China Horror Story May Have Happy Ending for H&Q Asia

If you’re itching to invest in China, here’s a story that should make you think twice.

Late last month, private equity firm H&Q Asia Pacific (H&QAP) was allowed by Chinese officials to take control of a portfolio company that it invested in eight years ago. It just goes to show that even experienced investors can never be too careful when investing in China. Chih Chien Wang, managing director for H&QAP in mainland China, recounted the story and the lessons learned in an exclusive interview with PE Week.

The investment in question is Shanghai Links Executive Community, an upscale housing development built on a golf course near Shanghai’s burgeoning financial district of Pudong. It is intended to house a community of about 5,000 expatriates in western-style homes.

Back in 1997, a group of private equity investors – H&QAP, HSBC Private Equity, New York Life, and Bankers Trust – invested about $50 million in Shanghai Links. The developer of the project was SeaLand Housing Corp. of Hong Kong, which was run by Canadian Barry Hansen and his brother, Stuart Hansen.

Later, the private equity investors accused the Hansen brothers of fraud and filed suit in multiple courts – from the Turks & Caicos Islands to London. The High Court of London ruled in 2002 that the Hansen brothers were “unprincipled businessmen” who had “forged” documents, and the court awarded damages of $66.5 million to the private equity investors, according to the Financial Times.

“The essence of our problems was the fraud and embezzlement by the project’s original sponsor [Barry Hansen],” Wang told PE Week. “He claimed that he had paid $33 million for the land use rights and another $8 million in construction costs.” But what H&QAP and its co-investors discovered after delivering on their $50 million investment was that the developer had actually paid just $260,000 toward the land use fees and was embezzling funds coming into the company for other purposes, Wang says.

Even though the courts ruled in favor of the private equity investors, control of Shanghai Links remained in the hands of the Hansen brothers. H&QAP had to spend months in meetings with various government agencies in China to convince local officials that it should have control of all rights in the project and have changes made to the documents of ownership. Wang says his firm had to plead its case to the State Administration for Industry and Commerce, Foreign Investment Commission and the Ministry of Commerce.

All of the politicking finally paid off on Feb. 22, when the private equity investors were allowed for the first time to meet with Shanghai Links’ employees and tenants, and spend nine days reorganizing operations. Shanghai Links reopened on March 1, and H&QAP is now making improvements to the property.

Wang says he learned at least two lessons from the painful experience.

Lesson No. 1: Go the extra mile on due diligence. When you sign an investment agreement written in Chinese, “you have to know what you’re reading,” he says. “We saw the accounting reports [indicating] $33 million in payments,” but after more careful scrutiny, H&QAP realized that the documents had been written very cleverly in conversational language to disguise the fact that the payments had not actually been made, Wang explains. The only way to avoid a similar mistake in China, he says, “is to go to the bank and see the foreign exchange records” to make sure the payment was made. Clearly a trip worth making, given H&QAP’s experience.

Lesson No. 2: “You need on-the-ground operations here,” Wang says. It is imperative to have people who know their way around the government and its regulations.

Despite all the troubles with the investment, H&QAP can look forward to a nice return. The Financial Times reports that the land and housing prices around Shanghai Links have more than doubled since H&QAP and the other firms invested eight years ago.