China’s tech revolution creates diversification headache for LPs

A growing number of Chinese businesses are being marketed as TMT-based, an industry conference in Hong Kong has heard.

Private equity portfolios are at risk of becoming less diversified as Chinese businesses take advantage of rampant demand for technology deals, according to remarks at a conference.

Speaking at the HKVCA China Private Equity Summit 2019 in Hong Kong on 30 May, Jie Gong, partner at fund of funds Pantheon, said Chinese portfolios could be heavily weighted towards technology as more companies introduce a telecommunications, media and technology (TMT) angle to their business model.

Some managers have been accused in recent years of “tech-washing” assets to secure higher valuations. As of November, global tech companies had traded at 22x EBITDA in 2018, according to S&P Global Intelligence.

“Aspirational GPs, as well as entrepreneurs, very much want to make their companies in the mode of technology companies and have every incentive to enlarge that technological layer into being the core of the company,” Gong told delegates.

“Being an LP, that presents somewhat of a challenge because from a diversification point of view you don’t want your whole portfolio to look like an overall tech fund.”

The incentive is clear for GPs. Global software buyouts delivered a 1.9x median gross return between 2005 and 2014, compared with 1.6x for non-software deals, according to data from CEPRES PE.Analyzer.

Gong said early stage venture is “more isolated from the language troubles” of the market, as investors can assess an entrepreneur’s background and true nature of the business.

“It’s important to keep that diversification across industries and to go back to basics to ask ourselves: ‘Is this actually a retail company, or is this a technology company?’ It’s very useful to peel the onion several layers to understand […] whether this is a true TMT deal or a deal with a layer, or even camouflage, of technology.”

Gong was joined on stage by Nina Gong, managing director at The Carlyle Group, who noted that almost two-thirds of deals the firm has completed in China above the $150 million ticket size in the eight months to April can be characterised as TMT or new economy.

“In every deal we look at, there’s always a tech angle,” said Gong, who specialises in consumer and retail.

“There is no consumer and retail company in China or even the world that doesn’t have a tech theme or doesn’t have a digital strategy. Most of the deals or successful companies we look at as targets have at least 20, 30 [percent], or even half of their revenue coming from new economy channels or e-commerce channels.”

The internet and technology sectors, which make up China’s new economy, accounted for almost 85 percent of the growth in greater China private equity since 2010, according to Bain & Co’s Asia-Pacific Private Equity Report 2019. China claimed more than 70 percent of the total value of Asia-Pacific internet and technology private equity deals last year with $59 billion deployed – more than 20 times what was spent in 2010.

Eighty percent of greater China-focused funds were considering or actively pursuing new economy deals as of April.