Baring on China’s consumer boom

By Private Equity International

Increased affluence is driving demand for high-end products and opening up opportunities, says Baring Private Equity Asia’s Guy Cui.


The consumer and services sectors are set to dominate China’s economic landscape by 2030 as the affluent middle class shift to higher quality products. Guy Cui, a Beijing-based managing director of pan-Asian manager Baring Private Equity Asia, explains why taking a controlling stake is vital to maximise the investment opportunities.


What’s your view on the rise of the consumer and services sectors?
It’s a trend that we have been following for quite a while. According to a recent report by Morgan Stanley, China will have gross national income per capita of almost $15,000 by 2030. Their view is based on a slowdown in GDP growth, from the current 6.5 percent to around 3.1 percent per annum growth by end-2030. More importantly, the consumption and service sectors will account for a sizeable portion of China’s future GDP: services for around 60 percent of production and consumption for about 47 percent of expenditure.


I can see this happening. We have noticed the consumption and service-related sectors taking off in the last few years. And with China entering the field of high-income countries, consumers are increasingly focusing on safety and quality, rather than price. They are looking for branded, overseas products. I’ve seen this in the food sector, an industry I’ve been focusing on for the past five years.


We expect this will continue, and we could see even more robust activity in sectors such as healthcare, education, food & wellness, environmental services and intellectual property in the coming years.


How about the moves by the government to drive consumer growth and develop national champions?
As a long-term trend that is possible, but obviously before you reach that goal there is a natural process of evolution. For example, infant formula and dairy products could be considered “new” for Chinese consumers before the 1990s. I still remember when Mengniu was founded in 1999. At that time the dairy industry was still in its infancy in China. Now you see national champions like Mengniu and Yili are leaders in the industry, but that has taken nearly 20 years.


The mass-market national champions are still growing strongly, but it will take some time for them to dominate the market. While China has leaders in general dairy products, the infant formula market is still dominated by international brands – approximately 80 percent in tier 1 and tier 2 cities – hence it’s easier for Chinese companies to acquire overseas brands to accelerate the process of becoming national champions.


With heightened competition in China’s hot sectors, how do you differentiate yourself?
I don’t see much difference in the level of competition between now and before. The competition has always been there. How we differentiate ourselves is by our ability to add value. In the past, it was relatively simple when most of the investment opportunities in China fell into the growth capital category. That meant that all the GPs were chasing minority investment opportunities in fast-growing companies, and only needed to select the right sector and the right founder. There was very little value-add, aside from knowing the founder and the reputation of the firm, because most of the founders were looking for help to achieve an overseas IPO in Hong Kong or New York.


Today the market is much more sophisticated. That was an essential development – because of the slowing economy there’s less of the traditional high growth opportunities, and GPs today need to be able to provide so much more value to their investee companies. Fortunately we picked up this trend very early. We are able to add value by being in control of the company, whether on our own or alongside a like-minded partner. We have developed an institutionalised model that uses in-house expertise and repeatable processes based on 20 years of experience. That allows us to be deeply involved in the company’s operations and to create value for all shareholders.


What role does pricing play in value creation?
We believe pricing is not the most important factor when the company decides which private equity firm will become their partner. We look at how we can help the business and approach the company with a clear plan on how we intend to take them to the next level. Because we take controlling ownership stakes, we are more willing to invest in resources together with our partner. In this way, we don’t compete with our peers simply on price.


One example is COFCO Meat, a company we bought in 2014 alongside other investors, and which is now listed on the Hong Kong Stock Exchange. The company’s business is hog farming and manufacturing pork products. At the time we invested in the company, it was barely making a profit. Within two years, the company has achieved a listing in Hong Kong and its latest results show net profits of 950 million yuan ($138 million; €130 million). We spent enormous resources on working with management to improve operational efficiency and invest in technology – all key value drivers that had been planned in advance to increase the company’s top and bottom line. We also redesigned the remuneration structure, brought in long-term incentives and upgraded the senior management.


Do you prefer mass market consumption goods over niche high-end goods?
We want to invest in businesses that have the potential to become the market leader in a large and growing market. But we also have a prerequisite that the business must be stable, profitable and scalable. Given the broader appeal of their products, consumer staples companies usually have those characteristics more often than niche products, which only appeal to certain people and might be more difficult to scale.


But we still like the high-end market as it fits within the trend of upgrading the consumer product and service experience. We are particularly interested in niche, high-end products which appeal to the mass market.


For example, together with Bright Food Group, we invested in Weetabix, a leading UK-based company that produces ready-to-eat cereal products. Our aim is to help Weetabix expand in China as an iconic UK brand. With its “good-for-you” and “healthy-for-you” market positioning, it naturally falls into the high-end category in China. However, breakfast foods can also be considered as a mass market consumer staple. We have noticed the extremely high growth of sales of Weetabix products in China over the past two years due to its unique positioning. We continue to believe there is strong appetite from the rising affluent middle class consumers for high-end branded food products.


What are the top types of interventions across your portfolio in China?
First we need to ensure that the right management team is in place from Day 1. That could be the existing CEO if we think they are the best person for the job, but we also invest with the intention of putting in new management. We are the owners but we are not the day-to-day operators, so we need to trust that the right people are in charge. The key is making sure that happens from the very beginning so that we hit our growth targets in the first year – that sets the tone for the whole investment.


Corporate governance is another area. This involves board composition, financial management and controls, and even remuneration structures. We also need to constantly work with the management to identify new key value drivers so that we can prioritise our resources and increase the company’s value.


What’s ahead for the firm in China this year?
China is an important market for BPEA. We are very glad that we’re one of the first firms in China to have realised the importance of doing control deals. We see a lot of opportunities for control deals in China, and have developed the necessary experience and expertise. Importantly we know how to work with a Chinese company, whether it’s a privately-owned enterprise or a state-owned enterprise, and can work together as partners and create value.


The other area we find interesting is the SOE space. We have worked with SOEs in the past and would like to do some more investments with them in the future. SOEs make up close to 50 percent of the Chinese economy, and they cannot simply be ignored. But more than that, they are great partners that can bring a lot to the table.