China's $350 billion mutual funds industry may be stumbling due to a sliding stock market and fierce competition but that has not stopped new foreign entrants from paying hefty premiums -- double of what they are offering in India, in some cases -- to get their toes in.
Lured by long-term growth prospects in Asia's second-biggest fund market -- estimated by some to hit $10 trillion in less than two decades -- foreign investors such as Power Corporation of Canada (POW.TO) and Japan's Mitsubishi UFJ Trust and Banking Corp have recently struck deals with Chinese money managers.
Some of those deals were priced at more than 8 percent of the target firms' assets under management (AUM) -- three times more than valuations for similar deals five years ago.
"It's a tough time for China's fund industry, but foreign investors are betting on the long-term growth potential in the world's fastest-growing major economy," said Howhow Zhang, head of research at Shanghai-based consultancy Z-Ben Advisors.
"On the other hand, in their home markets, there's little or even negative growth, so China has naturally become important strategically."
Zhang forecast China's funds industry could swell to $10 trillion by 2030, boosted by rising wealth and possible policy incentives that would channel more of China's massive savings and state pension funds into the capital markets.
The pricing of the recent deals also represented a huge premium from a global perspective. In mature markets, deals are often priced in a range of 2-4 percent of AUM and even in hot emerging markets such as India, valuation has fallen now to about 4 percent.
The valuation trend is at odds with the rather subdued picture of the fund industry in China.
Assets under management has stagnated at around 2.3 trillion yuan in the past three years, even as the number of mutual funds more than doubled to around 890 during the period. Around 55 percent of the total assets are in equity and balanced funds.
Competition intensified among fund managers to attract and retain investors as China's stock market tumbled 22 percent in 2011 following a 14 percent slump during the previous year.
But a few factors are keeping valuations buoyant. Limited options for partnerships in China as well as lengthy approval procedures for new entrants are significant ones.
Then, there is the hope that local money managers would be allowed to list. Several major fund houses, including Bosera Funds and China AMC have been preparing for public share sales as they await policy changes, a source with knowledge of the situation told Reuters.
Also, acquiring a stake in an existing fund house is seen by many as a more efficient way of accessing China, compared with forming a joint venture from scratch, where building a brand and growing market share may take years.
Overseas money managers may operate in China only via joint ventures, in which foreign stakes are capped at 49 percent.
Of China's 66 fund houses, more than half are Sino-foreign ventures, with 13 foreign investors, including Deutsche Bank (DBKGn.DE), Morgan Stanley (MS.N) and Manulife Financial (MFC.TO), having entered the market through acquisitions.
More are expected to follow suit.
For example, Sumitomo Mitsui Financial Group (8316.T) SMFG.L, Japan's third-largest lender by assets, plans to acquire a minority stake in mid-sized Chinese fund house China Post & Capital Fund Management Co, sources with knowledge of the deal told Reuters earlier this month.
In addition, at least nine overseas companies, including Taiwan's SinoPac Financial Holdings (2890.TW), Korea's Mirae Asset Financial Group and UK insurer Aviva Plc (AV.L) have unveiled plans to form China ventures.
"If you look at the China position, because it is such a rapidly growing market, there is a premium price if you can get into it," said Stewart Aldcroft, senior adviser of securities and fund services in Asia Pacific for Citigroup Inc.
In the latest deal, Power Corporation of Canada paid 1.784 billion yuan for a 10 percent stake in China AMC, the country's biggest fund house that manages around 180 billion yuan, valuing the deal at more than 8 percent of AUM.
In contrast, a unit of Singapore's DBS (DBSM.SI) in 2006 bought a 33 percent stake in China's Changsheng Fund Management Co for only 174.9 million yuan, or 2.7 percent of AUM. Valuations have been climbing steadily since, according to deals with publicly announced price tags.
"In a mature market, 3-4 percent is the norm but in a growth market like China you would expect it to be quite a premium on that and when there is limited availability, again, that's also worth a premium," Aldcroft said.
Obtaining new money management licences in China is often a lengthy and unpredictable experience. China's securities regulator granted only one licence in 2007, compared with eight in 2005, for unexplained reasons, which has led many foreign investors to turn to acquisitions.
But after the 2007-2011 buying spree by investors, including Italy's Assicurazioni Generali, Japan's Nikko Asset Management Co and Dutch insurer AEGON, there are few targets left that are both healthy and up for sale.
"Getting anybody good in China is very difficult. If you had hundreds and hundreds of good managers available, then it would be easy but they aren't," Aldcroft said.
"Anybody who is doing well isn't going to be selling right now. It's a sellers' market so the prices are very high."
Morgan Stanley, for example, has bought into a struggling Chinese fund house after agreeing to pay 13 percent of AUM -- a valuation level that analysts say reflects the Wall Street bank's eagerness to enter China as well as the distressed situation of the target company.
Foreigners also face competition from local bidders who have been seeking a stake in fund management companies in the hope that regulators would one day allow money managers to sell shares publicly, potentially boosting investors' returns.
"It's not clear when regulators would give the green light to fund house IPOs but there are some companies actively preparing for a listing," said Zhang of Z-Ben Advisors.
"And when it comes to deal pricing, the prospect of a listing has been taken into consideration."