UK private equity giant
Overseas private equity investors in China have traditionally invested using offshore vehicles in partnership with the management of the target company. The creation of such vehicles required permission from the Chinese Government and following legislation that came into force in September last year, such permission has become significantly more difficult for investment in sectors deemed strategic or sensitive. “There’s been a backlash against foreign investment,” says Jeremy Gordon, chief executive of
The mood currently sweeping the halls of power in China is that local funds have to be encouraged if the country is going to be able to fend off the constant advances from US and European firms – this is not to say that such investment is not welcome, but the Government does not want top tier Chinese companies to be entirely in foreign hands. It was within this context that an amendment was made to the Partnership Enterprise Law in August 2006 and enacted in June this year.
Designed to encourage the growth of more home-grown funds, the amendment introduces the limited liability partnership to Chinese law for domestic investment vehicles. Prior to the change only unlimited liability partnerships were allowed, which were similar to the GP structures seen in more mature private equity markets, and unattractive to outside investors because of the risk attached. By creating an LP structure, Chinese GPs will find it easier raise capital from overseas investors – domestic Chinese funds are financed predominantly by state-owned enterprises – and the Government wants this capital to be denominated in the local currency, the renminbi, not the US dollar. Beijing doesn’t need any more US dollars, but it does need the intellectual skills which US and European private equity investors can bring.
Funds dedicated to investing in China raised a total of US$5.26bn in the first half of 2007, an enormous 239% increase on last year’s figures, helped in no small part by the likes of
Yet the firms are finding it difficult to spend this money. The Chinese Government’s 9.9% investment in Blackstone’s IPO in May has understandably intensified the spot-light, but despite possessing a population of 1.3 billion and a GDP of US$1.9trn, private equity activity has been low. Private equity investment fell by 25.3% in H1 2007 compared to the same period last year, a drop largely attributable to the restrictions placed on foreign private equity investment by Beijing, according to the AVCJ. Only 28 deals have been completed so far this year (up to July 20), according to data from Thomson Financial, which, although an increase on the 23 wrapped up by the same time last year, is still less than the 67 seen in Australia, a country with a population size 1.5% of that of China’s and with a GDP of US$637bn.
In the short-term, this is unlikely to change as the Government’s ambition of a fully-fledged domestic private equity market takes time to come to fruition, but there are early signs of success. Reports emerged in July that Fang Fenglei, founder of China’s first investment bank and now head of the Chinese securities arm of Goldman Sachs, is considering setting up a US$790m (CNY6bn) fund based on the LP structure introduced in June. Bloomberg suggests there are at least six other LP-structured funds in the offing.
“Chinese funds are mushrooming,” says Ludvig Nilsson, director and managing partner of Jade Alternative Investment Advisors, an advisor and LP in Chinese private equity. Some of these new funds are being set up by people who used to work for US or European investment banks and private equity firms, while others are local firms who are now on their third or fourth fund “which means that they have been successful and are therefore worth backing” observed Nilsson. “The winners will be the single-country funds. The pan-Asian fund used to dominate four or five years ago, but investors today want specific, focused funds.” Nilsson is currently involved in the fund raising for Jade China Value Partners, apparently the first fund-of-funds dedicated solely to China.
CDH is the biggest local firm in the country: it has US$400m of assets under management, and is aiming to raise US$1.6bn for its third offering by the end of the year – CDC parted with US$75m for a position in the fund.
The changing face and expansion of the Chinese LP community will have a significant impact on the future of the private equity market there. “A tremendous amount of wealth has been generated over the last two to five years in China,” says Nilsson. “There are lots of rags to riches stories here.” As a result, many of these individuals are now looking to become investors. Nilsson continues: “Private equity is now viewed as one of the most exciting sectors to invest in. If you look at the rich-list of guys in China, most of them will have had private equity backing.”
Clement Kwong from ARC Capital suggests the bounty of money resting in the banking sector will also provide another source of funding. “There is a massive amount of liquidity in the banking system, and so a large number of mutual funds have been established to mop this up,” he says. “They need to put their money somewhere and have already been investing in the wider-Asian market.”
Overseas investors are not being completely ignored in favour of domestic firms. It is being reported that China’s Ministry of Commerce is revising its rules on foreign-backed private equity firms. The Foreign Venture Capital Enterprises (FIVCE) structure was launched in 2003. Open to early stage and growth/expansion capital investors, they were promptly ignored by firms for being too unwieldy and complicated. FIVCEs may be organised as actual companies (with limited liability for every investor) or unincorporated associations. The unincorporated association form has features similar to those in limited partnerships – one ‘indispensable investor’, who has unlimited liability and greater flexibility in terms of timing of capital injection (ie subject to capital calls rather than having to pay in all capital commitments within two years).
Maurice Hoo, partner at law firm Paul Hastings in Hong Kong, says: “Although the FIVCE regulations have been in place since 2003, few sino-foreign joint venture funds have been formed. Over the past six to eight months, however, we have seen an increasing interest from international investors in FIVCEs. Such interest can be attributed to a strong RMB that appears to be moving toward increasing convertibility – and therefore a reassessment by the international investors of currency risks – and, secondly, the regulations that six Chinese ministries jointly promulgated in August 2006 governing acquisitions by foreigners that have made investing in Chinese businesses through offshore special purpose vehicles rather challenging, prompting investors to seriously consider making investments onshore in Chinese companies directly, and therefore in turn creating a platform to do so inside China.”
It is far too early to speak of competition for assets in China – less than 10% of deals go to auction according to Nilsson – but the future battleground of domestic versus foreign firms, is being drawn. Anna Cheung, one of the founding team members of 3i’s Hong Kong office in 2001, believes that overseas funds will have the edge for the time being. “It’s beyond just money. The Chinese Government is looking for foreign expertise, the ability to add value, corporate governance. At different stages of their life, companies need different types of investors.”