US funds struggle to cash out from China

Fewer IPOs and TikTok bill in Washington undermine exit to once bountiful investments

SUN YU — NEW YORK · Mar 18, 2024

US institutions with private fund investments in China are struggling to exit what were once among their most successful bets as the regulatory environment tightens and geopolitical tensions mount.

Four public pension plans with more than $4bn allocated to China-focused private equity funds told the Financial Times they were ready to delay redemptions from investments nearing the end of 10-year lifespans.

Their hesitation reflects fears that US initial public offerings of Chinese companies, an important avenue to exit private capital investments, will remain subdued following a plunge caused by the Beijing-imposed delisting of DiDi, a Chinese ride-hailing app, from the New York Stock Exchange in 2022.

Their concerns have been exacerbated by the launch this month of US legislation that would require ByteDance, a leading Chinese technology group backed by more than a dozen private funds, to divest or face a ban of its popular TikTok video-sharing app.

“China has been a place where you could deploy capital, but getting it out is harder,” said Allen Waldrop, director of private equity investments at the $81bn Alaska Permanent Fund Corporation, which has exposure to China. “Now it is a much more severe issue.”

US-backed private funds have for much of the past decade been among the most active investors in China’s burgeoning consumer and internet sectors, as the likes of Sequoia Capital and Silver Lake financed some of the country’s most successful start-ups such as Alibaba and Meituan.

The investment boom carried on even after a trade war broke out between Beijing and Washington. From 2018 — when Donald Trump, then US president, imposed punitive tariffs on imports from China — to 2020, Chinese companies received $33bn from private equity led or co-led by US funds, according to Future Union, a group that advocates for US private equity funds to divest from Chinese companies. The sum topped the $20bn received from 2015-17.

The IPO bonanza that enabled hundreds of Chinese companies to go public in New York ended abruptly in 2022, when Beijing undertook data security reviews of companies seeking overseas listings. Records show that only five Chinese companies with US-backed private equity investment have gone public in New York since the beginning of 2022. The figure was 18 in 2021.

US-led private equity and venture capital investment in China also fell 68 per cent year on year in 2022, according to Crunchbase, a financial data provider.

While the Federal Reserve’s aggressive interest rate increases have been a blow to US IPOs across the board, Beijing’s policy intervention has played an equal, if not bigger, part in keeping local Chinese companies from listing abroad.

In July 2021, for example, the Cyberspace Administration of China banned DiDi, funded by prominent US investors such as Silver Lake and Coatue, from local app stores for launching a New York IPO despite national security concerns from the authority.

Several months later, China’s stock regulator announced rules that required local companies to go through a complicated review before gaining approval for overseas listing. DiDi withdrew from the NYSE in June 2022 as part of the regulatory overhaul.

The stringent review has forced many companies to put off or even give up their US IPO plans, even though a listing would provide the best outcome for their private equity shareholders.

“Investors have gradually come to realise that it has become almost impossible for many Chinese companies to list abroad,” said Ming Liao, a partner at Prospect Avenue Capital, a Beijingbased private equity fund.

The bill on ByteDance, which passed the US House of Representatives last week, has made achieving an exit even harder as the Chinese internet group, financed by prominent US funds, could plunge in value if it were to lose one of its most valuable assets.

“These investors can’t make any adjustment to their China allocation that has grown too big because of their allocation to ByteDance that has been caught up in the geopolitical crosshairs between the US and China,” said the head of private equity investments at a public pension plan that owns ByteDance stakes.

The IPO slump has taken a toll on China-focused private equity managers once known for their stellar performance. The net internal rate of return, a performance benchmark, of the $2.2bn Warburg Pincus China fund, which began operation in 2016, plummeted to 7.9 per cent in September last year from 25.5 per cent two years ago, according to public filings.

“You have the China complications, but you also have the broader market complications,” said Waldrop. “For those [China-focused] funds it’s a particularly acute issue.”

While most investors do not have to make an imminent decision, they are aware of risks that are set to worsen in the coming years as an increasing number of private equity funds become due for liquidation about a decade after their launch.

“The fact that there’s something that you cannot exit from would of course be a source of concern,” said an executive at a second public pension plan with more than a dozen Chinese private equity investments, adding that “any unexpected lengthening” of investment lifecycle would affect his fund’s future deployment.

Yet most industry insiders could barely find a better solution than extending the private equity duration in the hope the IPO window will reopen.

“Investors are not really going to have much of a choice,” said Niklas Amundsson, a Hong Kong-based partner at Monument Group, a private equity placement agency. “They just have to keep on rolling over the [investment].”