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ASIAN VENTURE CAPITAL JOURNAL

PRIVATE EQUITY ASIA

M&A ASIA

Asia’s Private Equity News Source avcj.com May 22 2012 Volume 25 Number 19

FoCusanalysis

The SOE connection PE fi rms are drawn to state-owned assets, but it’s not for everyone Page 9

Negotiating pointsT&C concerns for LPs backing China funds 6

Hugging the bear China, Russia deepen private equity ties Page 18

The slow demise of China’s pre-IPO deals

Page 14

Foreign-backed renminbi funds meet a regulatory stumbling block

Page 12

FoCus

data

pre-ConferenCe issue avCJ private eQuity anD venture Capital forum China 2012

HarbourVest Partners’ Sebastiaan van den Berg

Page 19

PE fi rms help corporate China go global

Page 3

3i, Accel, Apollo, Bain, Baird, Carlyle, Globis, Helion, Ironbridge, Lightspeed, Longreach, New Silk Route, TPG

Page 5

Editor’s ViEwpoint

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industry Q&a

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Anything is possible...

There are many barriers to liquidity in private equity: complexity,

transaction size, deadlines, disparate assets, confidentiality, alignment,

tax, shareholder sensitivities – the list goes on.

But with creativity, experience and determination ... anything is possible.

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Number 19 | Volume 25 | May 22 2012 | avcj.com 3

Editor’s [email protected]

“Do you have a hanDle on your own management capabilities? Have you analyzed the cultural differences of the two sides? Do you understand the relationship between unionized labor and management in that place? If the other side’s engineers resign, are you really going to send people from Changsha overseas, and make the whole company speak Hunanese? If you don’t know yourself and know your opponent, then this kind of confidence scares me.”

This was Chinese Vice Premier Wang Qishan’s response to a request from Xiang Wenbo, president of Sany Heavy Industries, for central government assistance in overseas acquisitions.

Sany Heavy’s ambitions are entwined with the role of private equity in outbound investment by corporate China. In September 2008, six months before Wang made his remark, the Hunan-based firm reportedly lost out on a $422 million deal for Italy’s Compagnia Italiana Forme Acciaio (CIFA). The winner was provincial rival Zoomlion, a Hony Capital portfolio company. In February of this year, Sany Heavy finally secured an overseas acquisition of its own, buying Germany’s Putzmeister for $475.9 million. Sany took 90%, with CITIC Private Equity taking the remainder in return for its transactional expertise and, presumably, some advice on post-deal integration.

So what is the best way for private equity to participate in Chinese outbound investment – the Hony model, the CITIC PE model, or something else?

Chinese outbound M&A activity has been sharply rising since 2004, with deal volume exhibiting annual growth of 24.4% and deal value rising nearly 10-fold. Large-ticket investments are dominated by natural resources, with manufacturing the second most popular area. Chinese companies are being wary, picking up assets where they see value and a clear integration structure, rather than just for the sake of it. Wang’s words, it appears, are being heeded.

It is now commonplace for investment banks running asset auctions to send teasers to Chinese corporates, whether they are genuinely prospective buyers or not. Similarly, there are

plenty of intermediaries shopping opportunities to these companies in return for a slice of the deal. There is nothing wrong with this – indeed, Chinese players might be so preoccupied with domestic business or inexperienced in overseas M&A that they appreciate a little prodding.

However, outbound transactions are most effective when they form part of a concerted corporate strategy. In this respect, PE firms are best served to act as facilitators, and the deeper their involvement in the process, the more they stand to gain financially. According to industry sources familiar with the Putzmeister deal, CITIC PE came in at a reasonably high valuation. By contrast, Hony backed Zoomlion two years before it acquired CIFA, and the company’s revenues have increased 23-fold ever since.

The challenge in any deal is creating a true alignment of interest, something which is often difficult given that PE firms operate within restricted investment timeframes, while their strategic counterparts have a longer-term outlook. One approach that appears to address this issue involves the GP acting almost as a personal shopper for the corporation.

In these situations, the GP’s value-add is its ability to identify companies with potential, execute a transaction and then restructure the asset in a way that maximises the China appeal. What follows is a slow integration with the corporate buyer, the GP using its familiarity with both parties to ease the transition. The GP exits via a trade sale while the Chinese corporate secures a smooth passage through what might otherwise have been a difficult M&A process.

Success relies on the private equity firm understanding the Chinese company: its strategic requirements, its concerns and even the personalities of key decision makers. Perhaps these relationships are still in the process of being forged, but it is a trend worth watching.

Tim BurroughsManaging EditorAsian Venture Capital Journal

Helping corporate China go abroad

Managing Editor Tim Burroughs (852) 3411 4909

Senior Editor Brian McLeod (1) 604 215 1416

Staff Writers Susannah Birkwood (852) 3411 4908

Alvina Yuen (852) 3411 4907

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Catherine Chau, Edith Leung, Mansfield Hor, Tony Chow

Senior Research Manager Helen Lee

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AVCJ Group Limited. ISSN 1817-1648 Copyright © 2012


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AsiA PAcific

sDcERA invests $75 million in TPG Asia Vi San Diego County Employees Retirement Association (SDCERA) has invested $75 million in TPG’s sixth Asia-focused private equity fund. TPG Asia VI is targeting $4 billion of capital, with the GP committing at least 2.5% of the capital. The firm is allowing LPs to lower their commitments by as much as 10% from its previous Asia fund.

carlyle to raise $3.5b for fourth Asia buyout fundCarlyle Group plans to raise $3.5 billion for its fourth buyout fund in Asia, which would be the private equity firm’s biggest targeting Asia. An initial close is expected to happen in the second half of the year. The new vehicle, Carlyle Asia Partners IV, is set to be 37% larger than its predecessor.

AusTRAlAsiA

AMP acquires Australian schools project for $232mAsset manager AMP Capital has received approval to acquire the South Australian Schools Public Private Partnership project for an enterprise value of $232 million. Investing via its Community Infrastructure Fund and Core Infrastructure Fund, AMP’s new project consists of six newly built schools in Adelaide, including from primary, middle, secondary, special education schools and childcare centers. AMP will hold 100% of the project.

TPG, carlyle sell Healthscope assets TPG Capital and the Carlyle Group have sold the New South Wales, Queensland and Western Australian pathology businesses of their portfolio company, Healthscope, for A$100 million ($100 million). The buyer was pathology and radiology group Sonic Healthcare. The businesses have combined annualized revenue of A$105 million.

GREATER cHinA

Alibaba to buy back 20% of Yahoo’s stake for $7.1bAlibaba Group has agreed to repurchase about

a 20% stake in itself from Yahoo for $7.1 billion ahead of an initial public offering. The US internet company bought 40% of Alibaba - founded by Jack Ma - in 2005, paying $1 billion plus ownership of Yahoo’s China operations. Yahoo will receive at least $6.3 billion in cash and up to $800 million in newly issued shares in Alibaba.

l capital to invest in wedding photo firm L Capital, the private equity arm of French luxury goods conglomerate LVMH, is targeting a Chinese wedding photography company as its next investment to tap the emerging consumer market. “We are looking at a Chinese wedding photography company,” said Ravi Thakran, L Capital Asia managing partner, adding that the company “is very large in China.”

carlyle to sell Ta chong for $1.25b The Carlyle Group looks set to sell its 40% stake

in Ta Chong Bank to Yuanta Financial in a deal which could value the bank at up to T$37 billion ($1.25 billion). Sources said that the private equity giant and the Chen family - which owns about 30% - intend to sell the Ta Chong in a share swap that would value their equity at T$15-17 per share. Carlyle would get a 7% stake in Yuanta through the deal, which could be announced later this month.

David Johnson to head OMM in Hong KongLaw firm O’Melveny & Myers (OMM) has promoted its senior capital markets partner, David Johnson, to head its Hong Kong office. Johnson has worked with issuers, financial institutions, and investment funds on a variety of public and private equity and debt capital markets offerings, as well as PIPE deals for global firms including Avenue Capital and Bank of America Merrill Lynch.

Baird invests in chinese trucks manufacturerBaird Capital Partners Asia has invested in Chinese truck maker Henan Bingxiong Refrigerated Truck.CC Industries (CCI), the management company for a group of industrial companies in the transportation and food processing equipment industries, also participated in the funding round. So did CCI portfolio company Great Dane, a US manufacturer of dry van, refrigerated, platform trailers and refrigerated truck bodies.

Paul Hastings hires shanghai partnerPaul Hastings has hired Sean Tai as a partner in its corporate department in Shanghai. He joins from O’Melveny & Myers. In addition to a strong track record in private equity, Tai boasts almost 10 years of experience in cross-border M&A and real estate transactions in Greater China. He has also worked on numerous debt financings, corporate governance cases and securities law compliance situations.

lightspeed leads series A round for Tujia.comEarly stage investor Lightspeed China Partners and CDH Investments have participated in a Series A round of funding for Tujia.com, the first online vacation rental services provider in China. The new capital will allow Tujia to grow its operations and service capabilities to meet the increased demand from middle to high-end Chinese travelers.

PE giants sell AMc cinemas to china’s Wanda for $2.6bApollo Global Management, Bain Capital, CCMP Capital Advisors and Spectrum Equity Capital have sold AMC Entertainment, owner of the eponymous cinema chain, to China’s largest entertainment group for $2.6 billion. The deal is thought to represent the largest-ever buyout of a US company by a Chinese firm.

Dalian Wanda Group will assume around $2 billion of AMC’s debt, while Apollo and Bain are expected to receive an additional $500 million over an undisclosed period of time. Together

with J.P. Morgan’s buyout arm, Apollo purchased AMC for an enterprise value of around $2 billion in 2004. The firm was then merged with Loews Cineplex Entertainment Corp, backed by Bain Capital, Carlyle Group and Spectrum Equity Investors, and had plans to IPO in 2008, but these were postponed until July 2010.

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avcj.com | May 22 2012 | Volume 25 | Number 196

longreach seeks to sell Taiwan bank for $1.2bLongreach Group is planning to sell its stake in Taiwanese lender EnTie Commercial Bank at TW$30 or more per share, which would value the deal at about $1.2 billion. Longreach, which acquired 51% of EnTie for $637 million in 2007, has reportedly invited around eight corporate finance teams to compete for the sales mandate.

Paul Wang joins Dechert as partner in Beijing International law firm Dechert has announced that Paul Weidong Wang has joined the firm’s corporate practice as a partner in Beijing. Prior to the appointment, Wang was a partner at DeHeng Law Offices where he served as the head of venture capital and private equity.

nORTH AsiA

nippon Mirai capital in Alc buyoutALC Press, a listed language-focused educational service provider, has approved a tender offer from Nippon Mirai Capital and plans to go private. The takeover bid price is set at JPY27,500, representing a 33.73% premium over the stock’s three-month average trading price. Shinsei Bank will provide up to JPY2.6 billion ($32 million) in financing. ALC, which went public in August 2006, provides language learning materials as well as learning courses over the internet.

nomura plans Ashikaga iPO Nomura is planning to sell shares of regional bank Ashikaga in an IPO on the Tokyo Stock Exchange as early as December. The bank may trade at a market value of JPY200 billion ($2.5 billion) to JPY300 billion. Ashikaga has hired Nomura as the lead manager of the IPO and may sell new shares in addition to existing stock, two people familiar with the deal told Bloomberg.

Globis leads $3.6m series A round for quiz developerGlobis, the Japanese venture capital firm, has led a GBP2.3 million ($3.6 million) Series A round of funding for Quipper, a UK quiz applications manufacturer. Benesse, a Japanese education and publishing company, and Atomico, the VC firm led by Skype co-founder Niklas Zennström, also participated. Quipper, which received seed funding from Atomico last year, will use the new

capital to expand and improve the quality of its content.

sOuTH AsiA

3i gives up indian quoted equity plan3i has dropped plans to raise a dedicated fund aimed at India PIPE deals due to weak investor interest. A spokeswoman for 3i said the firm was “constantly assessing what other opportunities may be attractive across all the markets in which we operate.”

iifl real estate fund makes first investmentIIFL Alternate Asset Advisors, the venture capital arm of the India Infoline Group (IIFL), has made the first investment from its venture capital fund, backing a slum redevelopment project. IIFL Real Estate Fund has channeled INR800 million ($14.7 million) into the project, based in central Mumbai, which will generate about 1.2 million

sq. ft of saleable space and be developed by Sheth Creators.

nsR-backed Augere Wireless to exit indiaAugere Wireless, a portfolio company of New Silk Route, is reportedly selling its 4G broadband spectrum in two Indian states, as part of a move to leave the country. Regulatory uncertainty has caused Augere to close down its India operations in Madhya Pradesh and Chhattisgarh and ask its local employees to hand in their resignation, two company executives said.

india funds given 6 months to comply with regulationsIndian private equity funds have been given a six-month window to comply with new rules governing alternative investment funds (AIFs). While existing vehicles are free to complete their investment cycles, they will not be able to raise fresh capital until they have registered under the new system.

Accel, Helion back series A round for TaxiforsureAccel Partners, Helion Venture Partners and seed investor Blume Ventures have backed a Series A round of funding for India’s Serendipity Infolabs, which runs online taxi booking site Taxiforsure.com. Anand Daniel of Accel and Ritesh Banglani of Helion will hold board seats at the company following the deal.

sOuTHEAsT AsiA

cedrus investments to launch indonesia officeGlobal boutique investment firm Cedrus Investments will open a representative office in Jakarta later this year, in a move to tap private equity clients that are seeking exposure to Indonesia and Southeast Asia. This representative office will operate under the name PT Cedrus Investments.

iDM Venture capital backs online gaming networkSingapore-based firm IDM Venture Capital has led a $3 million funding round for Xfire, an online social platform that for PC-based gamers. The company has now raised a total of $7 million. The initial $4 million investment was led by Intel Capital in 2011.

ironbridge targets $1b for fund iii Australian private equity house Ironbridge Capital has said it will target up to A$1 billion ($1 billion) for its third fund, for which it will begin fundraising in the second half of this year. Joint Chief Executive and Founding Partner Neil Broekhuizen said that the vehicle will seek to raise between $500 million and A$1 billion.

This announcement comes as Ironbridge seals its last investment out of Fund II, buying a 60% stake in Sydney-based Southern Cross Dental Laboratories for an enterprise value of $95 million. The deal succeeds previous healthcare investments by Ironbridge in private hospital operator Affinity Health, drugs manufacturer iNova Pharmaceuticals, diagnostics and day surgery firm Healthbridge and elderly care operator Qualcare.

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Certain employees at state-owneD Harbin Pharmaceuticals enjoy one of the most luxurious working places in the world. As illustrated by a series of photographs that went viral last year, the headquarters of Harbin subsidiary Sixth Pharmaceutical is every bit the 18th century Rococo masterpiece. Modeled on the Palace of Versailles, the interiors feature engraved wood paneling with gold foil inlays, carvings of angels and crystal ceiling lamps. Then there are the mod-cons: a swimming pool, gymnasiums and pool rooms.

The building – yet another example of state sector managers’ tendency towards excess as a means of discounting economic returns – was erected several years before CITIC Capital and Warburg Pincus invested into Harbin Pharmaceuticals in 2005. They are currently trying to pass it on to the local government for use as a museum while the general manager who ordered its construction was ushered into retirement three years ago. This was no easy process: Sixth Pharmaceutical was built in his self-image just as much as the headquarters.

“It shows how perverse the state-owned enterprise (SOE) system can be,” Yichen Zhang, CEO of CITIC Capital, tells AVCJ. “In China, you cannot easily separate people from assets and you often must wait to take action in order to minimize the potential disruption. Not respecting this rule is to ask for trouble.”

State sector reform has preoccupied the Chinese government for 30 years and the slow pace of change means it is likely to remain an issue for 30 more. Taking over underperforming, inefficient assets and turning them around represents a massive opportunity for private equity investors, not least because there is so much low-hanging fruit. However, few industry participants have the connections, operational expertise and diplomatic skills to make these deals work.

History lessonsThe entrenched systems and hierarchies within SOEs that are so difficult to budge date back to the early days of China’s reforms in 1980s. Rather than rollout a market economy overnight, the government focused on expanding output

and boosting productivity through a “dual-track system,” under which SOEs were allowed to exceed their sales quotas and private enterprise was given license to operate in areas unoccupied by the state.

The system succeeded, but it was imbalanced. While the private sector thrived, SOEs saw their initial expansion undone by deflation in the 1990s and many started to lose money. Privatization was seen as the antidote. “The number of SOEs declined dramatically from 61,300 in 1999 to only 20,300 in 2010,” says Gao Xu, chief economist of China Everbright Securities. “In terms of assets, the ratio of SOEs to total industrial enterprises also dropped to 40% from 70% in the same period.”

This has narrowed the gap, but not removed it. In 2010, the average return on assets for

Chinese SOEs was about 6% compared to 12% for private enterprises. Chronic managerial problems within SOEs are routinely blamed for the gulf in performance. A key issue is that the people tasked with running these companies receive little in the way of financial incentives to ensure they do well.

Often political appointees, these managers don’t see the world in terms of economies of scale and market metrics. In many cases, priority is given to personal and political interests, such as expanding fixed investment regardless of cost

in order to build a power base or pursuing short-term growth spurts to meet local government jobs or tax targets.

“From a market perspective, a final perverse incentive is that local officials do not stay around to face the consequences of these short-term behaviors,“ says Matt Fish, managing director of New Pacific Consulting. “Indeed, these actors encourage quick-fix SOE investment strategies precisely to achieve rapid promotion to new positions in different locations.”

Reform-mindedHarbin Pharmaceuticals was a case in point. Sixth Pharmaceuticals’ headquarters aside, when CITIC Capital and Warburg Pincus invested, the company was spending four times its annual net income on television commercials and

investing in a portfolio of 100-plus products, many of which didn’t make any money at all. Most damaging of all, each subsidiary maintained its own finances, which meant that profit-making businesses were receiving low interest returns on bank deposits while loss-making units paid heavy premiums to borrow money.

Centralizing Harbin Pharmaceuticals’ financial structure meant facing down resistance from managers desperate to hold on to power. When the change was finally completed in 2009, it turned out the company had a net cash position

Enemies of the state? The likes of Hony Capital and CITIC Capital have made a name for themselves by turning around loss-making state-owned enterprises. Although lucrative, this area is not for PE firms that are either too foreign or too faint-hearted

State-owned enterprise share of China’s industrial sector

Source: China Everbright Securities

80

60

40

20

0

%

Share by pro�ts Share by number of loss-making enterprisesShare by assets

1998 20042001 2007 2011


of RMB4 billion. Since CITIC Capital and Warburg Pincus first invested, Harbin Pharmaceuticals’ profit has increased six-fold.

“You need to be sensitive and patient enough to move gradually because if you change everything on day one, everybody turns against you,” says CITIC Capital’s Zhang. “What you need is a right incentive system so that when these managers give up some of their power, they get some other benefits in return.”

First moversCITIC Capital was among the first Chinese private equity firms to pursue SOE deals. Hony Capital has also emerged as a prime mover in the space. It began investing in SOEs in 2003 and they currently account for half of its 65 portfolio companies. These deals – which are often buyouts and therefore command bigger ticket sizes than typical growth equity transactions – have delivered an average IRR as good as the firm’s investments in private enterprises, John

Zhao, Hony’s CEO, tells AVCJ.“When we find people who want to hold on

to the power and don’t know how to run the company, we don’t touch them,” he says. “We help capable managers who understand the limitations of being a SOE and sometimes we are able to get controlling stakes; China Glass and CSPC Pharmaceutical Group are examples.”

Hony invested in China Glass – then known as Jiangsu Glass Group – in 2004, took it public in Hong Kong a year later, and then supported an acquisition spree of other state-owned glass assets in order to expand market share and build up economies of scale. With a view to repeating this success, in 2007, the private equity firm backed Jushi Group, a subsidiary of China Fiberglass Group, and subsequently took a significant stake in China Yaohua Glass Group.

“Most SOEs in this space see the need to strengthen and we see the opportunity,” Zhao adds. “Local governments typically do not have a sophisticated mindset concerning the

consolidation of the industry; they just like us invest into their region. We use successful companies such as China Glass as a platform to consolidate the whole industry.”

Exclusive accessAlongside CITIC Capital and Hony, CCB International, China Everbright and New Horizon are among the more active players chasing SOE deals. Each has strong government connections, either through state-backed parent companies or ties to powerful agencies and quasi-state institutions. Hony, part of Legend Holdings, is itself controlled by the Chinese Academy of Science while CITIC Capital is owned by China Investment Corporation (CIC) and CITIC Group Corporation, the country’s largest conglomerate. The names are sufficiently revered in SOE circles to open doors.

“We are always in an exclusive position with local governments because the CITIC brand itself is already enough to push away many players when we bid for these potential deals,” says CITIC Capital’s Zhang. “In the case of CITIC buying it, local government can defend the underlying rationale easily because of our close connections with them.”

On the contrary, other private equity firms, which don’t enter negotiations with the blessing of local authorities, face all kinds of obstacles, from arranging regulatory approvals to securing alignment with company management. According to one China-focused foreign GP, it’s not worth the effort – especially when private enterprises account for 70% of GDP and 80% of the labor force. “The decision makers are government officials and often they have no incentive to sell the business at a cheap price,” the GP adds. “You start working on a deal and it may or may not happen.”

The Carlyle Group’s attempted buyout of Xugong, a state-owned construction equipment manufacturer, in 2005, is the most notorious example of a deal gone wrong. The private equity firm agreed to buy 85% of Xugong for $375 million in what would have been the biggest control transaction by a foreign player in China. It prompted unease that the Jiangsu provincial authorities were selling a strategic asset to a foreign investor, and Sany Heavy Industry, which was itself keen on buying Xugong, stoked these fears.

No regulatory approval was forthcoming and Carlyle ended up quietly abandoning the acquisition three years later.

In the case of Harbin Pharmaceuticals, CITIC Capital originated the deal and negotiated with the local government. US-based Warburg Pincus was invited to participate as a co-investor because it was able to commit additional capital


Game change: a new era of soe investmentsNot all Chinese state-owned enterprises (SOEs) are financial black holes. Some, notably those

operating in industries where they are part of an oligopoly, generate enormous profits. China Mobile, for example, is the largest of China’s three telecom providers and the number one mobile phone operator globally, with annual revenue of RMB528 billion ($83.4 billion) in 2011.

By carving out dominant positions in key areas – such as energy, electricity supply and tobacco, as well as telecom – SOEs accounted for just 9.6% of loss-making companies in China in 2010 compared to over 50% in the late 1990s. Publicly listed by still controlled by state interests, there is neither the will nor the incentive for the likes of China Mobile or PetroChina to change the status quo.

“I think the golden age of privatizing SOEs has gone and many of the remaining ones are considered as commanding highs of the national economy, and are highly profitable given their monopoly status,” says Gao Xu, chief economist of China Everbright Securities.

Although the number of SOEs has declined drastically, John Zhao, CEO of Hony Capital, argues that opportunities within the space are increasingly interesting. The objective is not to control and restructure these firms, but to assist them in overseas M&A, which requires sophisticated strategies and financial knowledge. Hony-backed Zoomlion’s acquisition of Italy’s Compagnia Italiana Forme Acciaio SpA in 2008 and CITIC Private Equity’s participation in Sany Heavy Industry’s purchase of German pump manufacturer Putzmeister in February are examples of this. Zhao expects more to follow.

“The landscape of SOE investments has changed,” he says. “In the early 2000s, we invested to help SOEs achieve better efficiency, and now some of them come to us with the aim of becoming global leaders through offshore M&A.”

Hony first invested in Zoomlion in 2006, when it had RMB3 billion in revenue and RMB300 million in profit. Six years on – following the overseas acquisition, which was also supported by Goldman Sachs and Mandarin Capital Partners – Zoomlion’s revenue and profit have grown 16-fold and 23-fold, respectively. It has become the fifth-largest construction machinery manufacturer globally.


and off ered pharma sector expertise. However, even local players must work their

way through considerable amounts of red tape and, more importantly, pay close attention to the way political winds are blowing. An inevitable consequence of the 1990s SOE privatization drive was the concern that entrepreneurs had been handed state assets on the cheap. In the early 2000s, Beijing took regulatory action to prevent these assets being spirited overseas and local and national agencies have become mindful about who they sell to and at what price.

For example, the State-owned Assets Supervision and Administration Commission (SASAC), which is responsible for overseeing SOEs controlled by the central government, has introduced a minimum purchase price for private sector investors. The net asset value of the company, rather than its future income projections, is often one of the key criteria, and this is a potential turn-off for private equity.

“A company with very large assets and very low earnings would probably be very expensive under this method and so we would probably get rid of the deal,” says Johannes Schoeter, founding partner of China New Enterprise Investment (CNEI). “You need to make sure despite of those rules, you are still able to get an attractive valuation.”

The vast majority of CNEI’s capital has been earmarked for private enterprises. One SOE investment is expected to close soon, but it has been in the works for two years because the seller must balance political and economic considerations.

Good timingIn this way, gauging a local government-related entity’s appetite to sell a state asset, and the best time to do it, is a vital and time-consuming process. It can take many months create an alignment of interest between the various stakeholders, with management and government agencies having to be convinced one-by-one.

Lunar Capital is in a similar position with a large enterprise in a remote northern Chinese province. It has been looking at the asset for more than three years, building up relationships with management, but sometimes delaying a decision, as opposed to forcing one, is the best course of action. Patience is paramount. “We have setup an operating framework and mindset that allows us to cultivate a deal for three years and execute in fi ve, but how long are domestic private equity fi rms willing to wait?” asks Derek Sulger, Lunar’s managing partner.

On top of all this, fi nancial and legal

due diligence of state-owned assets can be protracted and painful. A manager who puts personal and political objectives before commercial considerations is liable to supply unreliable fi nancial records, either as a result of incompetence or willful obfuscation. After investing in one SOE and conducting full due diligence, CITIC Capital discovered that the management was far more corrupt and less cooperative than it could possibly have imagined. In these situations, the only viable solution is to ask local governments for exit or restructuring support, and take a fi nancial hit on the way out.

Even when an SOE is profi t-making, exits are not always easy. A private equity investor might hold a controlling stake, but the timing of an IPO – the most popular form of exit as it enables the PE player to exit and gives other stakeholders the opportunity to remain – is largely up to the state-related interests. The onus is on fi nding a solution that is politically acceptable, and this means secondary and trade sales are often unfeasible.

“For certain SOE assets, trade sales would be possible but they are mostly to domestic players,” Zhang adds. “I am sure some multinational companies are interested in buying attractive Chinese state-owned assets, but the regulatory challenges would be huge.”

Asia has over US$318 billion in private equity funds under management

Just where and how are these funds distributed? Read all about it in AVCJ Private Equity and Venture Capital Report, the annual series of regional reports by the leading source of information on Asian private equity, venture capital and M&A.

Reviewing the year’s activity in the industry, the regional reports are filled with up-to-date data and intelligence on fundraising, investments, exits and M&A. They also feature information on key companies and transactions. Offering global perspective alongside local opportunities, the regional reports include Australasia, China, India, North Asia, and Southeast Asia.

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it was the missive that international private equity firms dreaded, but always half-expected. Despite years in the making, the rules governing foreign participation in local currency funds in China are still disturbingly gray, a shortfall generally blamed on poor regulatory coordination. Towards the end of April, the National Development and Reform Commission (NDRC) seized the initiative: In decreeing that one foreign-invested renminbi fund shouldn’t qualify for local treatment, it appears to have damned them all.

Responding to a request from The Blackstone Group for clarification as to whether its local currency vehicle would be considered local for investment purposes, the NDRC answered in the negative. Crucially, the regulator’s statement – not an official policy directive – cited Blackstone “and this type of situation where the GP is foreign-invested.”

When the likes of Blackstone, The Carlyle Group and TPG Capital won the right to launch renminbi funds in 2009 they hoped it would present a means of circuiting the obstacles to foreign currency vehicles: regulatory bureaucracy that slows down transaction approvals and restrictions on target investment areas. These obstacles remain.

“A big part of the story when marketing these funds was that it makes you local, but it doesn’t work anymore,” says Maurice Hoo, a Hong Kong-based partner at Orrick. “A good number of market participants have always believed that it would be like this. When you have a gray area there are people who are more aggressive, while others are more conservative.”

These sentiments are echoed by several other industry participants, whose assessments range from the cynical (“maybe it was just marketing talk anyway”) to the sympathetic (“foreign GPs have this overly romanticized view of renminbi funds”).

To ask or not to ask?Opinion is divided, however, as to Blackstone’s culpability in the matter. Following the introduction of the Qualified Foreign Limited Partnership (QFLP) program, which allows foreign capital to be channeled into renminbi vehicles, Shanghai added a twist of its own. These funds would be able to operate on an equal footing

with local players if less than 5% of the total corpus came from overseas.

One view is that Blackstone was pushing Shanghai to get the pilot program approved nationwide, but pushed too far. The other is that prospective LPs said they would only invest if the private equity firm could guarantee its domestic treatment would extend beyond Shanghai. Blackstone had little choice but to seek clarification.

“They knew Shanghai would have to pass up the inquiry to national level but if you want to do that, you should have already approached senior government officials,” one China-focused GP tells AVCJ. “Once something is on paper it becomes very difficult to overturn.”

The China Private Equity and Venture Capital Association (CVCA) has initiated lobbying efforts with the NDRC and the Ministry of Commerce (MofCom), but it is uncertain how much impact this will have. According to Vincent Huang, a partner at Pantheon who helped set up the Limited Partners Association of China (LPACN), regulators at central level have never said that treating foreign-invested funds as local entities was feasible.

A key issue is the fact that the capital, no matter where it comes from, is ultimately controlled by managers who carry foreign passports and therefore dont have legitimate local income to make GP contributions in renminbi. It has been suggested that PE firms should appoint senior executives to run these funds who hold Chinese passports but there are very few of them.

The likes of IDG Ventures and Sequoia Capital have created renminbi vehicles by eschewing the joint venture approach and setting up onshore Chinese companies, owned by local partners,

to act as the GP. It is unclear exactly how this approach passes muster with the regulators, but it is unlikely to be replicated by the big foreign players. “They might not be comfortable setting up special companies because, although there are contractual agreements, there is less protection,” says York Chen, founding partner at ID Techventures. “That is the compromise you have to make in China.”

Patheon’s Huang adds the LPACN is lobbying for an alternative solution – loosely described as the QFLP program expanded nationwide – that would potentially allow foreign LPs invest directly in local funds without changing the nature of these funds. It will not happen unless there is high-level political support.

In the meantime, Orrick’s Hoo argues that the NDRC’s clarification will impact fundraising for renminbi vehicles launched by foreign PE firms as joint ventures with local governments.

Blackstone reached a first close on its Shanghai-based RMB5 billion ($790 million) renminbi fund last April while Carlyle neared the halfway mark on its own similar-sized vehicle one year earlier, with both funds securing the bulk of their commitments from local government-related entities. This February, TPG announced it had received RMB4 billion across two renminbi funds, each worth RMB5 billion. Fundraising has been much slower than the foreign private equity firms would have liked – a result of intense competition from local players that are perceived to have better deal access and a shallow domestic LP pool.

“There is a serious question as to whether some of these funds that have been launched or announced will ever close,” says Hoo. “The funds with a major brand are likely to be better positioned and so what we might see is the

Foreign RMB funds at a crossroadsApparent confirmation that foreign-invested renminbi funds can’t qualify for local treatment has left the leading overseas private equity firms in a quandary. Life has become harder, but all is not lost

“A big part of the story when marketing these funds was that it makes you local, but it doesn’t work anymore. A good number of market participants have always believed that it would be like this” – Maurice Hoo

[email protected]

emergence of tiers among the foreign funds.”At the heart of this theory is the idea that,

while damaged, the investment story hasn’t been destroyed. Even though foreign-backed funds may not be able to commit capital with the pace and certainty they might have liked, they retain some selling points. Certain sectors remain off limits, but assets in areas such as natural resources and broadcast media are barely realistic targets for fully domestic funds, let alone foreign-invested entities. Similarly, large-scale control transactions, in the rare event that they might be available in China, would face regulatory hurdles even under the Shanghai model.

From the perspective of a potential portfolio company, the benefi ts of getting immediate access to capital – often at massive valuations – must be balanced against those of taking investment from a high-quality player that may also have strong local government backing. The brand value of a Blackstone or a Morgan Stanley, which suggests access to global expertise and connections, isn’t necessarily diminished by the NDRC’s clarifi cation. These funds still have the edge over US dollar-denominated in vehicles, which must go through foreign exchange controls when investing in China.

In this respect, there is much to be said for foreign private equity fi rms establishing a

presence in the renminbi space with a view to developing local knowledge that complements global practices. While initial forays into the market were in part driven by competitive pressure, a few years from now it might look like more than a marketing exercise.

“Without a renminbi fund, you don’t have an onshore track record, and this makes it harder to convince people you have the capability to operate here,” says Pantheon’s Huang.

Mixed blessingsIn the short term, though, renminbi funds of all stripes threaten to fl atter to deceive. In 2011, local currency funds attracted more than $24 billion, twice the fi gure achieved by US dollar funds, while total renminbi-denominated investment topped US dollar fi gure for the fi rst time. It has created a market in which valuations are propelled upwards and returns downward and there have already been defaults in the local LP base as investors become disillusioned. Ultimately, there won’t be enough capital to support the several thousand local currency funds that have sprung up in recent years.

A number of successful renminbi managers are now looking to raise US dollar vehicles in order to tap the more reliable global LP community. Sources with links to MofCom tell

AVCJ that a string of new incentives is being lined up for US dollar funds.

At the same time, there are reports of regulatory confl ict. Power grabs are inevitable once an industry reaches a certain size and signifi cance and, in this case, the NDRC is seeking to consolidate its position of command in the face of arguments that China should follow global practice and appoint the securities regulator as private equity’s watchdog. No one expects these issues to be resolved until well after China’s fi fth-generation leadership is fully installed in early 2013.

Until then, the industry is likely to remain a work in progress, with a few more clarifi cations and no offi cial policies. Foreign-invested funds are now in a slightly less gray area than before, but PE in China still lacks clear guidelines and the basic legal and practical infrastructure required to facilitate long-term development.

“We have raised about 20 funds and I’ve never had to get into as much detail as I did with the renminbi fund,” says Yichen Zhang, CEO of CITIC Capital. “We had to register with the NDRC and with the Tianjin authorities for taxation and licensing, and then we had to arrange custodian banks. We did a capital call and the manager of CITIC Bank in Tianjin had to phone me up and confi rm it.”

Where do these funds come from? How are they being invested? In which sectors? What regulatory changes are making an impact on investment strategies?

AVCJ provides the answers and more in its series of pan-Asian industry reviews. The reports provide an independent overview of the private equity, venture capital and M&A activities in the region, including the latest statistics and analysis by AVCJ’s research team. The annual reviews also deliver insights on investments made, capital raised, sector-specific figures and more—making them essential reading for all private equity investors, investment bankers, accountants, lawyers, corporate financiers and management consultants looking at the Asian market.

avcj.com*accumulated investments between January 2001 and September 30, 2011.Source: AVCJ

More than US$477 billion have been invested by private equity funds into Asian companies

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PE fundraising, investment and IPOs vs. Shenzhen P/E ratios

PE funds raised by type

PE investments by deal type

Leading PE-backed IPOS

PE investment (US$m) PE fundraising (US$m)

PE-backed IPOs (US$m)

Other Venture capital

Buyout

Special situations Growth equity

Venture Other Buyout Growth

SME Board (ave P/E)ChiNext (ave P/E)

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The slow demise of pre-IPO dealsThe introduction of the Chinext and SME Boards in Shenzhen offered a new exit route for PE-backed firms. It created an explosion in fundraising and investment but dwindling exit multiples are deflating the bubble

China Minsheng Banking Corp.; (HKSE); US$4b

China Pacific Insurance; (HKSE); US$3b

China Longyuan Power; (HKSE); US$2.5b

Glorious Property Holdings; (HKSE); US$1.2b

Longfor Properties; (HKSE); US$907m

Shenzhen Hepalink Pharma; (SZSE); US$869m

Beijing Originwater Tech; (SZSE-ChiNext); US$374m

Nationz Technologies; (SZSE-ChiNext); US$348m

Liao Ning Oxiranchem; (SZSE-ChiNext); US$336m

Zhejiang Narada Power; (SZSE-ChiNext); US$299m

Huatai Securities; (SHSE); US$2.3b

Zhongsheng Group; (HKSE); US$482m

Beijing Haohua Energy; (SHSE); US$480m

International Mining Machinery; (HKSE); US$325m

Befar Group; (SHSE); US$305m

Agricultural Bank of China; (SHSE/HKSE); US$20.8b

Zhengzhou Coal Mining Machinery; (SHSE); US$413m

Boshiwa International Holding; (HKSE); US$367m

Shenzhen Grandland Decoration; (SZSE); US$309m

Wuhan Guide Infrared; (SZSE); US$287m

China Rongsheng Heavy Industries Group; (HKSE); US$1.8b

Changsha Zoomlion Heavy Industry; (HKSE); US$1.7b

Xinjiang Goldwind Science & Technology; (HKSE); US$1b

TPK Holding; (TWSE); US$925m

Sihuan Pharmaceutical Holdings; (HKSE); US$849m

Source: AVCJ Research Source: AVCJ Research








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Sinovel Wind Group; (SHSE); US$1.4b

Far East Horizon; (HKSE); US$782m

Shanghai Great Wisdom; (SHSE); US$387m

Tongyu Heavy Industry; (SZSE-ChiNext); US$342m

Changshu Fengfan Power Equipment; (SHSE); US$291m

Sun Art Retail Group; (HKSE); US$1.7b

Beijing Jingyuntong Technology; (SHSE); US$394m

Zhejiang Kaishan Compressor; (SZSE-ChiNext); US$354m

Beijing Jangho Curtain Wall; (SHSE); US$344m

Lancy; (SHSE); US$273m

Shanghai Pharmaceutical; (HKSE); US$2b

Huaneng Renewables Corp.; (HKSE); US$799m

Renren; (NASDAQ); US$743m

Tongkun Group; (SHSE); US$498m

Jiangsu Shuangxing Color Plastic New Materials; (SHSE); US$440m

New China Life Insurance; (SHSE/HKEX); US$1.9b

China Securities; (HKSE); US$1.7b

Jiangsu Phoenix Publishing & Media Group; (SHSE); US$702m

Soochow Securities; (SHSE); US$511m

Baoxin Auto Group; (HKSE); US$414m

Pubang Landscape Architecture; (SZSE-SME); US$207m

JiaJia Food Group; (SZSE-SME); US$190m

Beijing Shouhang Resources Saving; (SZSE-SME); US$163m

Xizang Haisco Pharmaceutical; (SZSE-SME); US$127m

Guangdong Delian Group; (SZSE-SME); US$107m


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the Cult of personality whiCh surrounds many of China’s private equity funds rarely extends into more mature markets. Other than Terra Firma’s Guy Hands and Coller Capital’s Jeremy Coller, few US or Europe-based GPs have built their organizations around one particular luminary. In China, however, while far from being one-man bands, a disproportionate number of entities ride on the backs of a single high-profile individual. John Zhao, CEO of Hony Capital; Fred Hu, founder of Primavera Capital and ex-Greater China chairman at Goldman Sachs; and Boyu Capital’s Mary Ma are notable examples of this.

This specific divergence has resulted in more focus being placed on key man clauses in China funds than in other parts of the globe. According to Squadron Capital, which surveyed 104 Asian GPs, 33 of which were focused on China, 90% had a key man clause in place, which compares favorably against similar polls conducted on US funds.

“Key person provisions are probably more important in Asia than in many other markets, given the fact that many GPs at the earlier stager of their evolution – and even some at the later

stages – are single-person dominated,” says Wen Tan, managing director at Squadron, who led the research. Another reason cited by industry participants for the increased focus on this clause in China is team volatility, which has led to multiple spin-outs in recent years.

There are several areas in which the distinctive characteristics of the China market have had a

knock-on effect on terms and conditions. While certain terms were automatically adopted from the US by Chinese firms upon their establishment – such as no-fault divorce clauses – preferential carry, fee offsets and GP contributions have all seen a deviation from Western market norms.

Carry in investingPremium carry is a fund facet tracked by private equity-focused law firm Cooley. Following its survey of 20 China-based funds, and a comparable poll of 30 US funds, Cooley found that 20% of China vehicles were offering premium carry, more than in the US, albeit on a minority of deals. One reason for this, according to Jordan Silber, a partner with the law firm, is the greater prevalence in China of both captive funds and joint ventures where GPs have teamed up with local corporations.

“For those kinds of funds, there’s more tolerance among LPs for putting up with a higher rate of carry than in non-sponsored funds,” he says. “They know that it’s being shared with a larger team, so they want to ensure the team in China gets 20%, believing that 5% is going to the

team outside of China. Several leading LPs have told me that’s the way they think about it.”

The overwhelming demand among investors to pocket a piece of China’s growth story is another factor which leads to LPs conceding extra financial rewards to GPs. Whereas it would be atypical for private equity funds launched in the US today to command a premium carry from

the outset, China-focused firms are frequently doing this. Managers with a strong reputation locally are being excused from the need to prove themselves through track record – and thereafter earn a higher rate of carry – by the almost feverish desire for their product.

It is this basic model of supply and demand that has kept China funds’ use of preferential carry terms at relatively low levels. Despite Squadron reporting a 9% year-on-year increase in the number of Asian GPs granting differential carry terms to a subset of investors, US funds are much more likely to offer these concessions. This is because the easier fundraising environment means far fewer fund managers in China are backed into the position of offering such deals to attract capital.

“Out of the 25 or so China funds that I have worked with, maybe 10% have offered premium terms,” reveals Cooley’s Silber.

RMB vs. USDOf course, while the difference in nature between China and US-based funds is interesting to note, other issues provoke greater concern among LPs. The conflict of interest that can occur when China-focused GPs’ parallel renminbi and US dollar funds have different terms and conditions is a prime example.

Bridging the gapDifferences between the Chinese and US private equity markets are reflected in fund terms and conditions. LPs that back managers operating US dollar and renminbi funds should look carefully at the small print

China parallel fund managers were asked: Does your renminbi fund commitment period di�er from your US dollar fund’s commitment period?

Source: Squadron Capital Asia Pacific Private Equity Fund Terms Survey (May 2012)

No43%

Yes57%

Top 10 China-focused managers of parallel RMB-USD funds

fund managerus dollar capital under management (us$m)

renminbi capital under management (us$m)

Hony Capital 3,324 3,561

CDH Capital 4,220 1,911

CITIC Private Equity 990 1,426

Blue Ridge China 1,752 238

New Horizon Investment Advisors 1,590 158

Legend Capital 1,148 663

SAIF Partners 3,447 475

CEL Venture Capital 1,416 317

DT Capital 490 317

Tsing Capital 298 222

Gobi Partners 203 95Source: AVCJ Research

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The main areas of potential conflict, according to James Ford, private equity partner at O’Melveny & Myers in Hong Kong, are in the allocation of investment opportunities and the time commitment of the team. Investors commonly worry that the challenges involved with doing foreign direct investment from the US dollar fund will lead the GP to focus its efforts on the more easily deployed renminbi vehicle.

Squadron’s findings suggest this could be a very real fear, as of the GPs it surveyed that had agreed to allocate their investments on a pro-rata basis between the two funds, 35% were actually doing this on less than half of their deals. That means 65% of transactions were being allocated to a particular fund purely at the discretion of the GP.

Another point of contention among LPs is the existence of unequal investment periods and fund lives between renminbi and US dollar vehicles. Squadron discovered that more than half of parallel funds were not coterminous; in all of these cases, the renminbi funds were of shorter duration. This could end up forcing GPs to invest their renminbi vehicles at a quicker pace and also to exit before the investment is fully mature.

“We worry about this for our clients – we like to see them having cycles that match because

there are so many factors that make it so much easier to be fundraising for both funds at the same time,” cautions Silber. “There is a big chance for conflict as you get off-cycle. It isn’t an issue that has come to the forefront yet because we’re in the infancy of managers having both funds, I think it will become significant in 3-4 years.”

Some LPs have resorted to lobbying for clauses to be written into their contracts to help level the playing field as much as possible between parallel funds. One such clause gives investors the option to end the fund if the renminbi vehicle is drawn down by a specified percentage more than its US dollar counterpart. Another option is for the management fee on the US dollar fund to step down once the renminbi fund is fully invested. This encourages

GPs to keep up the pace of investment on both corpuses.

O’Melveny and Myers’ Ford suggests that the most important aspect is to ensure that LPs are satisfied with the overall alignment of more straightforward elements, such as investment allocation, investment period and fund life, from

the outset. No investor wants to terminate an agreement after paying fees for three years, after all.

“We’ve seen a lot of time spent on complex conflict mechanics, but they tend to create as many problems as they resolve. Ultimately, we see LPs focussing on overall alignment as the key, and often the asymmetry of capital [USD funds are frequently much bigger] tends to provide a lot of comfort.”

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“Key person provisions are probably more important in Asia than in many other markets, given the fact that many GPs at the earlier stager of their evolution – and even some at the later stages – are single-person dominated” – Wen Tan


[email protected]

DepenDinG on whom you ask, russia is either a nascent private equity market of unbounded horizons or a blighted desert with very few prospects for the foreseeable future. Either way, the creation of the a $4 billion joint fund by China Investment Corp. (CIC) and the Russian Direct Investment Fund (RDIF), has drawn attention to potential opportunities. If all goes to plan, it could see a huge amount of capital travel from China to Russia.

“While there are a number of risks around investing in Russia, the rewards can be significant if you understand the rules, follow them and forge a local network to work through the bureaucracy,” says James Cook, founder of private equity firm Aurora Russia. “Russia has enormous potential and you can still achieve high returns for your investments.”

Nevertheless, concerns about these risk factors – a combination of generic investor fear and skepticism about rule of law and a reputation for corruption – means PE activity is muted. The industry is worth about $4-6 billion in Russia, with fundraising reaching just $1.4 billion between 2008 and 2011. This is poor compared to the country’s BRIC cohorts: China generated $28.6 billion over the same period, with India and Brazil on $15 billion and $5 billion, respectively.

Patricia Cloherty, chairperson and CEO of Delta Private Equity Partners, argues that these numbers don’t illustrate the country’s strong growth potential. She notes that there were 73,000 cell phones in use in 1995; a decade later it was 180 million. Similarly, in 1995, Moscow had only two shopping malls; by 2005 there were 44 mega-malls and many others of more modest size under construction.

“For a country that had no consumer choice for over 80 years, the growth prospects – and I’m only referring to the non-tech sectors – are extraordinary,” she says. Delta’s IRR from 1995 through to the first quarter of 2012 amounts to a whopping 207.9%, net of fees.

Mixed opportunitiesA tech deal is perhaps the most spectacular illustration of the private equity’s potential in Russia, however. Baring Vostok Capital Partners acquired 35.7% of internet search services provider Yandex in 2000, paying an estimated $5 million. By the time it went public last year, the

company had a 60.9% share of the Russia search market and net profits in excess of $600 million. The IPO generated $1.3 billion, giving Baring an 800x return on its investment.

One stellar transaction shouldn’t be allowed to distort perceptions of the whole market. The Carlyle Group’s David Rubenstein is among those with little positive to say about it. “The perception is the best deals go to the oligarchs, and because these oligarchs have a fair amount of money there isn’t so much need for Western private equity capital. So there haven’t been that many great investment success stories,” he told a conference in 2010.

Mega-deals aside, Russia’s private equity industry might be approaching some kind of inflection point. In the short term, there are concerns about economic growth – the stock market is down 20% since March, while industrial output and fixed-asset investment are also in decline – and the impact a slowdown would have growth capital available to companies. Longer term worries persist regarding capital flight, the impact of the euro-zone crisis and Russia’s stubborn dependence on energy and natural resource exports, which account for an estimated 17% of GDP. Clearly diversification is a priority and this is where private equity – and, ultimately, China – comes in.

RDIF was designed to facilitate investment in Russia, with each capital commitment it makes supposed to be matched by an equal contribution from a co-investor. The target is to attract $50 billion from foreign buyout firms, sovereign wealth funds and companies seeking to expand in the country. The fund will receive

$10 billion from Moscow over the next five years, of which $2 billion was in place by the end of 2011. Two investments have been made so far.

According to Sergio Men, managing partner of Hong Kong-based Eurasia Capital Partners, RDIF amounts to the best guarantee that foreign investors will find in terms of matching funding and minimizing concerns over corruption. “The government needs to create some success stories if it seriously hopes to attract massive volumes of FDI down the road,” he says.

Another source was more cynical, suggesting that RDIF’s primary function is to generate good publicity. At time of writing, RDIF CEO Kirill Dmitriev is barnstorming in the US, hoping to do just that.

Ties to ChinaHalf of the $4 billion corpus for the joint fund with China will come from CIC and RDIF, with Chinese institutional investors likely to contribute the remainder. Apparently 70% of the capital will be spread over projects in Russia and the CIS group of countries, with the remaining 30% earmarked for investment in Chinese businesses with some sort of Russian involvement. Targeted sectors include engineering, agriculture, forest and timber industries, transportation and logistics, with a special focus on energy efficiency and energy-saving opportunities.

This fund should be seen as one part of an expanding bilateral trade picture. According to Chinese data, trade between the two countries reached around $80 billion in 2011 and growth rates are said to be staggering. Heilongjiang province, which borders Russia, saw trade spike 154% to $19.3 billion. China’s demand for electricity and oil from Russia shows no sign of dwindling.

What all this means for PE activity, however, is unclear. Resource sectors are traditionally peripheral plays for private equity players, but Aurora’s Cook says that proximity makes the two countries natural partners.

“I think deals will be done in the general infrastructure or infrastructure services, plus forestry and in the hot spots of the big bilateral trade picture,” adds Delta’s Cloherty. “Also, this emerging partnership is also likely to be a help in terms of the balance of power – it keeps Russia from becoming too dependent on the West.”

Russia builds PE ties with ChinaRussia and China’s sovereign wealth funds have joined forces to boost cross-border trade. For Moscow, it is a much-needed opportunity to diversify the economy and attract more foreign investment

“The Russian government needs to creat some success stories if it seriously hopes to attract massive volumes of FDI down the road” – Sergio Men


Q: As a long-term investor, how much of a concern are valuations in China right now?

A: Even in a growth-type environment, if you overpay for an asset it will hurt you in your returns. Many fund managers are feeling the heat in this space – it’s very crowded, it’s hard to find proprietary deal flow and so it’s difficult to be disciplined on price. As a result, you see people going into more early-stage deals but also going later, doing more buyouts and state-owned enterprise (SOE) deals that are difficult to transact and where there are more natural barriers to entry. Valuations have come down somewhat: the public equity markets in China are difficult and that has filtered through into the private equity space, with entrepreneurs becoming more realistic about what they ask for.

Q: Do you feel under pressure to find the next big thing, such as local GPs that have access to those deals that are more difficult to transact?

A: It’s about balance. As a fiduciary of other people’s capital, there has to be a level of cautiousness but we are also in a risk-taking business. When we construct a portfolio, we are not investing purely on promise – we need to make sure we have visibility and can adequately analyze whether a particular team can be successful. A firm doesn’t have to be in its third or fourth cycle, but there needs to be some evidence they can do what they want to do.

Q: What do you look for in a Chinese GP?

A: Team turnover has always

been a point where Chinese fund managers score low. If performance has been poor, there is a risk people will leave; if performance has been great, there is also a risk people will try to spin out and get better economics for themselves. It happens globally but even more so in China. Another issue is GPs’ ability to return cash on cash. They make investments, have huge mark-ups in their portfolios, but they forget to monetize. Even some of the most successful managers have residual holdings in funds one or two where the companies have listed and they are just holding on. They say, ‘It’s a great company, it’s growing at 30%, let’s hold on to it.’ Western GPs tend to say, ‘It’s a 4x, let’s sell. It could have been an 8x, but tough luck – it could also have been a 2x.’

Q: Are Chinese GPs raising too much money?

A: On the whole, yes. There is a sense that they want to grab what they can while the music lasts. We try to tell them we are

long-term investors and will be there for the next fund, but the message doesn’t always get across. They don’t want to turn away capital. A lot of successful funds globally face this dilemma, but a good number stay extremely disciplined.

Q: There is a perception that HarbourVest has been conservative towards China. Now you have opened an office in Beijing, is this changing?A: I don’t think it’s an entirely accurate perception but I don’t mind it. There are two

parts to our China experience. We invested in China in the early 1990s when it was a big part of what private equity did in Asia and it didn’t work out so well for anyone. Then we had the Asian financial crisis and suddenly many countries opened up to foreign capital and control-type deals. These investments in South Korea, Japan and Australasia generated really strong returns while minority deals in China were less sophisticated than they are now – you just got 5-10% of a company and hoped for the best. The conservative approach to China comes from that.

Q: How did you respond to resurgence of China funds in 2003-2004?

A: We didn’t feel like we were going to take another bet. We thought we’d see how it works out and if indeed it made sense to go back into the market. That continued into 2005-2006 when you had the big wave of interest in China and India and a lot of Asian fund-of-funds came into existence on the promise that

they would get you exposure to these markets. Although we were quite conservative, we still built a pretty meaningful China portfolio. We are in our sixth Asian fund-of-funds, which is just over $1 billion and about 40% is allocated to China. And our historical performance has been strong: looking at realized returns alone, we have invested $400 million and it is now worth $1 billion, so that’s 4.5x; including unrealized returns, it’s more like 2.5x. This has come through China funds, regional funds that invest in China, and also through our US venture funds.

Q: In practical terms, what

difference does a China office make?

A: We are going to be more accessible. We have 14 investment professionals in Hong Kong, 4-5 focus on China and someone is there almost every other week. Having a permanent presence provides better access to GPs and developments happen so quickly in China that being on the ground is critical.

Q: Does it also signal more of a focus on country funds than regional funds?

A: There is a place for both, but you need to look at these regional funds and their country teams and stack them up against the teams of country funds. There are other elements that make regional funds interesting – they can do certain types of deals, add value and deploy resources in a way that country funds cannot. They also have sector and industry knowhow on a global basis. That said, we are rebalancing more towards country funds in China.

SEBASTiAAN vAN DEN BERg | industry Q&a [email protected]

Talent spotterSebastiaan van den Berg, managing director at HarbourVest Partners, on what he looks for in a Chinese GP and why the firm recently decided to open an office in Beijing

Asian Venture Capital Journal

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