Scaling the Great Wall: More Buyout Firms Raise Capital To Enter China


By Ari Nathanson

October 17, 2005

Talk to the average U.S. or European private equity firm doing business in China, and you’re likely to hear complaints about government obstacles, the country’s weak legal system and the challenges of obtaining financial information-all of which have prevented investment in China from establishing any kind of consistent pace. But in an increasing number of cases, those concerns are ultimately drowned out by a common refrain: The potential in China is simply too great to ignore, no matter what level of aggravation.

Over the past several months, many global private equity firms have made logistical moves or have raised substantial Asia-focused funds that include China-dedicated capital to better position themselves within the Great Wall. Bain Capital, for instance, recently hired Jing Huang away from SAIF Ventures to head up its newly formed Bain Capital China, while Kohlberg Kravis Roberts & Co. announced plans last month to open two offices in Asia, one of which will be located in Hong Kong.

On the fundraising front, earlier this year, U.K.-based CVC Capital Partners Ltd. closed the largest-ever Asia-dedicated buyout fund, CVC Capital Partners Asia Pacific II, with $1.975 billion in limited partner commitments. That move was followed in September by Hong Kong-based CCMP Capital Asia (f.k.a. JPMorgan Partners Asia), which held a $1.575 billion close on Asia Opportunity Fund II, the world’s second-largest Asia-focused buyout fund. Both investment vehicles include China in their list of target regions.

While the fundraising flurry clearly has a gold rush feel to it, market pros stress that private equity firms are starting to make real gains in China, and some of the historical obstacles are gradually improving. “The vague specter of large potential-but unproven-gains to be had from investments in China has been displaced with a very solid track record of real results,” says Thomas Britt III, a Hong Kong-based partner at Debevoise & Plimpton LLP. “Those real results have come about, in part, because of a significantly greater degree of legal predictability and certainty in China investments today than had previously been the case.”

And as China’s legal structure slowly congeals, some Western private equity pros are looking for a greater opportunity to penetrate China’s domestic market (more than 1.3 billion people strong) as opposed to investing solely in the manufacture of exports, which, to date, has made up the majority of foreign-led PE investing in the region.

One eye-catching industry is China’s domestic automotive market, says Leland Lewis, a partner at Key Principal Partners LLC. “The penetration of automotive [in China] is tiny compared to total population,” he said. “There are 1.3 billion people living in China and last year they only sold about 4 million cars [nationally]-and that’s actually a huge jump up from a few years ago, whereas in the U.S., there are 300 million people, and we sold 16 million cars last year.”

Other domestic industries in China that buyout pros have become mindful of include the Internet and value added telecommunications service providers, Britt says.

Time Is Money

However, none of this is meant to negate the fact that China is still considered the Wild West of the East by U.S. and European buyout pros. As Western business attempts to acquaint itself with its Far Eastern counterparts (and visa versa), time proves to be as important an investment as capital. Take, for example, The Carlyle Group’s $300 million deal for control of Xuzhou Construction Machinery Group. The transaction, which has been in the works for at least 20 months, and will grant the Washington, D.C.-based buyout shop an 85% stake in China’s chief manufacturer of construction equipment, is only now rumored to be nearing a close.

“The laws there still tend to be rather gray versus the black and white we’re used to, and there are always questions of whether the laws will be enforced,” says Lewis. “So you always have to work a little differently on that front because China is certainly host still host to many risks,” that have burned investors in the past.

So while at least part of the rationale for high levels of confidence in the region is the appealing track record of successful exits-such as Baring Private Equity Partners Asia’s NASDAQ listing of Chinese Internet company Netease, which has achieved a market capitalization of over $1 billion and an IRR of north of 70%, and its sale of short messaging services company Newpalm at an IRR of 45%-there remains a healthy note of caution in the region.

“The simple fact of the matter is that many people have lost a lot of money investing in China,” Britt says, “so one cannot be entirely sanguine about what can go wrong with an investment in the wrong company, or with the wrong management team, or in an industry where the market has turned away.”

So what’s next in terms of China’s foreign-led PE saga? “I think the next interesting chapter in the story of U.S. and Europe private equity investing in China will be LBOs and MBOs-acquisitions where the cash-flows from the acquired businesses are used to service debt incurred to fund the acquisition,” Britt says. “When the legal structures refine themselves to facilitate this type of acquisition financing, I think it will be a very exciting time for numerous private equity firms looking at China, particularly those looking for larger, multibillion-dollar deals.”


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