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China PE firms: the agri industry needs scale

A lack in economies of scale, low-tech farming techniques and broken value chains remain thorny issues for China's agriculture industry, according to local private equity professionals.

Against the backdrop of decisive, long-term Chinese government action to develop the country’s agriculture sector and raise domestic incomes, private equity investors have discovered a lucrative market in Chinese agriculture.

Explosive growth in agriculture technology, logistics, machinery, biotechnology and multifunctional leisure farms underpins the market’s appeal over the long term. But, at this stage, the lack of economies of scale, low-tech farming techniques and broken value chains remain thorny issues.

“Modern agriculture sub-sectors favoured by investors are mostly at a fledgling stage and are largely family-run businesses,” said Fu Zhekuan, chairman of Shenzhen-based QF Capital, a private equity fund manager. “They have unsophisticated mechanisation and farming practices, and loose food safety controls. The market is largely fragmented and industry value chains are usually incomplete. This makes achieving desirable profits a challenge.”

David Tang, managing partner of state-run Agriculture Fund of China (AFC), offered another take.

“Capital aside, the market needs instrumental forces like equity investors to spur consolidation of small players to create economies of scale, and the consolidation process should be extended from consumer-serving ends all the way to the upstream sub-sectors, which we hope will transform the agricultural industry structure in the country,” he told Agri Investor.

The agriculture sector in China only started attracting local private equity funds from around 2007, as international firms were the first to tap the sector. The launch of the NASDAQ-styled ChiNext in 2009 paved the way for a more liquid private equity market and a more diversified range of exit options, according to Tang.

Private equity deals in China’s agriculture sector span primary production and animal husbandry; deep-processing and industrialisation of raw agri products as well as farmlands; seeds and fertilisers; machinery; agriculture finance; logistics; and tourist farms. Tea and natural medicine production is another interesting area for investment, according to private equity professionals.

QF Capital manages an initial Rmb 550 million ($90 million; €72 million) fund, with four others ranging from Rmb 200 million to Rmb 500 million recently set up in different Southern Chinese provinces. A part of these funds will target agriculture. Most of QF Capital’s deals derive from developed provinces on the Eastern coast of China, which boast quality consumer products, technology and services from northeast, central and western China. The region also has better farming techniques and scale – its key strengths, according to Fu. “Meanwhile, unique agriculture products grown in far-flung border provinces like Tibet and Qinghai also provide some luring investment targets,” he added.

State-run funds, such as the Rmb4bn China Agricultural Industry Development Fund, are also very active in the sector. Established in 2013 by the Ministry of Finance, China Cinda Asset Management, business conglomerate Citic Group and the Agricultural Development Bank of China, this was the country’s first national agricultural industry fund.

The Rmb1.5bn AFC is sponsored by the Chinese Academy of Agricultural Sciences under the Agriculture Ministry. AFC’s investment strategies are co-ordinated with national policies to develop the high-tech upstream seed market and animal husbandry.

”Animal husbandry is one attractive space given the sheer size of the industry as well as the large number of animal feed and listed companies it can nurture,” Tang of AFC told Agri Investor. “The other space we target is deeply-processed food companies with well-recognised brands.”

“Contrary to developed countries like the US where heavily-processed and high value-added agricultural products, such as preserved fruits and vegetables, canned meats and frozen food, account for 80 percent of the entire agri sector versus raw and fresh materials which account for roughly 20 percent, China is roughly in reverse proportion, a scenario that mitigates profitability and value-added potentials for farmers,” Tang elaborated.

There is also a lot of growth potential in China’s livestock market which currently accounts for just 40 percent of GDP. This is compared with 60 percent in Australasia and some Scandinavian countries and 85 percent in the Netherlands and Israel, according to academics at the China Agriculture University.

Heavily-processed agricultural products accounted for 80 percent to 95 percent of supermarket and retail chain sales in developed countries in 2011, creating returns of about three to four times on the raw material, according to Deloitte Touche Tohmatsu, a global professional services firm. In China these products accounted for just 30 percent of sales adding between one and two times of value presenting an opportunity for growth, according to Deloitte.

For QT Capital’s Fu, ideal portfolio firms have one of the following attributes: possess the entire value chain from plantation to consumers via well-recognised brands but are in need for growth capital for expansion; provide niche outsourced agri-related services (such as fish farming which is still nascent in China); or operate in a niche such as agriculture technology – innovative seeds, green animal feeds, pesticides or fertilisers are examples. Agtech is a sector that mushrooms quickly in China, he added.

The average deal size of QF Capital ranges from Rmb$30million to Rmb$100 million and they have normally snapped up a return on investment of between four and five within a five to seven year timeframe. The three-year plus investment in Fujian Sunner Development Corporation, a chicken producer, made by a former Fu-led team garnered an extraordinary ROI of 23 times, he told Agri Investor.

AFC launched a fund to invest into public companies (PIPE) and M&A to spur consolidation. Its PIPE deals focus on high-tech imbedded sectors such as agriculture machinery, while the M&A transactions will target companies with scale and business specialities.

PIPE deals have gained momentum more generally among Chinese PE funds as a means to facilitate the expansion of small and medium-sized listed companies. And agriculture presents a hugely appealing opportunity, according to QF’s Fu.

“More large-scale agriculture firms or even behemoths will come to the fore and further large multifunctional farms integrating plantation, tourism and agriculture parks will be one of the strong forces in the Chinese agriculture scene, and hence will whet investors’ appetites for more deals for at least another five years,” he said.

This article was written by Cybil Hui Chen Chou.