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Yuan-dollar restructurings: Worth the effort for the right buyer

Secondaries firms with local knowledge and an appetite for bureaucracy could reap the rewards.

Although coronavirus has put the brakes on new Asian GP-led deals, some that started last year have closed in 2020. One, involving Chinese general partner Kinzon Capital, is the latest example of a small but growing trend: yuan-to-dollar restructurings.

As reported by Secondaries Investor, TR Capital was lead backer of the transfer of seven growth-stage assets out of yuan-denominated Kinzon RMB VC Fund I into a dollar-denominated vehicle, a process run by Lazard. The deal was worth $100 million in net asset value and follow-on capital, with existing LPs having the option to roll or sell. A similar deal was done in 2018 by Loyal Valley Capital, Secondaries Investor reported, and another by the same GP in 2019.  

For the GP, such deals can serve several purposes. They allow them to approach international investors with a seeded, dollar-denominated fund: less risky, from the investor’s perspective, than making a blindpool investment.  

A GP may want to list a portfolio company overseas in order to drive a higher valuation. Yuan investors are restricted from participating in initial public offerings outside China. This creates an opportunity for secondaries investors to buy them out.  

There are other benefits to attracting US dollar investors. “[They] are harder to access but more stable, less fickle compared to RMB,” says Bonnie Lo, chief operating officer at secondaries firm NewQuest Capital Partners, which backed the Loyal Valley restructurings. “Many Chinese GPs are rough diamonds…  You work alongside them to help put in place an operation that can allow them to continue to raise US dollar funds.” 

For buyers, yuan-to-dollar restructurings can provide access to rare, interesting and potentially spectacular assets. Loyal Valley’s first continuation vehicle, Capital Advantage Fund, contained stakes in a number of Chinese ‘unicorns’ including ByteDance, the creator of video-streaming-app of the moment TikTok. 

These deals bring specific challenges. The yuan is not freely convertible, meaning government approval is necessary to do the required currency conversions. This process can be time consuming, said one Hong Kong-based funds lawyer. Some strategically important sectors, such as education and telecoms, cannot be directly accessed by foreign capital but have to be accessed via a vehicle called a variable interest entity.  

You have an offshore company that will invest into an onshore entity,” the lawyer explained. “That onshore entity will enter into a contractual arrangement with the portfolio company which gives the offshore investors control rights over that company without owning a majority of the shares in it.” 

Portfolio companies in these sectors need to be restructured into a VIE before a process can begin, he added another layer of red tape. 

There is a large universe of potential deals. After a few boom years, yuan fundraising plummeted by 86 percent in 2018 to $13 billion, according to Bain & Co. This was partly due to RMB investors pulling back, concerned by the lack of distributions their private equity investments have yielded up to now. All LPs in the Kinzon deal ended up selling, another indication that there is no shortage of Chinese LPs willing to cash out their holdings for the right price.  

For a secondaries fund with the ability to size up Chinese assets, the patience to see them to exit and the willingness to deal with regulation, yuan-to-dollar restructurings could prove fertile ground. Once coronavirus is out the way, of course.  

What do you think about the potential market for these deals? Contact the author on rod.j@peimedia.com