Private equity investors are bullish about the potential of technology and artificial intelligence-related companies but believe there’s still room for further correction, despite valuations having fallen from their highs just a few years ago.

Speaking in Hong Kong last week at the AVCJ Private Equity Forum 2024, panelists at a technology panel agreed that valuations of technology firms broadly have tumbled over the past three years, but it’s not nearly enough yet.

“There are a lot of companies that raised money back in 2021 at very, very high valuations, so there’s an overhang in the market right now,” said JP Gan, Founding Partner at venture capital firm INCE Capital. “These companies have cash on their balance sheets and, because of a lack of competition, have turned profitable or cash-flow positive so they don’t need to raise more money. They probably thought valuation back then was pretty good, even though it’s hard for them to raise again at those levels. I think it will take maybe two or three years for this overhang to go away.”

Wally Wang, Founding Managing Partner at Scale Asia Ventures (SAV), a US-based early-stage venture fund, added that there is still room for valuation correction in the growth-stage private market, as a combination of the higher interest rate environment and slower revenue growth at many of these companies lower their appeal.

This means while SAV is “hesitant” to enter the private market in the growth stage, it’s bullish in the earlier and later stages of these tech companies’ growth, added Wang.

But Shaun Lim, Co-President of private equity firm HOPU Investments, pointed out that valuation is just one element of what PE investors look for when making investment decisions. The target’s fundamentals – including cash flow, balance sheet, sustainable growth and exit options – are all becoming bigger focus points, he reckons.

US-Asia parallels

The three panelists all mentioned the strong focus on the US’s Magnificent Seven companies – a term used to collectively refer to tech majors Apple, Microsoft, Google parent Alphabet, Amazon.com, Nvidia, Meta Platforms and Tesla – which together account for a third of the market value of the S&P 500 Index.

Lim said the US and Asian or Chinese markets are decoupled given their different ecosystems for these technology heavyweights. But there are also parallels to be drawn and much to be learned from the US success.

“These US companies are still very much involved in the innovation game,” reckons Lim. “So if investors are interested in that, it gives us a direction on what to focus on – good companies with a strong balance sheet that are very innovative and can disrupt the industry.”

AI would be a game-changer, with Lim saying the ABCs of AI are driving its development: algorithm, big data and computing power.

“Going forward, sky’s the limit [for further use of AI],” he added. “There’s strong growth there, and it’s going to be exponential.”

Among HOPU’s AI investments include AI drug discovery group XtalPi Holdings, renamed this year from QuantumPharm Inc, which listed on the Hong Kong Stock Exchange in June, according to stock exchange filings.

Wang reckons Asia is ahead of the US when it comes to AI applications, while the US has a lead on AI infrastructure. He said there are a lot of cross-border opportunities, with SAV helping numerous portfolio companies enter the Asia market.

Gan, meanwhile, thinks Asia will have an edge in robotics in the future, given the depth of the manufacturing industry in the region.

But investors keen to dip their toes or broaden their investment portfolio in AI or technology will have to contend with numerous challenges, given rising geopolitical concerns and fears of further US-China tensions after Donald Trump takes over the presidency in the new year.

“There are opportunities, but one has to be mindful of the challenges,” said Lim. “If you’re investing in a company that could get shut down or lose a substantial part of its revenue due to geopolitical considerations, it’s a big risk. We need to adjust and be vigilant.”

Optimism lies in the fact that many Chinese companies are pursuing overseas expansion or restructuring their businesses, creating interesting opportunities for investors, said Lim.

Gan added that what is essential is clarity on rules, including from the US on what is considered a Chinese company, so investors can get comfortable with policies and tweak their portfolios accordingly.