How secondaries will build the Great Wal(greens) of China

HarbourVest Partners’ single-asset restructuring is a prime example of how – if all interests align – such deals can be a perfect prescription for old assets with residual value.

What do you do when you’re holding onto an asset that is poised to benefit from a $160 billion market but is stuck in a fund that’s nearing the end of its second extension?

This is exactly what China-focused private equity firm Capital Today faced earlier this year with Yifeng Pharmacy, the sole remaining asset in its 2006-vintage China Growth Fund I. Yifeng has delivered 14x cost over the 10 years since Capital Today acquired it in 2008 and now boasts around 3,500 stores across Greater China.

“If we cashed out, we could make a lot of money from carry but instead we decided to roll over all our carry into a new fund and hold [Yifeng] for another seven to 10 years,” Kathy Xu, Capital Today’s founder, told Secondaries Investor. “The main reason is that we believe Yifeng can become the Walgreens of China.”

Xu felt she and her team could extract more value from Yifeng for several reasons. Pharmacies don’t need to keep up with market trends in the same way retail and fashion businesses do; when it comes to buying medication, customer trust is key – the older the brand the better, according to Xu. What’s more, structural changes in China mean that state-run hospitals and clinics, which dispense around 90 percent of the country’s drugs, may end up giving ground to drug stores, which currently account for only around 9 percent of sales.

In other words, Capital Today knew it was sitting on a potential goldmine in China’s pharmaceutical market, which is estimated to be worth 1.1 trillion yuan ($160 billion; €141 billion) by 2022, according to healthcare consultancy firm IQVIA.

Enter the secondaries buyers. Xu engaged Lazard to run a price discovery process that resulted in a consortium led by HarbourVest backing a new vehicle that acquired Yifeng. Secondaries Investor understands the group included Neuberger Berman, PineBridge Investments, Australia’s ROC Partners, Iconiq Capital and the World Bank’s IFC-Asset Management Company and that the deal involved $423 million in capital commitments, more than half of which came from the secondaries buyers.

Moving Yifeng into a new vehicle with new terms was a “really nice way” to hold onto a promising asset while allowing certain LPs, some of whom were funds of funds with finite investment periods, to cash out, Xu said.

Reinvesting 100 percent of Xu and her partners’ carry into the new fund was a crucial part of this story and demonstrated to LPs that the GP wasn’t running the process for short-term gains. As more of these types of deals spring up, expect the issue of carry reinvestment to play an even more important role.

What’s an acceptable minimum level of carry reinvestment in a fund restructuring? Let us know: or @adamtuyenle