Invest in China's consumers, says PE veteran

Amid a slowdown in China’s economy, the consumer sector remains relatively buoyant with Nielsen’s consumer sentiment index in Q2 2013 rising two index points to 110 from the previous quarter, and up four points from same period last year.

Lunar Capital founder and managing director Derek Sulger, who is based in Shanghai, spoke to AsianInvestor during a recent visit to Hong Kong to discuss his view on PE opportunities in China’s consumer sector.  

Established in 1999, the China-focused private equity firm owns a range of consumer portfolio companies that include Guizhou Yonghong Food, a snack-maker that specialises in beef jerky; baby apparel brand Yeehoo; and household appliance producer Tenguard.

AsianInvestor: What is your view on China private equity right now, given the country’s slower rate of economic growth and stagnant IPO market?
Derek Sulger:  In the overall alternatives sector, hedge funds are struggling and private equity exits have not been fantastic. But this is probably a golden time for private equity, particularly in China, because the current market environment allows you to do much more interesting transactions. More importantly, it plays to our strong suit, which to buy and run companies.

I tend to prefer chaotic markets because you have more time to think and stay true to your own core competence. There’s no pressure, as in a bull market, to do anything stupid.

Has the bar of expectations by investors remained high, given the outsized returns realised in China PE a decade ago?
To some extent, returns were very high 10 years ago because investors were buying into businesses at a very early stage, but at the same time took on a lot more risk.  When you adjust for risk, the returns in China are just as good now as they were 10 years ago.

In strategies like ours – where you’re in control of your companies – the risk profile of the investments has dropped dramatically. 

Will Lunar change the way it does business, given the changes in the market?
No.  How we’ve done business 14 years ago is exactly the same as what we do today.  Five or 10 years ago, it was much more controversial to talk about buying companies that have good exposure to central and western China.

Some people pooh-poohed my stubbornness in wanting to be operationally involved in businesses. It’s a great environment now because this skill is starting to be recognised in China. Running companies well is a timeless ingredient to making good investments.

How does Lunar source its deals?
We have a formula, criteria and sectors we like. Our portfolio businesses tend to be very much consumer-focused.  Most of the brands in which we want to invest are the ones you see on supermarket shelves or in department stores. If no one knows who the company is, we probably don’t want to invest in it.

Is there is more competition for the types of companies and deals you’re seeking?
No. The Chinese market is much bigger and deeper than people often give it credit. When there are fears over competition, it’s because there has been a tendency in China for people to do the same thing.

For example, if an e-commerce company goes public, everyone will want to invest in an e-commerce company.  But there are only a few good ones, leading to a perception that there’s tremendous competition for e-commerce investments, and the price for these companies can rise dramatically high.

The more general businesses, such as older consumer brands, have been far less susceptible because there’s so many of them, and they are very diversified.

What would be China PE’s biggest selling point now for investors?
The returns have generally been good. Historically, private equity has been the best way to gain exposure to some of the more exciting trends. If you want exposure to the Chinese consumer, you can get much more robust exposure through private equity than the public markets.

That’s because there are very few good, listed consumer companies in China right now, whereas there are a lot of good small- and medium-sized Chinese enterprises in the private equity sphere. 

*A full version of this article will appear in the September print edition of AsianInvestor