M&A activity in China reached record highs in 2014, with the consumer, technology and financial sectors leading the way. According to PWC, total M&A in China surged by 55% in both volume and value, with foreign strategics increasing their activity by 58% and domestics 63%. Last year’s M&A growth provided tailwinds for private equity in China and much needed liquidity for its investors. Exits by trade sale and M&A hit a record high in 2014, accounting for 37% of the total. Trade sales to corporates are seen as necessary exits, particularly as the IPO market remains below 2010 & 2011 levels. However, despite domestic firms becoming more acquisitive, private equity has struggled to deliver attractive opportunities and deal flow in situations where they lack control, or where professional management, governance, and processes are absent.
We believe that a shift is underway, particularly amongst domestic Chinese corporates, toward buying rather than building. This is especially the case when faced with the challenge of expanding into a new business category or entering a new region. There are clear industry consolidation trends with businesses jockeying to increase market share and eliminate competitive forces. In China’s domestic A-share market, companies have targeted acquisition-led growth to meet the demands of shareholders. We believe that an alternative value proposition is to proactively target companies in fragmented sectors and implement processes to professionalize, grow and streamline businesses, create businesses that will ultimately be highly valued and attractive targets to acquirers. Our experience in dealing with the common succession issues in China shows that by professionalizing management and improving business processes long-term value can be unlocked.
The impact on our strategy is net positive. While a more robust M&A market does reflect competition for deal flow from strategics, there is plenty of room for Lunar to offer a more compelling value proposition to sellers. In businesses such as Yeehoo, we acquired the business from founders that were not seeking a full exit. Rather, they believed in our strategy of professionalization, growth and streamlining and wanted to participate in its success. Our ability to allow founders to retain a significant minority stake in their businesses and preserve their legacies can make for an extremely attractive proposition. In other situations, such as Yonghong, our ability to transition management from ageing founders to a professional team demonstrates value, and reflects a challenge that most acquirers may be unwilling to tackle. In China’s changing consumer landscape, margins, marketing, and branding matter more than before, and our discipline and repeatable processes drives value growth for portfolio companies. The proven multiplier effect of implementing process and new management combined with our reputation as an industry-insider ensures that we will maintain a robust and selective pipeline.
Several businesses within our portfolio are firmly on the radar of potential acquirers, domestic and foreign, and we believe that increasing M&A activity will positively impact our portfolio, as corporates seeking acquisitions will favor easier-to-acquire, professionally run targets that are well governed. Only GPs with deep industry experience will benefit as M&A continues to grow in China, something that Lunar welcomes as we have long championed our operationally-intensive approach of building better businesses. We are confident this trend will allow us to deliver returns and attract opportunities through “sweat equity” – the value of operational growth driven by the Lunar process and professionals.
Lunar | February 27, 2015