McKinsey's advice on investing in China

by: Ezra Marbach

Here are the key points and a quick thought:

  • Private equity funds with good connections account
    for the bulk of recent investments in China.
  • But, most investors will continue to struggle to pull
    off successful deals in China as investment conditions worsen.
  • Private equity investors might be better served by investing their
    funds in overseas companies that will benefit from China's economic
    boom.

The challenges of investing in Chinese companies:

  • An oversupply of capital is placing more negotiating power in
    the hands of the target companies - limiting potential
    investment returns.
  • Conducting due diligence can be difficult, concerns of withholding information.
  • Inexperienced investment teams find it hard to keep tabs on management of Chinese portfolio companies.
  • Private equity investors may struggle to secure domestic
    debt financing because many local banks remain wary of foreign "predators".
  • Private equity companies can expect
    little help from the Chinese operations of international banks, which
    have limited capacity for lending local currency.
  • Access to financing is particularly tricky for portfolio companies seeking to expand overseas through mergers and acquisitions.
  • Despite
    China's decision to lift a moratorium on IPOs, there are no timing guarantees.

Conclusion:

  • Private equity funds can
    find better China-related opportunities closer to home.
  • Many midsize US manufacturing companies
    have yet to move operations and sourcing to China. McKinsey suggests that
    there is little
    competition to invest in these companies, and they represent a huge opportunity.
  • The key is to develop a management team that can repeat these operational
    restructurings.
  • To recoup their investment, private equity firms might also consider selling their US portfolio companies to Chinese rivals looking to expand
    overseas.
  • Given the relative inexperience of the potential Chinese
    trade buyers, sellers may well be able to strike an
    attractive deal.

Quick thought: Little competition for mid-size manufacturing companies? Hard to imagine.

Another even more interesting scenario to capitalize on the outsourcing phenomenon was discussed recently in the Wall Street Journal. The WSJ profiled a US investment firm that is using the capital of number of Chinese factory owners to acquire US companies. The firm is then shifting the operations of the US companies to their Chinese investors' factories.

More here from McKinsey.