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Who's Afraid of Private Equity?
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Once called "raiders" in the United States, private equity investors are now coming in packs to China, a country where PE was a completely unknown phenomenon even 10 years ago.


Zero2IPO, a Chinese investment research firm, recorded a year-on-year increase of 102.2 percent in PE funds raised to target China in the second quarter of 2007, not including venture capital funds.


Based on statistics from 15 funds, the amount was $5.79 billion, the bulk of which was raised abroad. Going by the Zero2IPO figure, the amount of PE funds raised in the first half of the year stood at $13.4 billion, almost equal to the amount for the whole of 2006.


Buyout firms like Carlyle and Blackstone are often seen as predators in the US. AT Kearney, a global consulting firm, pointed out in a report this year that there are still common misconceptions that PE funds have no long-term commitment and that their sole goal is maximizing short-term gains, often achieved by cutting jobs, breaking up companies and hiving them off.


But for the Chinese, PE is just another form of foreign investment. Corporate leaders, especially from the private sector, embrace it as a partner with money and managerial quality.


Commenting on Carlyle's investment in Target Media, Yu Feng, founder of China's second-largest multi-channel advertising media company that was later merged into Focus Media under Carlyle's advice, says Carlyle offers support to Target Media in various aspects including strategy-making, structuring the management, merger and acquisition moves, corporate governance and listing procedures.


"They are sharing their global experience with high-growth companies like us."


Zero2IPO data show 31 of the 45 PE investment deals in the second quarter were targeted at high-growth companies, with a total investment of $1.018 billion.


Network synergy


After infusing the management team of a company with new entrepreneurial spirit, PE investors systematically use the international network of companies in their portfolio to improve its performance.


European PE firm 3i, which invested $20 million in Inner Mongolia Little Sheep Catering Chain Co, based in the Inner Mongolia Autonomous Region, invited Nish Kankiwala, former president of Burger King, and Yuka Yueng, CEO of KFC Hong Kong, as non-executive directors in the Chinese company to help it draw up its strategy and sort out its management issues.


3i itself chaired two seats on the company's board of directors, using its global network to help its portfolio companies explore an overseas market.


"Our purpose (to introduce PE) was not money, but wisdom. The purpose was to introduce high-level management and high-quality talent," says Zhang Zhanhai, CEO of Little Sheep.


In another case, Carlyle actively used its network in the US to help Shanghai Anxin Flooring Co Ltd, a leading solid wood floor manufacturer in China to launch the ARK sub-brand in the American market. The firm has successfully set up 50 sales outlets in the US with Carlyle's help.


"PE funds not only generate returns for investors, but also significantly enhance the value (for the company) through their portfolio companies," the AT Kearney report points out, based on analysis of data from 30,900 PE-financed firms in Europe and the US.


"The results are reflected in rapid sales growth, healthy margins, larger investment budgets and accelerated expansion into new markets."


According to Zhang Qi, an analyst with Haitong Securities, the average return on equity in Chinese listed companies is about 10 percent. That figure is 21 percent for American listed companies.


This indicates a wide gap between the two countries in terms of management ability to create value. For Chinese companies dissatisfied with their current performance level and seeking to fill the efficiency gap, PE is often the perfect fix.


To increase management efficiency, direct investment from a foreign competitor isn't always the best option for a Chinese company. The ongoing Danone-Wahaha saga is a pretty good example of the kind of tensions such marriages can generate, with the underlying fear of the foreign partner cannibalizing the home market. PE poses no such threat as it seeks no market, all it wants is profit.


Given the difficulty of securing a controlling stake in State-owned enterprises in China, investing in high-growth private companies even with minority stakes makes perfect business sense for many PE firms.


"Unlike American or European owners, who often encounter difficulties in finding successors when their children refuse to take over the family business and thus sell their companies to PE, Chinese corporate leaders, most of whom are first-generation entrepreneurs, won't part with their controlling stake," says Lily Jin, chief representative of 3i's Beijing office.


China focus


London-listed 3i has been focusing its investments in China as minority stakeholders since its entry in 2001.


The average amount of PE invested in a company in the second quarter is estimated at only $54 million over $113 million in the same period last year, according to the Zero2IPO report.


More PE investors are clearly settling for minority stakes in their Chinese portfolio companies to avoid risks, as evidenced from the fact that their average amount invested in targeted companies is on the decline.


The continuous inflow of new money definitely reflects the pull of the "China story". A handful of pioneers have indeed made it big by listing their portfolio companies on overseas stock exchanges such as the NASDAQ. But the new M&A rule issued by the Ministry of Commerce in September has set up new hurdles for the traditional overseas listing model of red chips that most foreign-invested PE investors followed.


"The alternative is to set up a joint venture in China and to prepare for a domestic listing. We have tried that in some cases, but I have to say there are great potential risks," says Shen Nanpeng, founder and partner of Sequoia Capital China.


Unlike the sophisticated NASDAQ, with which PE is familiar, the A-share listing is a totally different ball game. The lock-in period for foreign strategic investors to sell shares on the A-share market after an IPO is three years, much longer than the six-month lock-in period on the NASDAQ or the New York Stock Exchange.


(China Daily September 6, 2007)


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