China M&A Industry Trends: Consumer and Retail Sector
We spoke with JD Capital’s Director of Global Fund Management Sen Zhang to learn about the current M&A landscape in China.
6 July 2021
A year ago, we interviewed JD Capital’s Director of Global Fund Management Sen Zhang about the current private capital boom for the Q3 2020 SS&C Intralinks Deal Flow Predictor. Sen joined JD Capital, a leading Chinese private equity (PE) investment and management agency headquartered in Beijing, in 2016. During this time, the firm went public on the Shanghai Stock Exchange (SSE:600053.SH) and has domestic teams based in over 40 cities across the globe.
In his role, Sen manages the firm’s USD 324 million China-focused growth equity funds. His vast experience includes fundraising, investments and operations for his firm’s various cross-border transactions.
SS&C Intralinks: What are some of the key driving factors for dealmaking in the consumer sector?
Sen Zen: When JD Capital considers a deal in the consumer sector, we use the formula: number of users x consumption frequency x market penetration = Value of a consumer business. With this formula serving as a guiding principle, consumer businesses we are looking at usually have great growth potential in one of these three factors. For example, Shansong (闪送), the largest C2C express delivery service in China, was an investment of choice because it had growth potential from all three factors. Users grew by 10x since our investment due to more business familiarity. This, in turn, led to increased frequency of usage. With a combination of these two success factors, Shansong introduced its services to Tier 2 and Tier 3 cities to further dominate the C2C express delivery market. These same key driving factors are what led us to invest in Haidilao (海底捞), Nayuki (奈雪的茶) and other leading consumer brands in China.
In which subsectors do you see the biggest opportunities in the next 12 months, and why? How have your investment strategies and your approach toward selecting portfolio companies evolved?
We’ve been looking closely at Condiments, Food and Beverages, Restaurants, Pet Products, Skincare and Cosmetics. With increased spending power in China, consumers’ preferences have shifted to healthy and high-quality products which have opened up exciting new opportunities in Condiments, Food and Beverages. With urbanization across China, there is a significant lifestyle change for residents that is altering consumer behavior. Demographically, Gen Z in China have a purchasing preference for functionality, cost-effectiveness and culture, rather than previous generations’ desire for specific brands.
What are some of the major changes of consumer behaviors you have noticed recently? What does it take for consumer companies to remain relevant in the “new normal”?
Digitalization has seen the most significant improvement in the post-COVID-19 era. When we looked at digitalization deals in the consumer market before COVID-19, younger consumers were the target audience. However, the acceleration of digitization picked up tremendously in the few weeks of nationwide quarantine last year. Not only on the business side, but also consumers where all generations became accustomed to online purchases, digitized healthcare, remote work, study and healthcare solutions.
Community group-buying is a paradigm shift we’ve seen emerge from this crisis. This business model transformed many B2C businesses into a B2B model, leaving community managers to manage the “last mile” delivery. While having greatly improved operational efficiency, some companies have been left behind after failing to meet the localized preferences of customers.
Online distribution channels were once seen as a “value add” for businesses serving customers but were not a must in order to survive. When JD Capital invested in Nayuki during the height of COVID, the money raised was immediately used to develop and launch its online order system which modernized the company dramatically. Rather than lining up in-store for drinks, people are virtually lining up for the same product.
What differences do you expect to see between Tier 1 and non-Tier 1 cities?
In Tier 1 cities, customers consider the company culture when making their purchase decisions. The same can’t be said for non-Tier-1 cities where functionality and price are still the main driving factors for purchase decisions.
Is China’s consumer sector poised for further industry consolidation, particularly where it relates to offline (brick-and-mortar) and online retail players?
Building up an ecosystem will be the primary driver for both M&A and minority investments. I’ll point to our investment into Xiaomi that were decided upon largely due to its outstanding product lineup. However, Xiaomi has built up its online store over the years with various small smart home appliances. The company continues to expand through M&A and minority investments to enhance its smart home ecosystem.
Which players do you expect to be the most acquisitive (e.g. investors with certain industry backgrounds or resources, etc.)? Do you anticipate opportunities in companies with room to optimize operational strategies?
From our observations, Tech giants will drive acquisitions in China’s consumer market. With a significant amount of customer data, Tech giants can quickly scale up a successful business model and integrate it into their platform. We’ve seen it in the bike-sharing and portable charger businesses in the past, and it will also happen with increased community group-buying.
What are some of the risks and challenges of investing in China’s domestic consumer sector?
Data accuracy remains the highest concern when we invest in China’s consumer businesses. For B2C businesses, it is incredibly challenging to verify all of the financial and operational data. Therefore, at JD Capital, we choose to be vertically integrated with an in-house due diligence team. Compared to a traditional due-diligence process where you can only analyze a business for one to three months, our in-house due diligence team will track target companies and their performance for several years before we start investment discussions. This enables us to quickly identify the accuracy of data during the due-diligence process.
What do you think will be the biggest recurring theme for the consumer sector in 2021?
“Revenge spending” could be the biggest theme in the consumer sector. With COVID-19 under control, we could see explosive growth in domestic tourism, restaurants, bars and other entrainment.
For more 2021 insights from China and other regions across the world, check out our detailed predictions in the Q3 2021 SS&C Intralinks Deal Flow Predictor. Independently verified as a highly accurate six-month forecast of merger and acquisition (M&A) activity, the SS&C Intralinks Deal Flow Predictor is compiled by tracking early-stage M&A transactions that are in preparation or have begun due diligence globally.
Adrian leads SS&C Intralinks’ alternative investments business in North Asia. Leading a team dedicated to addressing the needs of alternative investment managers, Adrian facilitates the fundraising, fund reporting and transactional activities of private equity, venture capital, hedge and real estate funds of all sizes, strategies and vintages across the region.