Winter is Coming for Chinese Mega Deals, But Chinese FDI Isn’t Going Away

Chinese dealmakers have been cheering their banner year of $200 billion-plus in foreign acquisitions in 2016. Yet at the same time, the Chinese government has decided to clamp down on the mega deals that have made those investors famous. Wanda Group, owner of AMC Entertainment and global flagship properties, has become just the latest target of Beijing’s heightened scrutiny. Regulators have now ordered Chinese banks to revisit the financing for Wanda’s overseas investments, stranding six of the company’s latest transactions.

This will have big implications for the mega deals that dominate media coverage, reinforced by this past weekend’s headlines of the latest Wanda crackdown. If the Chinese government takes the dramatic step of freezing financing for some outbound investments, it will significantly affect the flow of deals, and not just from Wanda. Even by delaying or restricting financing, these tactics will dampen the mood among Chinese investors. So it appears that mega deals are sure to be squeezed, which means that overall Chinese foreign direct investment (FDI) could well plateau or enter a trough for a period.

But here’s the thing: that does not mean Chinese FDI is going away. In fact, those firms that manage to weather the coming winter will end up more adept, adaptive, and able to capitalize on future opportunities. This is particularly true for the Chinese private equity and venture capital (PE/VC) investor class.

As I have written previously here on Two Fen, the Chinese PE/VC industry has risen as a serious global financier, raising some $73 billion in funding in 2016. Now that Beijing is tightening the screws on the “big five” Chinese rainmakers that have been singled out by regulators—Wanda, Anbang, HNA, Fosun, and Sino-Europe Sports Investment Management Changxing—that means PE and VC firms will be the ones that remain with the financing muscle to continue investing.

What makes these Chinese PE and VC firms more resilient isn’t simply the size of their wallet, but also the nature of their funding sources. On average, half of their cumulative funding is denominated in foreign currencies, and this matters in the current environment of stricter capital controls (see Figure 1).

For Chinese investors, on top of the typical complexities involved in any investment, it is necessary to get permission from the State Administration of Foreign Exchange (SAFE) to move currencies across borders to pay for completed deals. This can impose higher transaction costs.

In short, having access to financing in foreign currency should give Chinese PE and VC firms more leeway to get around SAFE and expedite the payment process. Some Chinese law firms have touted this fact to bolster PE and VC firms as preferred partners in outbound FDI. (Even Fosun, one of the “big five” under tougher scrutiny, hastily reassured markets over the weekend by claiming that it also had overseas funding.)

Figure 1. Chinese PE and VC Funding Sources (in $ billion)
Source: PwC.

Having powder in the keg is sure to be important. Still, it alone cannot guarantee the success of an investment, especially as Chinese outbound FDI shifts toward technology-intensive areas such as aviation and artificial intelligence. Acquiring specialized industry knowledge will be a crucial advantage for these PE/VC investors, particularly in the fast-evolving tech sector.

But this, too, could become an area of strength and adaptability. In the area of technology, at least, Chinese PE and VC firms are ahead of their domestic counterparts because they were the first to nurture many of the major Chinese tech giants (GGC Capital for Baidu, Yunfeng Capital for Alibaba, and Hillhouse Capital for, among others).

In other words, Chinese PE/VC firms comprise an investor class that knows the tech sector deeply and whose fortunes are intertwined with China’s tech boom—and, from their vantage point, potentially new tech opportunities globally (see Figure 2).

Figure 2. Chinese PE Investment Breakdown (in $ billion)
Source: PwC.

The current policy environment may tie the hands of Chinese mega dealmakers, such as Anbang, HNA, and Wanda. But that could simply shift the focus of Chinese FDI to another class of investors, as PE and VC firms can now step in and potentially define Chinese FDI in the coming years.

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