-China trade war put a drag on deals’ completion and purchase price multiples
Mergers and acquisitions in China are likely to slow further in the second half as private equity investors put transactions on hold amid the escalating US-China trade war.
Industry players also say private equity buyers and business owners are beginning to discuss the impact from the US trade tariffs ranging between 10 per cent to 25 per cent on Chinese companies’ gross margins, and their negotiations are increasingly touching on how to split the additional tariff cost in their purchase price multiple discussion.
Inbound deal value into China dropped 20 per cent for the first half of 2018 from the second half of 2017, to US$4.91 billion across 206 deals. That figure includes M&A activity from both corporate buyers and private equity and venture capital sponsors, data from Dealogic shows.
Jeffrey Wang, managing director and co-head of BDA Partners’ Shanghai office, which advises on cross-border M&A deals, said in the first half the then escalating trade friction between China and the US had not affected the pace of private equity M&A activity in China, but if the trade war worsens considerably, more deals will get suspended as supply chains get disrupted.
“If trade tensions worsen considerably to the extent that imports affect domestic demand, then it’s conceivable that more deals will get suspended,” said Wang.
Completed China-inbound deals dropped by 29 per cent in the first half of 2018 from a year ago while pending deals rose 10 times, Dealogic data showed.
Lyndon Hsu, global head of leveraged and structured solutions at Standard Chartered in Singapore, said private equity investors looking at capital goods manufacturers or businesses that have a supply chain embedded within China are most likely to be affected by the trade war. These contrast with businesses that have purely domestic exposure, such as retail services and consumption-focused sectors.
“Any owners of businesses that have decided to sell, I think they would be reconsidering completing a transaction now. There will simply be a slowdown or deferral in M&A activity until there is more clarity on the ongoing trade war not escalating further,” said Hsu.
During the first half when US and China were immersed in what some had regarded as mere trade rhetoric, Barry Tong, partner at advisory firm Grant Thornton, said he still saw robust private equity activity in the Greater Bay area, which links Hong Kong and Macau with nine Chinese cities into an integrated economic and business hub.
He said PE funds in Hong Kong and China focusing on growth equity strategy have been particularly active in pursuing opportunities in high-value added manufacturing businesses, which could be exposed to export sales; and the telecom-media-technology sector, which is more geared towards domestic demand.
As the hostilities morphed into the full-fledged trade war, which have subject US$50 billion of Chinese exports to tariffs, with a third US$200 billion round of tariffs pending, the impact on the financing terms could be more palpable.
Tong said the prospect for Chinese business owners being subject to higher financing terms from private equity sponsors can come in the form of higher coupon rate that a convertible bond will be issued at.
Many private companies with difficulties accessing bank credit for growth often issue convertible bonds to private investors, who also find it attractive as the bonds give them equity-like capital gain on the upside, and bond-like downside protection.
Hsu said that if the trade war remains unresolved, and tariffs imposed by the two sides stay indefinitely, then sellers and investors would come to accept new valuation benchmarks, as investors’ capital still needs to be put to work.
Private equity group Warburg Pincus follows this golden rule when investing in China’s property market
“Some investors would be keen to invest on lower valuation benchmarks on the basis that, at some point in the future, tariffs would be modified or removed, at which point then they would make a gain out of higher valuation at exit,” he said.
In 2017, deal multiples, measured by the enterprise value-to-Ebitda (earnings before interest, tax, depreciation and amortisation) ratio, on Asia-Pacific private equity-backed M&A was at 11.5 times, down slightly from 2016 but high compared to all the years between 2007 and 2014, data from Bain & Co showed.