Sunday, September 23, 2012

Investments in China

There was a time when I used to speak with a few people from the Indian PE industry; one such person (from 2011) said that LPs are not happy with India because compared to China, Indian investments have not returned money (through exits) and not returned enough in % either when compared to investments in China.
Back then, it made me stand a little in awe of China and how it was able to provide such good exits to PE funds.
Things have changed now, and it is not related to the China 'slow-down' of growth rate falling to below 8%. Things have changed because my interpretations have changed.

1. When one looks at the Chinese stock indices (and I have not looked at them well), one sees that the returns have been disastrous - this is largely due to a significant weight of Chinese SOEs (State owned enterprises) in the indices which keep getting capitalised by the centre and whose main focus seems to not be on profitability but on 'growing the economy' through investments.
The capitalistic machinery always drives on profitability and not on general welfare.
This point implies that there are very few large private (non-govt.) Chinese organisations which are creating significant value for shareholders, nonetheless, PE players have been able to make tons of money. For me, this means that as long as one can pass along a hot potato, one will generate god returns.

2. Returns are a function of entry and exit points. If the entry is at a high price, the exit also needs to be at a high price, but the exit is governed by the availability of fools at the other end whereas for the entry you yourself can be the buying fool.
In India, may be, many PEs overpaid for companies prior to 2008 and wanted to exit before 4-5 years. In China, capital has been more easily available (and so has debt capital) which facilitates over-priced transactions.

3. Short-sellers and researchers have become more active in China in the recent past. Look at Kynikos, Bronte, Muddy Waters and others. Focus Media is a good example of things going well while the going is well :)
Let's see how the cookie crumbles. Because, what happens when cheap debt funding dries up? And what happens when investors lose faith in accounting numbers?

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