Carlyle wary of China deals as it braces for tepid recovery

Carlyle Group, which has $3.25 billion invested in China, is wary of new deals in Asia’s largest economy as it primes its portfolio companies for a tepid recovery in a world still reeling from the coronavirus.

Yang Xiangdong, a 19-year Carlyle veteran who leads the $217 billion buyout giant in Asia, said there’s nothing to be gained from trying to be the “hero” who calls the bottom of the ongoing churn.

“China ramped back up so fast and we were expecting business to be back to 100% normal by now or soon, but we haven’t quite seen a return to that level yet across the whole portfolio,” Yang said in an interview in Hong Kong.

The firm held off in the first five months on making any fresh investments, part of Carlyle’s decision globally to tread carefully as rivals rushed in to snap up distressed assets. Its energies have been focused on ensuring its portfolio companies adapt quickly to business in the coronavirus era, where McDonald’s China now offers customers the temperature details of the chefs flipping their burgers and lab operator Adicon has pivoted to tapping the booming market for Covid-19 testing among workers returning to the office.

The outbreak has worsened a slump after a dismal 2019, when a trade dispute with the U.S. and deleveraging weighed on growth and investments in China. The climate is further clouded this year by growing political tensions with the U.S. over a clampdown on Hong Kong and moves in Washington to limit Chinese companies’ access to American capital. A recent spike in virus cases in Beijing now casts even more doubt.

Private equity investments involving a foreign buyer have amounted to just $600 million through May this year in China, about half of the same period last year, according to Prequin. The number of deals slid to 9 from 16.

The firm held off in the first five months on making any fresh investments, part of Carlyle’s decision globally to tread carefully as rivals rushed in to snap up distressed assets. Its energies have been focused on ensuring its portfolio companies adapt quickly to business in the coronavirus era, where McDonald’s China now offers customers the temperature details of the chefs flipping their burgers and lab operator Adicon has pivoted to tapping the booming market for Covid-19 testing among workers returning to the office.

The outbreak has worsened a slump after a dismal 2019, when a trade dispute with the U.S. and deleveraging weighed on growth and investments in China. The climate is further clouded this year by growing political tensions with the U.S. over a clampdown on Hong Kong and moves in Washington to limit Chinese companies’ access to American capital. A recent spike in virus cases in Beijing now casts even more doubt.

Private equity investments involving a foreign buyer have amounted to just $600 million through May this year in China, about half of the same period last year, according to Prequin. The number of deals slid to 9 from 16.

“You have to reassure the senior management and make sure they don’t panic and they have to transmit that to their employees,” said Yang. “This was particularly important during the peak in February.”

Its most daunting immediate task was ensuring that its McDonald’s franchise in China had the six million face masks it needed.

Carlyle then worked with the fast food chain to ride out the calamity. To alleviate health concerns, McDonald’s developed a contact-less business model where customer don’t interact with employees. Helping tracing of the virus, its deliveries offer details such as names and the temperatures of the chefs as well as the delivery person. With such changes in place, delivery sales jumped to 40% of the total from 20% as it was forced to close a quarter of its more than 3,500 outlets in February. Sales in May approached last year’s levels, and the business has recovered further this month, according to Carlyle.

Luolai Lifestyle Technology Co., a textiles and home ware shop which Carlyle bought a 10% stake in 2019, lost as much as 30% of its sales in the first quarter. It has since pushed its franchisees online, helping it return to growth in May.

Some interventions were even more severe. Adicon, China’s third-largest independent lab operator, saw its business crumble in February. The company reacted quickly to tap the emerging field of screening people returning to work for Covid-19, and managed to post year-on-year revenue growth already in April, also helped by its existing businesses line.

The lessons learned in those early days -- ensuring cash to pay for utilities and acting fast to secure supply chains -- became a blueprint for Carlyle in guiding its other businesses around the world as the virus spread, according to Yang. Carlyle now convenes cross-border forums for portfolio CEOs, where veterans like McDonald’s China boss, Phyllis Cheung, has shared her experiences on working through the crisis.

Carlyle’s businesses are now beginning to move to a more offensive posture, said Yang, but he doesn’t expect a return to normalcy in 2020 with especially small and medium size companies in China seeing a revenue drop of at least 10% this year and even bigger drops in profitability.

One lesson learned from the crisis is that bigger is better and having top management teams is crucial, according to Yang.

That will serve as a guidepost for making deals ahead as Carlyle cautiously goes back on the prowl.

“Clearly we have to maintain this absolute focus on our assets in the ground, but we are now also feeling a new pace emerge on the investing side as the world begins to reopen and recover,” Lee told Carlyle’s global fund heads in early June.