PE Firms Trapped in China After $1.5 Trillion Betting Spree

Bloomberg reports PE Firms Trapped in China After $1.5 Trillion Betting Spree

Private equity firms that amassed more than $1.5 trillion of assets in China in just two decades are now struggling to offload once-promising investments they were counting on for hefty returns.

With public markets in a slump and offering unattractive valuations, buyout firms are exploring private sales. But mounting concerns about the risks of investing in mainland China have left so-called secondary buyers demanding discounts of 30% to more than 60%, according to people familiar with the market. Haircuts in Europe and the US are closer to 15%.

The lack of easy exits — affecting the likes of Blackstone-backed PAG and Carlyle Group Inc. — has shifted the world’s second-largest economy from a vast frontier for buyouts into an uncertain landscape for long-term investing. Demand for Chinese assets cratered in the past few years, with record outflows even from public markets, as the economy struggles to regain traction and concerns mount over the political direction under Xi Jinping.

Michael Pettis Chimes In

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"Meanwhile," the article continues, "difficulties with valuations and exits have led to an increase in dry powder, which stood at $216 billion at the end of 2022." It has long been known among PE practitioners that finding new capital is easier than finding good deals.

— Michael Pettis (@michaelxpettis) November 15, 2023

Problem is Scare Demand

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This never made any sense, which is why it has been proposed for years but never seems to happen. One reason is that private companies are constrained by weak demand, and don't seem eager to expand production. The problem, in other words, is scarce demand, not scarce supply.

— Michael Pettis (@michaelxpettis) November 15, 2023

Weak Demand the Main Constraint

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I think we'll see something similar as investment shifts from the property sector to manufacturing in general. If weak demand is the main constraint, expanding supply cannot be a sustainable solution (unless you're small enough that the rest of the world can absorb it).

— Michael Pettis (@michaelxpettis) November 15, 2023

Weak Demand Question

Q: Why is demand in China weak?
A: Overreliance on property bubbles and overreliance on exports

The answer was well understood (or at least it should have been). Yet, everyone was clamoring to get into China hoping to tap China’s consumer demand.

Now they want out and cannot get out.

Adding insult to injury are Trump’s and Biden’s trade wars, and Biden’s export restrictions. China responded with its own measures.

Tesla’s Oct China-made EV sales fall 2.6% from Sept

Reuters reports Tesla’s Oct China-made EV sales fall 2.6% from Sept

Tesla’s market share in China’s EV segment shrank to 9.89% in the third quarter from 12.98% in the second quarter and 9.93% a year earlier.

It missed third-quarter estimates for gross margin, profit and revenue. It also undershot third-quarter forecasts for its global deliveries, as planned factory upgrades for a revamped version of the Model 3 curbed production.

BYD, Tesla’s biggest Chinese rival, secured its market leadership with a 22.12% gross margin in the third quarter.

Huawei-backed EV brand Aito has also made a splash lately, with its revamped M7 model garnering more than 50,000 orders within the first 25 days after it went on sale in mid-September.

China Export Subsidies

The issue of export subsides came up the other day on Twitter.

"Load of BS, if China subsidise export where is that money come from?"

@Rainloard137 is someone who does not understand trade math.

China subsidizes exports at the expense of Chinese consumers for the benefit of US consumers.

There is no debate on this. It's a fact. https://t.co/zGVYdQsGrm

— Mike "Mish" Shedlock (@MishGEA) November 12, 2023

Chinese consumers subsidize US consumers. It’s the US manufacturers and politicians who complain over this.

Every country in the world wants to increase exports and reduce imports. Mathematically it’s impossible.

The falling yuan relative to the dollar makes things more difficult for US exporters.

Despite Subsidies, the Supply Chain for Electric Cars is Still Mostly Chinese

Amusingly, Despite Subsidies, the Supply Chain for Electric Cars is Still Mostly Chinese

Eurointelligence on the EU: “Nobody is yet capable of meeting the 45% domestic content requirement.”

“The standards are impossible to meet right now because the car industry is still reliant on Asian-made batteries, which constitute some 40% of the value-added of the car. One industry study shows that the introduction of the customs duty would lead to a fall in EU production by 500,000 during 2024-2026. The UK car industry would suffer correspondingly similar falls in sales. The cost of cars would increase by some €4000.”

In the US, China wins either by licensing Chinese technology in Michigan or by having leased EV batteries built in China.

This has Ford and GM battling over parts.

On September 30, I discussed An Epic Battle: Ford to Use China’s Battery Technology, GM Wants it Blocked

In a battle between GM and Ford, $7,500 in tax credits are at stake depending on Biden’s definition of “foreign entity of concern.” The exclusion aims to reduce US reliance on Chinese batteries and materials to make them.

Global trade is a mess. A key reason is that everyone is starting to think like Trump. He believes there is a winner and loser in trade. And if everyone acts that way, we all lose.

Today President Biden meets with Chinese President Xi Jinping to discuss trade, the Mideast, and other topics.

Don’t expect much of anything to come from it. Both sides are entrenched. And it’s not just a matter of winning, both sides want the other side to lose.

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