China's private equity business to rebound

China's private equity market shrank in the first quarter due to COVID-19 but is expected to rebound strongly in the second half, according to a private report.

The industry contracted last year across multiple dimensions, with deal value and volume both retracted due to softness in the macro economy, especially for deals in excess of US$1 billion, Bain & Company said. The total number of deals exceeding US$100 million also dropped by 32 percent, causing the average deal size to decrease by 22 percent overall.

Exit values also weakened with underperforming and unpredictable public markets, and yuan funds went through a major shakeout due to continued stringent regulations.

Despite the contraction, growth deals continued gaining share in 2019, driven by a few large deals. Meanwhile, buyout value continued to shrink. The internet and technology sectors remained the pillars of China deals, with an increase in the number of health care sector deals, the report said.

“Private equity in China has been one of the big success stories in Asia Pacific over the past nine years with its meteoric rise, but investors are now seeing a shock impact on the market similar to what we observed with SARS,” said Lucia Li, a Bain & Company partner. 

"With SARS, investment activities rebounded starting in the fourth quarter of 2003 with significantly more deals in industries sensitive to the quarantine and so we believe that there will be strategic opportunities in the market moving forward once things settle," Li said.

The COVID-19 outbreak was the cause of the continued contraction in the first quarter, posting a further 55 percent drop in deal value and a 7 percent drop in deal count compared with the same period last year. 

The impact of this contraction will persist in the second quarter as quarantine rules are likely to continue until the end of April, Li said. "This is likely to hurt overall mobility and work efficiency until then. Additionally, it will lead to a significant decline for the first half of 2020 versus 2019 in both deal count and value."

The company expected to see a decline in deal counts by between 1 and 5 percent, while deal value will drop at about 15 to 25 percent on top of an already low level in 2019.

Taking the situation during SARS as a reference, the main drivers of a rebound will be the increased financing needs for those sectors most impacted by the pandemic and the aggregation of delay deals and new deals, the report pointed out.

The SARS rebound pattern is applicable to COVID-19, implying a relatively optimistic market in the second half of 2020, it said. 

The market could begin to bounce back as deals delayed in the first half recover and an increasing number of enterprises look for financing needs due to poor cash flow.

"Despite the impact on the China market, the current trajectory suggests that an extreme decline in economic activity will be short-lived, as industries have already started to recover at varying speeds," said Zhou Hao, another partner. 

"Investors should still remain focused on how to succeed in a post-COVID-19 world. Even though current macro-economic challenges continue to impact the market, there will be growth in the country," Zhou added.