Sometimes it pays to wait. As investors were clamoring for China-related deals in the first half of 2008, Bohai Industrial Investment Fund Management, one of the country’s few government-backed private equity (PE) funds, sensed a hot market and chose to stand on the sidelines. Now, looking back over a year in which the financial crisis has laid waste to large tracts of the global PE industry, Bohai finds itself on relatively steady ground.
The hedge funds and proprietary desks of investment banks have retreated from the market. Foreign PE firms that remain are either focused on helping portfolio companies stay afloat or hamstrung by an inability to raise funds from newly cash-strapped limited partners (LPs). Consequently, Bohai claims its negotiating power has strengthened on a greater number and variety of deals.
"For Bohai and other firms who have secured financing, the crisis has been good news during the investment phase," Ma Jun, Bohai’s managing director, told CHINA ECONOMIC REVIEW.
Not the norm
Bohai isn’t your typical Chinese PE firm. Established as a benchmark for the country’s nascent domestic private equity industry, its scale, government connections and management depth separate it from the pack of mostly small, private PE shops. But at the same time, the emergence of firms built roughly in its image – municipal governments are eager to join in the action – is a sign of things to come, and their activities are closely followed by both domestic and foreign participants.
Bohai ended its self-imposed stasis in March and the firm’s investment committee approved three deals over the ensuing three months, Ma said. The only one of these so far made public is an investment in Anhui-based automaker Chery, alongside CDH Investments and China Huarong Asset Management Corporation. Chery this year has received a total investment of US$424.3 million from domestic investors, though the full roster of investors has not been disclosed.
The Chery investment brought with it an added advantage: The company had already begun preparing for an A-share listing, a plan revived now that mainland and Hong Kong equity markets have outperformed global peers and the government has ended a nine-month moratorium on initial public offerings.
For all investors, exit routes are open that just a few months ago were all but closed – and Bohai isn’t the only one to sense a shift in the winds. Insiders say that while the industry went into a lull at the end of last year and in the first quarter of 2009, investors were still hard at work performing due diligence and meeting with target companies. The market is beginning to see the fruits of their labor.
The line between private equity and venture capital (VC) in China has always been blurry, a product of limited PE buyout opportunities and few VC firms opting for the true early-stage investments they typically pursue in the West. Nonetheless, PE investors poured US$15.2 billion into Chinese companies in the first half of the year, according to China Venture, a consultancy. This compares with US$11.5 billion in all of 2008, and US$19 billion in the heyday of 2007. Venture capital investment stood at US$9.5 billion in the first half, compared with US$5.1 billion in 2008 and an equal amount in 2007.
Most of this cash was flashed in the second quarter, with disclosed PE and VC investments reaching around US$8.8 billion, up 630% from the previous quarter, according to Shanghai-based consultancy JLMcGregor. Some expect this to be a harbinger of another wave of investment seeking a home in one of the few bright spots of a struggling global economy.
The impact of this influx of capital remains difficult to predict. Analysts say that Chinese small- and medium-sized enterprises (SMEs), who have poor access to bank loans, are in need of new funding channels, suggesting the market can safely absorb raised capital. Others sound a note of caution.
"There’s a lot of pent up demand, there’s a lot of time pressure on people to deploy capital," said Maurice Hoo, a partner in the private equity group at law firm Paul Hastings in Hong Kong. "If you look at how much money has been raised targeting Asia in the last two years, even in the case of China, you have to wonder how they’re ever going to deploy it."
Consultancy Zero2IPO estimates that US$61.2 billion was raised for investment in China last year, while only US$9.6 billion was invested.
Betting on consumption
As the financial crisis has dried up external demand for Chinese goods, investors have changed tack, eschewing companies with an export focus, and following the flag of government policy.
"The PE industry is like the general economy: It’s trying to follow the government’s guidance," said Liu Jing, a professor of finance and associate dean at the Cheung Kong Graduate School of Business in Beijing. "China is trying to switch from an export-oriented economy to domestic consumption, so people are looking for firms that produce consumer goods."
A cadre of top-tier foreign and domestic PE funds have been betting on rising domestic consumption in China. US-based TPG Capital kicked off the spending season in May by purchasing US$80.5 million worth of convertible bonds in footwear retailer Daphne International. The firm followed up in August with a 10.95% stake in Hong Kong-listed supermarket chain Wumart, acquired for US$212.9 million in partnership with Hony Capital, a domestic PE player.
In June, Bain Capital invested US$439 million in Gome, one of China’s largest electronics retailers and a company mired in scandal following the arrest of its founder, Huang Guangyu. [See: White knight: How Bain Capital’s investment helped dig Gome out of a hole] The same month Kohlberg Kravis & Roberts finished a series of investments in Ma Anshan Modern Farming, known as Modern Dairy, for an undisclosed amount, rumored to be in the region of US$150 million.
Finally, one stalwart of China’s beleaguered dairy sector, Mengniu Dairy, received US$780 million from leading domestic PE firm Hopu Investment Management and state-run grain trader China National Cereals, Oils & Foodstuffs Import & Export Corp (COFCO).
The Bain, TPG and Hopu investments demonstrate the allure of PIPE (private investment in public equity) investments amidst struggling equity markets. Despite this short burst of activity, PIPE deals are expected to remain few and far between in China.
"I think you have probably seen all of them already. [PIPE] investments are rare opportunities," said Cheung Kong’s Liu, adding that rising markets may have priced out further PIPE investments.
Entrepreneurs and investors judge the value of companies in comparison with the valuations of similar listed firms. Valuations dropped during the financial crisis. But with markets in Shanghai and Hong Kong outperforming their global peers, some in the industry are seeing signs of an uptick in entrepreneurs’ expectations.
"The window of opportunity for private equity firms to negotiate a reasonable valuation seems to be closing again quite quickly," said Douglas Ferguson, transactions and restructuring partner for KPMG in Hong Kong.
Bidding wars by competing PE firms may not yet be exerting upward pressure on the broad swathe of deals in China. But competition is rising as foreign investors look to China as a destination for investment – and as a rising domestic industry finds its feet.
Analysts say that domestic PE and VC investors have some growing up to do compared with their Western peers. However, what they lack in deep pockets or global reach, they make up for with government and industry connections. For firms seeking to become provincial or national players in China, domestic investors often hold the keys to the kingdom.
"You have 20-40 people who control the internet market in China and the local VCs can get to those guys. There’s huge exposure and opportunity for cooperation with big players," said the foreign founder of an internet startup in Beijing seeking its first round of venture investment from both foreign and domestic VCs.
Domestic PE firms have significant advantages over their foreign competitors, according to Bohai’s Ma. Not only are they allowed to invest in sectors of the economy, such as media and resources, which are off limits to foreign players, they can hit the ground running once they’ve identified their investment target. Foreign PE firm may have to wait three to four months for approvals from local government and the Ministry of Commerce or its delegates at the provincial level, before embarking on another round of approvals from the State Administration of Foreign Exchange. By contrast, Bohai took only three days to complete its investment in automaker Chery.
In the current economic environment some foreign private equity firms are beginning to look to overseas as a way to make their domestic play.
"There’s definitely a sense [among foreign PE firms] that it’s a smart move to try and team up with some of the large expanding acquisitive companies in China [for outbound investment]," said David Maund of Alvarez & Marsal Asia, a firm that specializes in improving underperforming assets acquired by PE firms. "The idea is to build a relationship with Chinese corporates by helping them in their overseas acquisitions, with the view to eventually helping them restructure their domestic operations."
Such an arrangement is favorable to local firms, as PE players can bring their global experience and connections to bear on deals, said Edan Lee, managing director of Olympus Capital. Lee is currently in talks with several mainland firms seeking to acquire assets abroad.
"They need us firstly because there could be a funding shortfall on their part, and secondly, the assets could be in a region they are not so familiar with. They like the idea of having someone alongside them putting in risk capital, and they know private equity will exit over time," said Lee, whose firm has deployed US$1.3 billion investments in Asia and invested in mainland companies such as aluminum firm Zhongwang International Group and Emeishan Special Cement.
However, some Chinese companies still balk at the difficulties related to managing overseas assets, according to Rob Abbanat, managing director of M1 Capital Group China in Shanghai. His firm had offered to help a Chinese paper company acquire assets in the US, but found the Chinese side skittish about committing to management operations overseas.
"Their initial reaction was, ‘If you can package those assets and send them back to us in China, that’s great. But if we have to set up a management team in the US, we’re a bit afraid to do that’," he said.
Such forays abroad may be the wave of the future, but for the moment, investors continue to set their sights on deals within China. And a lot of them appear to be biding their time.
"Investors are saying that they’ve got a lot of good deal flow and a lot of good opportunities, but there’s no incentive for them to move quickly,"