Healthcare buyouts to be a key opportunity amid China's private capital market slowdown, experts say
Healthcare buyouts to be a key opportunity amid China's private capital market slowdown, experts say
After years of superheated growth, China’s private capital market is losing its luster as bearish sentiment mounts amid rising investment risks, including the latest mass demonstrations. Fundraising in China plunged 81% to $21.5bn in 2022 YTD from $116bn last year, according to Preqin Pro.
But there are still pockets of opportunities for the picking in the Chinese private capital market, according to the expert panel at Preqin's the future of alternatives: China in focus webinar last week.
Buyouts, for instance, are set to become mainstream in the next 5-10 years, driven by the healthcare sector, despite currently only accounting for a fraction of the total AUM of investable money.
'In 2021, we scanned for 60 deals of potential (healthcare) buyouts, with an overall transaction size of about $3bn. In the last ten months, we looked at 100 more deals and overall sizes of more than $5bn,' said Yifei Wang, Partner at GL Capital Group. 'Within a short period, the trend has been accelerating.'
A lack of successors in established healthcare companies and the industry's evolution into more mature and structured growth are two key drivers behind the big-ticket deals. Many first-generation owners are now seeking specialized institutional investors to scale it to the next level, explained Wang.
2023 and 2024 poised to be best healthcare vintages in China
The MSCI China healthcare index peaked in September 2021, with drawdowns of about half since. Such valuation markdown could translate into private market valuations and make the next couple of vintages attractive for healthcare investments, highlighted Wang.
Last year, venture capitalists piled a record $29.8bn into 1,336 healthcare deals, doubling the total amount invested over the previous two years (Fig. 1). As a result, the huge imbalance in supply and demand has inflated healthcare valuation over the years. While current markdowns are bringing such sky-high valuations back to reality, positive cash flow remains king for companies to stay afloat without additional funding.
Investors used to be able to stomach unprofitable but high-growth and promising startups but since this year, the tables have turned as cashflow takes precedence as an investment consideration. In China, fund managers are also finding it harder to raise funds of the target size. Today, the average fundraising cycle in Greater China has stretched to a record 16 months, up from 11 months in 2021 (Fig. 2).
Growing interest in secondaries
Investors worldwide are increasingly divesting fund interest in the secondaries market to generate liquidity as the current public market challenges exacerbate the denominator effect.
In China, some view the secondaries market as representing a 'historic investment opportunity' as a torrid fundraising environment is throwing up favorable discounts, said Feng Guo, Managing Director at Gopher Asset Management.
Yan Guo, Principle at LGT Capital Partners, echoed the same sentiment: 'Many private companies are still held at 2021 valuation, while the public market and public comparables have corrected significantly this year. As a result, buyers would require a steeper discount, but many sellers are not ready to embrace this reality, so there's a pricing gap between buyers and sellers.'
She noted that bridging this gap is a major reason for the rise of structured solutions in secondaries deals, compared to a straight cash transaction.
China's secondaries market has entered a fast-growth stage, led by GPs, with an enormous scope of expansion, according to Feng Guo. China's secondary trading market currently accounts for below 1% of primary market transaction volumes compared with 8-10% for the global market. Coming from such a low base, he expects China’s secondaries market transactions to grow at a CAGR of about 30% over the next 5-10 years, tripling the growth of the primary market.
'GPs would like to use secondary opportunities to attract new LPs, and provide more liquidity for existing funds especially when overseas exits slow down,' said Yan Guo.
At the same time, there are growing calls for GPs to improve Distributed to Paid-In Capital in China funds to match those in mature markets, such as the US and Europe. The secondaries market is one of the tools that GPs are using to help achieve that.
With private companies staying private longer and quality assets getting harder to find, many leading fund managers also use secondary funds to hold prized targets by extending the fund duration and investment mandates, all the while generating fees.
To find out more about current trends in China’s private capital market, watch our webinar recording.