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China M&A: Three Recent Deals

May 30th, 2013 No comments

In the last month, three large takeovers were announced involving Chinese companies. In two of these, PE buyout firms (CITIC Capital and Blackstone)  are offering to take private Chinese companies (AsiaInfo-Linkage and Pactera) quoted on the US stock exchange. In the third, a Chinese acquirer (Shuanghui International) has offered to purchase all shares of US pork producer Smithfield Foods.

I’ve done a quick comparison of these deals across a range of financial variables — premium offered to current shareholders, p/e ratio, profit growth, last two years’ share price performance. I’ve also offered my own judgment on the risks and the industrial logic of the deal, on a scale of 1-10.

The results: the troubled deals, the ones with the highest risks and deepest uncertainties about future performance, with the most anemic share prices up to the date of the offer, with claims or investigations of accounting fraud, with the least industrial logic, are commanding the higher price.

Ah, the Mysterious Orient.

 

Correction: I wrote this article based on the first day’s English-language media coverage of the Smithfield-Shuanghui International takeover. Big mistake. I took at face value the media’s account that this was a merger between China’s largest pork producer and America’s. Turns out the coverage was wrong, and so my conclusion was also. In the software business, it’s called GIGO, “Garbage in, garbage out.” The Smithfield-Shuanghui deal is every bit as precarious an LBO as the other two. The only improvement is that the target company, Smithfield, is a better and more transparent business than AsianInfo-Linkage or Pactera. For the real situation on this Smithfield deal, see this blog post.

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M&A Policy & Policy-making in China — A Visit to China’s Ministry of Commerce

May 23rd, 2013 No comments

(Me in borrowed suit* alongside Deputy Director General of the Policy Research Department, China Ministry of Commerce)

China’s Ministry of Commerce invited me last week to give a private talk at their Beijing headquarters. The subject was the changing landscape for M&A in China. It was a great honor to be asked, and a thoroughly enjoyable experience to share my views with a team from the Policy Research Department at the Ministry.

For those whose Chinese is up to it, you can have a look at the PPT by clicking here The title translates as “China’s M&A Market: A New Strategy Targeting Unexited PE Deals”.

My China First Capital colleague, and our company’s COO, Dr. Yansong Wang offered our firm’s view that the current crisis of unexited private equity deals is creating an important opportunity for M&A in China to help strengthen, consolidate and restructure the private sector. Buyout firms and strategic acquirers, both China domestic and offshore, will all likely step up their acquisition activity in coming years, targeting China’s stronger private sector companies.

Potentially, this represents a highly significant shift for M&A in China, and so a shift in the workload and travel schedule of the Ministry of Commerce officials. M&A within China, measured both in number and size of deals,  has historically been a fraction of cross-border transactions like the acquisition of Volvo or Nexen

The Ministry of Commerce occupies the most prominent location of any government department in China, with the exception of the Public Security Ministry. Both are on Chang’an Avenue (aka “Eternal Peace Street” on 长安街)a short distance from Tiananmen Square

The Ministry of Commerce plays an active and central role in economic policy-making. Many of the key reforms and policy changes that have guided China’s remarkable economic progress over the last thirty years got their start there. The Ministry of Commerce is also the primary regulator for most M&A deals in China, both domestic and cross-border.

The key sources of growth for China’s economy have shifted from SOEs to private sector companies, from exports to satisfying the demands of China’s huge and fast-growing domestic market. In the future, M&A in China will follow a similar path. That was the main theme of our talk. More M&A deals will involve Chinese private sector companies combining either with each other, or being acquired by larger international companies eager to expand in China.

Ministry officials were quick to grasp the importance of this shift. They asked if policy changes were required or new administrative practices. We shared some ideas. China’s FDI has slowed recently. That is an issue of substantial concern to the Ministry of Commerce. M&A targeting China’s private sector companies represents a potentially useful new channel for productive foreign capital to enter China.

M&A, as the Ministry officials quickly understood, also can help ease some of the pain caused to private companies by the block in IPOs and steep decline in new private equity funding. In particular, they focused their questions on the impact on Chinese larger-scale private sector manufacturing industries.

I found the officials and staff I met with to be practical, knowledgeable and inquisitive. Market forces, and the exit crisis in China’s private equity industry, are driving this change in the direction of M&A in China. But, policies and regulatory guidance issued from the Ministry of Commerce headquarters can – and I believe will — also play a constructive role.

* Three days before my visit,  the Ministry of Commerce suggested I should probably wear a suit, as senior officials there do.  By that time, I’d already arrived in Beijing, so needed to borrow one from a friend. The suit was tailored for someone 40 pounds heavier. As a result, as the above photo displays, I managed to be overdressed and poorly-dressed at the same time.

 

 

China PE value-added: Empty promises? AVCJ

May 23rd, 2013 No comments

Fin

Author: Tim Burroughs

Asian Venture Capital Journal | 22 May 2013 | 15:47 secure

Tags: Gps | China | Operating partners | Buyout | Growth capital |Lunar capital management | Cdh investments management | Citic capital partners | Kohlberg kravis roberts & co. (kkr) | Jiuding Capital | Hony capital

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       China value-add: Empty promises?

Pulled by a desire to buy and build or pushed by a need to address restricted exit options, PE firms in China are placing greater emphasis on operational value-add. LPs must decide who’s all talk and who is action

By the time Harvard Business School published its case study of Kunwu Jiuding Capital in December 2011, the investment model being celebrated was already fading.

Within four years of its launch, the private equity firm had amassed $1 billion in funds and 260 employees, having turned itself into a PE factory “where investment activities were carried out in a way similar to large-scale industrial production.” Jiuding’s approach focused on getting a company to IPO quickly and leveraging exit multiples available on domestic bourses; and then repeating the process several dozen times over. With IRRs running to 500% or more, an army of copycats emerged as renminbi fundraising jumped 60% year-on-year to $30.1 billion in 2012.

But the average price-to-earnings ratio for ChiNext-listed companies had slipped below 40 by the end of 2011, compared to 129 two years earlier; SME board ratios were also sliding. Already denied the multiples to which they were accustomed, nearly a year later these pre-IPO investors were denied any listings at all as China’s securities regulator froze approvals.

The Harvard Business School case study noted that concerns had been raised about the sustainability of the quick-fire approach, given that some of these GPs appeared to lack the skills and experience to operate in normalized conditions. “The short-term mentality creates volatility,” Vincent Huang, a partner at Pantheon, told AVCJ in October 2011. “A lot of these GPs don’t have real value to add and so they won’t be in the market for the long run.”

Subsequent events have elevated the debate into one of existential proportions for pre-IPO growth capital firms. Listings will return but it is unclear whether they will reach their previous heights: the markets may be more selective and the valuations more muted.

There is also a sense that GPs have been found out lacking a Plan B; renminbi fundraising dropped to $5.1 billion in the second half of 2012. The trend is reflected on the US dollar side as the slowdown in Hong Kong listings over the course of the year left funds with ever decreasing certainty over portfolio exits. If GPs – big or small – face holding a company for longer than expected, what are they going to do with it?

“We value control and we can take advantage of the M&A markets if we have it. We also like the IPO markets here but any investment where we aren’t a controlling shareholder, we can’t set down the timetable for exit,” says H. Chin Chou, CEO of Morgan Stanley Private Equity Asia. “We ask ourselves, ‘Do we like holding this investment for five years because there is no IPO? At some point the IPO market will come back but until then you have to be very comfortable holding it.”

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Blackstone Leads Latest Chinese Privatization Bid — New York Times

May 22nd, 2013 No comments

NYT

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MAY 21, 2013, 7:07 AM

Blackstone Leads Latest Chinese Privatization Bid

By NEIL GOUGH

A fund run by the Blackstone Group is leading a $662.3 million bid for a technology outsourcing firm based in China, the latest example of a modest boom among buyout shops backing the privatization of Chinese companies listed in the United States.

A consortium backed by a private equity fund of Blackstone that includes the Chinese company’s management said on Monday that it would offer $7.50 a share to acquire Pactera Technology International, which is based in Beijing and listed on Nasdaq.

The offer, described as preliminary, represents a hefty 43 percent premium to Pactera’s most recent share price before the deal was announced. The news sent the company’s stock up 30.6 percent on Monday, to $6.87 — still more than 8 percent below the offer price, in a sign that some investors remain wary that a deal will be completed.

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Pactera ‘Challenged By Investors Every Day’ — Wall Street Journal

May 21st, 2013 No comments

WSJ

By Paul Mozur

In an interview with The Wall Street Journal  on May 10th,  the chief executive of China’s largest software outsourcing company Pactera Inc. PACT -1.04% said investors had been pestering the company “every day” to carry out share buybacks to bolster the company’s share price.

“Our shares are trading very badly, it’s at a multiple that I can’t even imagine,” CEO Tiak Koon Loh said during the interview.

Since that interview, Mr. Loh, along with Blackstone Inc. BX -0.58% and several other Pactera executives, decided to try to cash in on that low price with a bid to take the company private for $7.50 a share or a 42.5% premium to where shares closed Friday on the Nasdaq Stock Market NDAQ -0.19%.

Following on the heels of a bid by a CITIC Capital Partners-led consortium to take private another Chinese IT services company AsiaInfo-Linkage Inc. ASIA -0.17%, the Pactera deal has led bankers and commentators to wonder whether the recent trend of private equity firms jumping to take Chinese companies listed in the U.S. private  is looking a little frothy.

“The [Pactera] deal may go down in the annals of most expensive [leveraged buyouts] ever launched. Blackstone is offering current shareholders a price equal to over 200 times 2012 net income,” said Peter Fuhrman, chairman of China First Capital.

Nonetheless, in the interview before the deal, Mr. Loh laid out his reasoning for why Pactera has good growth potential ahead of it. In particular, he said the company stands to benefit over the next decade, not just in the industry of software outsourcing, but also in tech consulting services as China’s technology industry booms.

For example, Pactera partnered with Microsoft Corp. MSFT -1.33% and 21Vianet Group Inc. to help develop Windows and Office cloud services in China, which launched on Wednesday.  Mr. Loh said that the company has a number of other cloud projects it is working on, in particular helping provincial governments build cloud infrastructure.

“China has always grown faster than the global [outsourcing] market,” Mr. Loh said.

But there are reasons to be more bearish on Pactera, especially in the short term. With more than 10% of its revenues coming from Japan, the company is likely to be hit hard this year by the falling Yen, according to Mr. Loh.

“Everything you do is in Japanese Yen, and every contract is signed in Japanese Yen, and it has just dropped 25%,” he said, adding that business has grown despite recent political difficulties between China and Japan.

Another issue is integration. Pactera was formed by the 2012 merger of HiSoft Technology International Ltd. and VanceInfo Technologies Inc. Mr. Loh acknowledged that there had been some “leakage” of productivity as the two companies work to integrate cultures and some employees or teams had left, but he nonetheless said that he expected growth to return.

“But beyond this year and getting back to the norm we should see ourselves growing…. no less than the industry and no less than the industry is at least 16% [revenue growth] year on year,” he said.

More than just saying it, Mr. Loh is betting on it. Now it’s a matter of whether shareholders believe that kind of growth in the coming years could get them more than the $7.5 per share on offer from the deal.

Blackstone did not immediately return calls.

CITIC Capital’s Take Private Deal for AsiaInfo-Linkage: Is This The Chinese Way to Do an LBO?

May 17th, 2013 No comments

Are we seeing the birth of “Leveraged Buyouts With Chinese Characteristics”? Or just some of the craziest, riskiest and unlikeliest buyout deals in worldwide history? That’s the question posed by the announcement this week that China buyout PE firm CITIC Capital Partners is leading the “take private” deal of NASDAQ-listed AsiaInfo-Linkage Inc., a Chinese software and telecommunications services that company whose shares have halved in value from over $20 during the last two years.

CITIC Capital first disclosed in January 2012 its intention to buy out the AsiaInfo-Linkage public shareholders. At the time, the share price was around $7. The board set up a committee to search for alternative buyers. It seems to have found none, and accepted this week CITIC’s offer to pay $12 a share, or 50% above the price on the day in January 2012 when it first notified the company of its interest. That seemed a rich premium 17 months ago. It seems no less so now.

Rule Number One in LBOs: do not pay any more than you absolutely need to acquire a majority of the shares. Few are the M&A deals where a premium of +50% is offered. Fewer still when the target company is one where the stock has been seriously battered for many years now. The share price went into something like a free fall in early 2010, from a high of $30 to reach that level of $7 when CITIC Capital first announced its move.

CITIC Capital is buying AsiaInfo-Linkage at a price that equates to well over 20 times its 2012 earnings. That sort of p/e multiple is rarely seen in buyout deals. Dell’s buyout is priced at half that level, or a p/e of 10X, and a premium of 25% above the share price the day before rumors about the “take private” deal started to spread.

It’s one of the exquisite oddities of this current craze to take Chinese companies private that PE firms are willing to pay p/e multiples to buy distressed quoted companies from US investors that are at least twice what the same PE firms generally say they will pay for a perfectly-healthy private Chinese company located in China. If anything, the reverse should be true.

Rule Number Two in LBOs: have a clear, credible plan to turn around the company to improve its performance and then look to sell out in a few years time. In this case, again, it seems far from obvious what can be done to improve things at AsiaInfo-Linkage and even more so, how and when CITIC Capital will exit. To complete the $900mn buyout, CITIC Capital will borrow $300mn. The interest payments on that debt are likely to chew up most of the company’s free cash, leaving nothing much to pay back principal. Sell off the fixed assets? Hard to see that working. Meantime, if you fail to pay back the principal within a reasonable period of time (say three to four years), the chances of exiting at a significant profit either through an IPO or a trade sale are substantially lower.

Leverage is a wonderful thing. In theory, it lets a buyout shop take control of a company while putting only a sliver of its own money at risk. You then want to use the company’s current free cash flow to pay off the debt and when you do, voila, you end up owning the whole thing for a fraction of its total purchase price.

In CITIC Capital’s case, I know they are especially enamored of leverage. They were formed specifically for the purpose of doing buyout deals in China. Problem is, you can’t use bank money for any part of a takeover of a domestic Chinese company. (AsiaInfo-Linkage is a rarity, a Chinese company that got started in the US over twenty years ago, and eventually shifted its headquarters to China. It is legally a Delaware corporation. This means CITIC Capital can borrow money to take it over.)

I met earlier this year with a now ex-partner at CITIC Capital who explained that the company’s attempts to do buyout deals in China have frequently run into a significant roadblock. Because CITIC Capital can’t borrow money for domestic takeovers, the only way it can make money, after taking control, is to make sure the company keeps growing at a high rate, and then hope to sell out at a high enough p/e multiple to earn a reasonable profit. In other words, a buyout without the leverage.

CITIC Capital is run mainly, as far as I can tell, by a bunch of MBAs and financial types, not operations guys who actually know how to run a business and improve it from the ground up. Sure, they can hire an outside team of managers to run a company once they take it over. But, in China, that’s never easy. Also, without the benefits of being able to leverage up the balance sheet, the risks and potential returns begin to look less than intoxicating.

We understand from insiders CITIC Capital’s plan is to relist AsiaInfo in Hong Kong or Shanghai within three years. Let’s see how that plays out. But, I’d rate the probability at around 0.5%. The backlog for IPOs in both markets is huge, and populated by Chinese companies with far cleaner history and none of the manifest problems of AsiaInfo.

AsiaInfo’s balance sheet claims there’s a lot of cash inside the company. But, we also understand it took many long months and a lot of “No’s” to find any banks willing to lend against the company’s assets and cash flow. In the end, the main lenders turned out to be a group of rather unknown Asian banks, along with a chunk from China’s ICBC. The equity piece is around 60% of total financing, high by typical LBO standards.

AsiaInfo-Linkage is in most ways quite similar to  “take private Chinese company” Ptp deals of the kind I’ve written about recently, here and here. It has the same manifold risks as the other 20 deals now underway — most notably, you walk a legal minefield, can only perform limited due diligence, spend huge sums to buy out existing shareholders rather than fixing what’s wrong in the company, and so end up paying a big price to buy a company that US investors have decided is a dog.

One good thing is that AsiaInfo-Linkage hasn’t been specifically targeted either by the SEC or short-sellers for alleged accounting irregularities. This isn’t the case with the other take private deal CITIC Capital is now involved with. It’s part of the consortium taking private the Chinese advertising company Focus Media, where a lot of questions have been raised about the quality and accuracy of the company’s SEC financial statements.

AsiaInfo-Linkage seems to be a decent enough company. It is growing. Its main problem is that it relies on three mammoth Chinese SOEs — China Mobile, China Telecom, China Unicom — for over 95% of its revenues. The company’s founder and chairman, Edward Tian, is backing the CITIC Capital deal. Along with CITIC Capital, two other PE firms, Singapore government’s Temasek Holdings and China Broadband Capital Partners (where Tian serves as chairman) are contributing the approximately $400mn in cash to buyout the public shareholders and take control.

Interestingly, Edward Tian has for seven years been a “senior advisor” to Kohlberg Kravis Roberts, aka KKR, perhaps the world’s leading buyout firm. In theory, that should have put KKR in a prime position to do a deal like this — they have far more capital and experience doing buyouts than CITIC Capital, and they are already very familiar with the boss. But, they kept their wallet closed.

Disclosure: I’m a big believer in the value of doing control deals for Chinese companies. We’re just completing a research and strategy report on this area and we expect to share it soon. But, the deals we like are for the best private Chinese companies where the current PE firm investor needs to find a way to sell out before the expiry of its fund life. Such deals have their complexity, and using leverage will not be an option in most.

But, these good assets could most likely be bought at half the price (on a p/e basis) that CITIC Capital is paying to a company that shows little prospect of being able quickly to pay off in full the money CITIC is borrowing to buy it. If that happens, CITIC Capital may be lucky to get its LPs’ money back. Is CITIC Capital perhaps trying a little too hard to prove LBOs in China have their own inscrutable Chinese logic that it alone fully understands?

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China private equity bitten again by Fang — Financial Times

May 10th, 2013 No comments

FT

 

 

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By Simon Rabinovitch in Beijing

Financier Fang Fenglei is betting on private equity recovery

China’s unruly markets have vanquished many a savvy investor, but if one man knows how to play them it is Fang Fenglei.

From the establishment of the country’s first investment bank in 1995 to the complex partnership that brought Goldman Sachs into China in 2004 and the launch from scratch of a $2.5bn private equity fund in 2007, Mr Fang has been at the nexus of some of the biggest Chinese deals of the past two decades.

Even his abrupt decision in 2010 to start winding down Hopu, his private equity fund, was impeccably well timed. Since he left the scene, the Chinese stock market has been among the worst performers in the world and the private equity industry, once booming alongside the country’s turbocharged economy, has gone cold.

So the news that Mr Fang, the son of a peasant farmer, will return with a new $2bn-$2.5bn investment fund is more than a passing curiosity. The financier is betting that China’s beleaguered private equity industry will recover – a wager that at the moment has long odds.

The most immediate obstacle for the private equity industry in China is a bottleneck on exits from investments. Regulators have halted approvals for all initial public offerings since October, a tried and tested method for putting a floor under the stock market by limiting the availability of shares. But a side effect has been eliminating the preferred exit route of private equity companies.

Even before the IPO freeze, the backlog was already building up. China First Capital, an advisory firm, estimates that there are more than 7,500 unexited private equity investments in China from deals done since 2000. Valuations may have appreciated greatly but private equity groups are struggling to sell their assets.

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China’s IPO Drought Spurring Interest In M&A — FinanceAsia

May 7th, 2013 No comments

FinanceAsia

 

With slim hope of exiting through a lucrative public listing, Chinese entrepreneurs and their investors are considering sales.

China’s huge backlog of initial public offerings is creating an exit crisis for maturing private equity funds — and an opportunity for international investors interested in buying something other than a bit of a state-owned enterprise.

For China’s entrepreneurs, the dream of earning a rich valuation through an IPO is over, but the result could be a healthy increase in acquisitions as owners slowly come round to reality: that selling to a foreign buyer is probably the best way of cashing out.

There is no shortage of candidates, thanks to the unsustainable euphoria at the height of China’s IPO boom. The number of firms listing in China, Hong Kong and New York was only around 350 at its height, yet private equity funds were investing at triple that rate. As a result, there are now more than 7,500 unexited private equity deals in China.

“IPOs may start again, but it will never be like it was,” says Peter Fuhrman, chief executive of China First Capital, an investment bank that specialises in advising on private equity deals. “The Golden Age is likely over. There are 10,000 deals all hoping to be one of the few hundred to reach IPO.”

As long as the window to a listing was open, China’s entrepreneurs were willing to hold out in the hope of selling their business at a valuation of 80 or 100 times earnings. Even last year, when the window to IPO was firmly closed, few bosses chose to sell.

“Private equity activity was fairly muted in 2012 — you could count the meaningful exits on one hand,” says Lindsay Chu, Asia-Pacific head of financial sponsors and sovereign wealth funds at HSBC. But sponsors still have a meaningful number of investments that they will need to exit to return capital to LPs [limited partners].”

However, both Fuhrman and HSBC note signs of growing interest in M&A — or at least weakening resistance to the idea.

“I’m conservatively optimistic about leveraged buyouts,” says Aaron Chow, Asia Pacific head of event-driven syndicate within the leveraged and acquisition finance team at HSBC. “The market is wide open to do these deals right now, as financing conditions are supportive and IPO valuations may not provide attractive exits.”

Indeed, the ability to use leverage may be decisive in helping foreign buyers emerge as the preferred exit route for China’s entrepreneurs. Leverage is not an option for domestic buyers, which are also burdened with the need to wait for approvals, without any guarantee that they will get them.

This means foreign acquirers can move quicker and earn bigger returns, which may prove enticing to bosses who want to maximise their payday and get their hands on a quick cheque.

If this meeting of the minds happens, foreign buyers will get their first opportunity to buy control positions within China’s private economy, which is responsible for most of the country’s growth and job creation.

“The beauty here is these are good companies, rather than a troubled and bloated SoE that’s just going to give you a headache,” says Fuhrman. “It’s still a bitch to do Chinese acquisitions — it’s always going to be a bitch — but private deals are doable.”

Some of those deals may involve trade sales to other financial sponsors, as a number of private equity funds have recently raised capital to deploy in Asia and are well placed to take advantage of the opportunity, despite the challenges.

“There’s a lot of talk in Europe about funds having difficulty in their fund-raising efforts, but for the most part we’ve not seen that in Asia,” says Chu. Mainland companies will attract most of the flows, he says, but there are also opportunities across the region. “China is always going to be top of the list, but Asean is becoming an even bigger focus thanks to good macro stories and stable governments. Singapore, Indonesia and Malaysia are all attractive to private equity investors.”

© Haymarket Media Limited. All rights reserved.

Anti-Dumping or Blatant US Protectionism? How the US Tried and Failed to Destroy a Great Chinese Entrepreneur

May 6th, 2013 No comments

Reckless or evil? You decide. In July 2009, the US Department of Commerce started an anti-dumping investigation of the “narrow woven ribbon with woven selvedge” industry. Never heard of it?  It’s the colored ribbon Americans use primarily in gift-wrapping. It’s not a particularly big industry, probably less than $500 million a year in retail sales in the US. But, adding ribbon to gift-wrapped packages is a staple of American culture. The major store chains like Target, Wal-Mart, Michael’s and Costco all stock a wide variety of ribbon in different colors and widths, and sell it for a few dollars per pack.

Back when I was a kid, the ribbon was made by American manufacturers. Gradually, of course, much of the production shifted to Asia, first Taiwan, then China. Lowering manufacturing costs also kept retail prices down, which has likely allowed more Americans to use more ribbon to decorate their gifts.  Who could complain about that?

There remains one large American manufacturer called Berwick Offray, based in Pennsylvania. They’ve been in the woven ribbon business for over 100 years. They launched the complaint that led to the US government action, claiming they were suffering “material harm” because of Chinese ribbon being dumped in the US. According to the official document issued by the Department of Commerce in July 2009, the US government’s preliminary investigations seemed to confirm Berwick Offray’s contention that Chinese manufacturers were receiving state subsidies as a way to flood the US market and steal market share, harming Berwick’s business. The US government signaled its intention to levy punitive tariffs on the Chinese imports.

In its 142-page 2009 preliminary report, (click here to download) the Department of Commerce offers a feedlot of industry data, manufacturing techniques and product descriptions, all of which are aimed to substantiate the claim that Chinese manufacturers, who now hold the largest share of the US market, are selling the ribbon in the US below cost, with the loss being covered through a variety of unspecified subsidies from the Chinese government. Keep in mind that the total amount of US imports of woven ribbon from China seemed then to be below $100mn. A lot of market share data in the report was blacked out, presumably for commercial secrecy reasons. A lot of other information was absent because the Commerce investigators said they couldn’t find people willing or able to answer its questions.

So, the entire US federal government investigation, and preliminary finding of Chinese ribbon dumping was based both on incomplete data, and the dubious premise that the Chinese government would actively intervene with subsidies in such a small market. Total Chinese exports to the US in 2011 exceeded $400 billion. So, if the data is right, Chinese woven ribbon represents about 0.025% of total Chinese exports. The manufacturers are mainly privately-owned Chinese companies, not big SOEs with political clout in Beijing.

Among those Chinese manufacturers, one stands out for its scale, its variety of products and leading market share in the US. The company is called Yama Ribbon. They are based in Xiamen and dominate the industry in China. Yama is named in the Commerce Department report as one of the major exporters to the US. Since Yama is the biggest Chinese exporter, and the US government is suggesting Chinese government subsidies allow Chinese manufacturers to sell their ribbon below cost, it stands to reason that Yama should be fingered in the report as the main beneficiary of these subsidies. Right? The US government couldn’t possibly allege the Chinese government is subsidizing a product unless they’ve already confirmed the main Chinese producer is receiving such subsidies. Right?

Wrong. Trade policy, anti-dumping actions, punitive tariffs are very often a political toy in the US. Too often, US companies can use lobbyists or friendly politicians to pressure the Commerce Department to initiate an investigation. That alone can often cause exporters, whether they are dumping or not, to increase their prices, just to try to avoid any unilateral action by Washington. This, then, boosts the competitive position, and so the profits, of the US company that started the anti-dumping ball rolling. It isn’t called corruption, but often it should be understood as such.

Is this the case with Berwick Offray and woven ribbon? Did it use the US political process to help its foundering business in the US? That seems the case to me. Here’s why. After its initial report in 2009, the Commerce Department launched a more detailed analysis to identify all the subsidies Yama Ribbon and other Chinese manufacturers were receiving from the Chinese government.

In July 2010, the US officials announced they could find no evidence of Yama receiving any subsidies whatsoever. Yama Ribbon products were assigned an “anti-dumping” duty of 0%. It was a complete victory for Yama and a repudiation of misguided US protectionist trade policies. It received about zero press coverage, in China and the US, which is a shame.  Next time you hear someone spouting off about “unfair China trade practicies” or “predatory pricing”, think about Yama.

Several other Chinese manufacturers were found to be receiving subsidies, and their products were slapped with punitive duty rates of 125% to 249%. But, Yama is the main producer and exporter. If it’s receiving no subsidies, then it is impossible to claim the Chinese government is rigging the market to the detriment of Berwick Offray and the few other remaining US producers of woven ribbon.

How, you might ask, could the US government have even issued the preliminary 2009 report before establishing beyond doubt that Yama was getting favors from the Chinese government? The same question occurred to Yama’s founder and CEO, Yao Ming. (Yes, same name, but no relation to — physically or by bloodline —  to the Chinese basketball star.)  When he heard about the 2009 investigation and preliminary finding, Yao understood immediately it had the potential to damage, if not ruin his entire business, with 2011 revenues of over USD$50mn and over 1,000 employees. The US is his key market, over 70% of total turnover.

I’m fortunate enough to know Yao Ming. He’s a modest, hard-working entrepreneur, among the best I’ve ever met. My guess is as a businessman he could run circles around the people who manage Berwick Offray.  He’s not a political creature, speaks very little English, and until then, was unschooled in the ways of US trade policy. The US government was asserting Chinese ribbon exporters were getting subsidies and yet Yao knew he was receiving nothing. Knowing, and proving it to Washington, of course, are very different stories. He tried getting help from the Chinese Ministry of Commerce. But, they told him, effectively, he would have to fight this one on his own. They have bigger trade battles to wage with the US than this tiny one over gift ribbon.

So Yao hired lawyers, both in China and the US, and fought back. He’s the only Chinese entrepreneur I’ve heard about with this kind of character and self-confidence to spend a not-small amount of money to fight back against the US government. Even more remarkably, he won a resounding and speedy victory.

He more or less dared the US government to prove he was getting subsidies, including indirect ones like loan subsidies, special deals to buy factory land or tax holidays. When the US government couldn’t find a thing, it gave up pursuing Yama. Justice, in this case, was served. But, Yao was also lucky. His business is unusual in China. At that time, he has no bank loans, and his factories are rented. Both are rare among manufacturers in China. For any other manufacturer in China, it would be far harder to prove as quickly an absence of subsidies, direct or indirect. Yao needed to act, before the threat of an anti-dumping action permanently damaged his business in the US.

As an American citizen, I’m more than a little disgusted by what the US government did in this case: it made that 2009 announcement, declaring a preliminary finding, without really checking its facts. Had Yao not acted quickly, hired lawyers and proved his case, his business would have been sunk, and Americans would end up paying much more to decorate their gifts.

Had Commerce wanted to, it would have taken almost no time or effort to establish that Yama, as the largest Chinese ribbon exporter, was likely getting nothing from the Chinese government. But, they didn’t bother. That’s the worst of it. People at the Department of Commerce know how damaging an investigation and preliminary finding like this can be to any businesses implicated in wrongdoing.

In the end, from what I can tell, Commerce cared more about placating Berwick Offray than in making sure it didn’t unjustly harm a company faraway in China. Everything, in the end, has turned out well for Yao Ming and Yama. His business, including exports to the US, continue to thrive. He has some of the highest net margins I’ve seen in a Chinese manufacturing company. His revenues this year will approach USD$100mn. He has opened an office now in New Jersey to help handle all the orders. His Chinese competitors are now largely shut out of the US market because of the punitive duties. None seems to have had the scale or cash to hire lawyers and go to court in the US, as Yao Ming did. So whether these punitive duties are justified is, to me, an open question.

Yama’s business is number one in the US not because it sells product at the lowest price. It doesn’t. It has a better business model, thanks to the business smarts of its founder Yao Ming. He keeps a large stock of ribbon in a huge array of sizes and colors in inventory in the US, to meet spot orders. While it increases his costs, because of the extra working capital needed to finance the inventory, distributors and retailers can get orders filled more quickly. So, they buy from Yama. The company’s scale and service allow it now to earn margins that would be the envy of just about every other manufacturer operating in China.

Yao Ming is Chinese. But, he is the kind of Horatio Alger entrepreneur many in the US most admire. He makes a good product, sells it at a fair price, is good to his workers, and fought back against knuckle-headed Washington bureaucrats and won.