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Domestic private equity dominates the ChiNext. A model of things to come?

For whom the bell (profitably) tolls

When an investor takes a stake in a start-up company, it probably doesn’t expect to have to wait 10 years until it can cash out. But that’s exactly what happened with Beijing Venture Capital (BVCC) and the Rmb7 million ($1.02 million) pre-IPO investment it made in Beilu Pharmaceutical Company in 1999.

It wasn’t until October this year that the producer of traditional medicines was able to go public, as one of the first batch of companies to list on China’s new growth enterprise board, the ChiNext.

It was worth the wait – at the issue price, BVCC’s stake was valued at over Rmb200 million, according to New Fortune Magazine. That was 28 times the original investment, by far the highest return on pre-IPO financing for companies listed on the so-called ‘little’ board.

That’s not to say that all investors had to wait a decade to see a good return. There were several investors in ChiNext companies that more than quadrupled their money in less than a year.

Overall, 23 of the 28 companies that listed on the ChiNext last month had received private equity investments worth a combined Rmb737 million. According to the IPO price of the newly listed companies, the market value of these investments increased to Rmb5.3 billion.

There are common characteristics relating to these investors – they are nearly all domestic players, and they are often located in the same region of China as the companies they invest in.

Only two foreign funds made investments: US private equity giant Warburg Pincus took a chunk of Lepu Medical and the much smaller China-Belgium Fund invested in Zhongyuan Huadian.

One reason for the low level of foreign participation could be scale. The Warburg Pincus stake in Lepu sticks out because the investment was worth Rmb174 million, four times the size of the next largest investment in a ChiNext-listed company. The Carlyle Group has also recently announced that it has invested a combined $60 million into three Chinese high growth companies, suggesting the big international funds are more interested in writing a cheque for $20 million than for Rmb20 million.

But the ChiNext model of local capital going into local companies could be the future model of private equity in China. It’s an ideal that the government is keen on: renminbi-denominated investments encourage companies to exit on local exchanges that are accessible to domestic investors. They also reduce the risk of Chinese companies falling into foreign hands.

One way that the government has promoted local involvement is by making it more difficult for the foreign funds to do business.

Typically, dollar-denominated funds strike deals with Chinese companies that have an offshore entity (that is later used to exit the deal via an overseas IPO or an acquisition). These offshore entities are now almost impossible to set up.

As China’s financial institutions become wealthier, they are keener on setting up their own funds too. As of this summer, there were 12 in operation.

Instead of continuing with their dollar-based business models, foreign firms are switching tack, and raising capital for renminbi-denominated funds. The most high-profile of these was launched by the Blackstone Group earlier this month, which is looking to raise Rmb5 billion.

The foreign firms are also coming to terms with the fact that many of China’s most attractive investment opportunities are in small and medium-size enterprises.

So while the ChiNext proves that an investment in a small company can end in an exit via an IPO, investors like Warburg Pincus and Blackstone are going to have to get used to writing lots of $5 million cheques


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