[co-author: Felix Yau]

In the competition for Chinese investment opportunities, private equity funds have, in recent years, often been priced out of headlining M&A deals by strategic corporate buyers with deep pockets and aggressive global ambitions. One of the key drivers of this trend has been Chinese conglomerates, a handful of which have been responsible for the record levels of Chinese outbound M&A activity in recent years. However, with recent regulatory developments in China that have made high-value M&A deals more challenging for Chinese buyers to execute, the playing field may be leveling off and private equity funds may find themselves better placed to compete more effectively against such Chinese buyers for acquisition opportunities in Asia and beyond.

THE PLAYERS

The market for acquisitions across the globe has recently seen a large degree of competition between strategic corporate buyers and private equity funds for their respective slices of the proverbial M&A cake.  One of the key characteristics of M&A activity in 2016 was the abundance of mega-value transactions involving strategic buyers.  In the US and Europe alone, strategic buyers have reportedly spent a record US$1.7 trillion, representing approximately 80% of total M&A deal value in the US and Europe in 2016.  Furthermore, a 6% year-on-year global decline in private equity acquisitions that are valued at more than US$3 billion may also suggest increasing competition from strategic buyers for mega deals. 

A similar story is being played out in Asia, with Chinese outbound M&A activity in 2016 reaching a total value of around US$219 billion (representing an increase in value by 246% when compared to 2015).  Much of this Chinese outbound M&A activity centered around Chinese conglomerates such as Dalian Wanda, Fosun, Anbang and HNA Group routinely making headlines for their involvement in significant and high-value deals.  HNA Group alone has, for example, been involved in deals with an aggregate value of more than US$50 billion since 2015.  Examples of recent headlining Chinese outbound mega deals include:

• ChemChina's acquisition of the agribusiness Syngenta for US$43.8 billion;
• HNA's acquisition (through Avolon Holdings) of CIT Group's aviation leasing unit for US$10 billion;
• CEFC China Energy's acquisition of oil company Rosneft for US$9 billion;
• the acquisition of Finland-based videogame developer Supercell Oy by a consortium led by Tencent for US$8.6 billion; and
• Anbang Insurance's acquisition of Strategic Hotels & Resort for US$6.5 billion.

Strategic buyers benefit from access to an abundance of cash and the ability to point to long-term strategic plans to justify the high purchase price for their acquisitions.  By contrast, private equity funds must envisage a profitable exit within a shorter time frame, usually around 10 years, before they may make any investment.  This plays a significant role in enabling Chinese corporate buyers to complete deals quickly and drive up prices of transactions, which consequently prices out many private equity funds.

PRC REGULATORY HURDLES HAVE EMERGED FOR CHINESE CORPORATES…

However, Chinese outbound M&A activity has seen a slowdown since the start of this year, with many reporting tightening regulatory controls as a key factor.  Looking at the numbers, the total value of Chinese outbound M&A deals for the first half of 2017 is 42% less when compared to the same period last year.  This trend will likely continue for some time.  While a detailed analysis of the regulatory developments in China is outside the scope of this post, it is important to note that broad regulatory requirements have been implemented by a variety of government agencies in China with a view to controlling capital outflows.  Examples of these regulatory requirements include:

• classification of transactions into "encouraged" investments (including infrastructure projects relevant to the "One Belt, One Road" Initiative), "restricted" investments (including transactions that are deemed to be "irrational" or involve sensitive countries and sectors), or "prohibited" investments (including transactions affecting national security or national interests);
• an increased number of documents required to be produced for deals that need to be filed with, and approved by, the National Development and Reform Commission and/or the Ministry of Commerce; and
• compliance and authenticity requirements imposed by the People's Bank of China and the State Administration of Foreign Exchange for proposed foreign exchange transactions that involve more than US$5 million.  

In addition to the capital outflow restrictions, China's banking regulator, the China Banking Regulatory Commission, has recently been investigating the borrowing practices and debt levels of some of the major players in the China outbound M&A space.  The objective of such investigations has reportedly been to more closely align the investments being made by private Chinese conglomerates with the policies of the Chinese government and to stabilize the financial system by reducing the risks that the actions of these private companies could end up having on the Chinese economy as a whole.  While there have not been reports of anything amiss being uncovered by these investigations, it does reflect the Chinese government's increasing concerns over investments by such Chinese conglomerates, which have relied heavily on loans from Chinese banks for their acquisitions, and have certainly had the effect of curbing the voracious appetite of these active buyers of assets.

… BUT A BOON FOR PRIVATE EQUITY INVESTORS?

The regulatory developments in China may have the effect of increasing the ability of private equity investors to compete for M&A opportunities that may have otherwise been won by Chinese conglomerates.  Sellers are increasingly demanding greater certainty that a deal would not be stopped by any regulatory hurdles that may prevent deals from successfully completing.  Therefore, without being subject to capital control restrictions or being targeted by the China Banking Regulatory Commission (or any other Chinese regulator), private equity funds may have an advantage against Chinese conglomerates in the new deal landscape.  By contrast, Chinese conglomerates who previously overwhelmingly accounted for headlining Chinese outbound mega deals may now find it relatively difficult to continue on with their acquisitive streak.

To further add to their competitiveness against Chinese corporate buyers (as well as corporate buyers globally), private equity funds currently have record levels of capital to invest.  The private equity industry across the globe has reportedly raised well over US$500 billion from investors over the past 4 years, resulting in unprecedented levels of dry powder of approximately US$963 billion as at July 2017.  Recently, for example, the Apollo Investment Fund IX has raised US$24.7 billion, KKR raised US$9.3 billion for its Asia-focused private equity fund, and Blackstone raised over US$5 billion for its Asia opportunities fund.  Most notably, it has also been reported that Carlyle has plans to raise US$100 billion in the next four years. 

Overall, with the largest stockpile of dry powder that private equity funds have had on record, and with regulatory developments in China curbing the freedom of acquisitive Chinese conglomerates, the playing field is looking much more level between private equity funds and Chinese strategic buyers than it has been in recent years.  Add to that a maturation of the private equity industry across APAC; private equity funds in this part of the world (and elsewhere) may see their role, as a key driver of regional as well as global M&A activity, increase in the times ahead.