VentureWire ,

Sonja Cheung,

May 21, 2012,

(c) 2012 Dow Jones & Company, Inc.

Chinese private equity deals are likely to increase in the second half of the year as challenging public capital markets force companies to seek out private funding, according to industry insiders.

At the same time, they said it is unlikely that foreign investors will get a large slice of that pie as China's central government cracks down on selected yuan-denominated funds, allowing local general partners to remain in the driving seat for most domestic deals.

Chinese venture capital and private equity deals have usually ramped up in the latter half of the year, according to data provided by Zero2IPO Group, showing that in the second half of 2010 there were 430 venture capital deals compared with 387 transactions in the first half, while 204 private equity deals outweighed 159 deals.

For 2011, there were 45 more private equity transactions in the second half compared with the first half's 325 deals. Venture capital deals slowed slightly to 725 from 780.

This year up to the end of April, there have been 184 venture capital deals, and 130 private equity transactions, according to Zero2IPO.

Many Chinese companies that wanted to complete a public offering earlier but found the market unreceptive will likely seek out a "substantial amount of private money" instead, said Gary Rieschel, founder of Qiming Venture Partners, a firm focused on early-stage investments in China.

China's largest car-rental company, China Auto Rental Holdings Inc., which is backed by Hony Capital parent company Legend Holdings Ltd., pulled out of a U.S. listing in April that stood to raise $137.5 million.

Rieschel said that online commerce and group-buying companies that would have sought public listings will instead be looking to raise private rounds. This follows a steep drop in the share price of VIPshop Holdings Ltd. after completing a listing in the U.S. in April. The Guangzhou-based company previously received funding from Sequoia Capital and DCM. Additionally, Chinese social commerce site Lashou Group Inc. last year delayed its IPO. Lashou's investors include GSR Ventures.

"It's going to be difficult for some companies to maintain their valuations, especially those that raised rounds in 2010 with a view to listing in 2011 or 2012, their valuations will likely be down," said Rieschel, who is based in Shanghai. "As an investor, if you believe in their long-term success these could be considered attractive investments, but in the short term probably not."

Walker Wallace of O'Melveny & Myers LLP said there is "less crazy money being thrown around" since the initial public offering window for Chinese companies has started to close, and that there's now an increasing willingness from businesses to complete trade sales, that is especially beneficial for "marginal companies" with a "solid business but no IPO story."

Historically in China, general partners' exit strategy has largely focused on public offerings, while in the U.S. acquisitions have become more commonplace, Wallace said. However, China's merger-and-acquisition market is still at an early stage, both Wallace and Rieschel agreed, with only a handful of notable acquirers like search company Baidu Inc.

Even a recent ruling from the country's National Development and Reform Commission, which emphasized that foreign private equity firms will still be curbed from using their yuan funds in certain Chinese deals, is unlikely to dampen deal flow in the second half. If anything, domestic general partners will just step up and invest in the lion's share of yuan-denominated deals, while overseas firms wait and see as different parts of the government try to influence and control overseas players investing in China.

Rieschel noted "there's there's enough renminbi in the market, domestic deals don't need foreign firms." However, some yuan investors lack the experience of dollar-investors who have typically been in the market for longer, and as a result "bring less value in terms of ramping up the business," said Wallace, adding that "dollar-investors usually insist on an offshore structure, so for a company doing anything beyond China, this is a huge strategic advantage."

Looking forward, investment sweet spots likely will include companies involved in mobile payments and businesses that can help monetize mobile sites by advertising, said David Wolf, president and chief executive of Wolf Group Asia, a corporate strategic communications advisory firm. Rieschel's darlings include health-care and environmental science businesses as well companies that focus on the transition to mobile.

-By SonjaCheung; 86-10-8400-7754; sonja.cheung@dowjones.com; Twitter: @SonjaCheung.