China Private Equity

Launched amid much worldwide rejoicing when the financial crisis struck last year, China’s Rmb 4 trillion ($585 billion) stimulus package is given much of the credit for China’s continued strong economic performance this year. China’s GDP growth is likely to exceed 8%, and the domestic stock market is up by over 70% since the start of the year. 

A Keynesian miracle? To read a lot of the financial commentary on China, you might well conclude this is so, that government spending has single-handedly kept the economy jaunty, while both firms and consumers sank into a deep funk. It’s a great story, and provides a simple explanation for how China dodged the bullets that struck all other major economies. Other countries looked on enviously, and urged China to continue the fiscal pump-priming to help out the overall world economy. 

Problem is, the analysis is flawed. China’s stimulus plan is not all it’s cracked up to be. While the additional government spending has clearly played a part, it is not the only reason why China’s economy has remained so sound this year. The unsung heroes of China’s economic success this year are its ordinary consumers. It’s their continued confidence and increased spending that have really made the difference. 

Economic statistics are notoriously iffy in China. The further one gets from the economic lever-pullers in Beijing, the harder it becomes to track economic activity. That’s another reason why the stimulus plan was so often singled out as the main spur to China’s growth. It’s easier to calculate how much additional the Chinese government is spending building expressways than it is to see how many pairs of socks or bowls of noodles Chinese are buying. 

Another reason: a lot of the economic commentary comes from folks who believe that governments really are responsible for what happens, good and bad, in an economy. Again, it’s just so much simpler to view things this way, that powerful government men can pull out their checkbooks and spend their way to national prosperity. These are often the same people who will tell you, wrongly, that Roosevelt’s New Deal spending lifted the US out of Depression.

China’s supporters and detractors both give the government too much credit. There are those who are convinced China’s economic growth is all some kind of fraud, cooked up by the central government, and that once the extra government spending is dialed down, the economy is certain to crash. 

Again, pure hogwash. 

In China, the government rightly deserves credit for excellent economic management, for creating the circumstances, both marco and micro,  that allow the Chinese economy to continue to thrive. I’ve said it frequently, including in public forums: China is the best-managed major economy in the world. 

But, again, let’s also commend the country’s one-billion-plus consumers, too often seem as miserly skinflints, saving up all their money for their great-grandchildren’s rainy days. It just ain’t so. China’s consumers, with an ever-increasing choice of products, services and shops, are spending ever-increasing sums on improving the quality of their lives. Newer and better housing. New cars. Holidays. New wardrobes. You name it. 

I see it every day here, the untethered exuberance of the Chinese consumer. It’s true that in the early part of this year, there was a relative lull. Back then, shops were working harder to attract customers, by putting a lot of their goods on sale at steep discounts. About four months ago, the situation began to change markedly. No more major knockdowns. Prices now all seem to carry list price, and the prices for many common consumer products are as high, or higher, than in the US. 

Not much of this, it goes without saying, gets noticed by the world’s financial commentariat. Car sales in China are at an all-time high, and China is now the world’s largest car market. But, listen to the commentators, and they’ll tell you it’s the result of some small government tax breaks on new car purchases. Helpful, yes. The main spur? No. Car prices in China are still, in dollar terms, generally much higher than in the US. Based on a percentage of average disposable income, car prices in China are probably among the most expensive in the world. Same goes for property prices. Yet, Chinese keep buying. 

They will keep buying, at or near this record pace, long after any tax breaks phase out.  Chinese want the new cars to drive on the new expressways to carry them to the new shopping malls to buy the new furniture for their new apartments. 

Of all the economic statistics I’ve seen lately, the one that best captures what is going on now in China is this: revenues in China’s restaurant industry were up 18% during the first half of 2009, to over $120 billion. That’s not due to stimulus, or bank loans, or tax concessions, or a government mandate to entertain more. It’s largely because Chinese are out having a good time, more often, and spending a lot more doing so than they did a year ago. 

It’s one of the best barometers of a nation’s mood, restaurant spending. In China, the mood is buoyant, the outlook bright, and the woks are working overtime.

I spent the day in Shanghai on Friday, attending a private equity conference, and giving one of the keynote speeches. I’d thought about giving my talk in Chinese, but in the end, the discretion/valor calculus was too strong in favor of using my native language. I was one of only two speakers who used English — or in my case, a kind of half-bred version of miscegenated Mandarin and English. The rest of the conference participants — including two other Westerners and dozens who participated in panels – all spoke in Chinese.  It was quite humbling, and I’m determined to use only Chinese next time around. 

Shanghai has, so rapidly, become a truly international city. It’s one thing to say, as Shanghai’s leadership has been doing over the last decade, that Shanghai will surpass Hong Kong as Asia’s largest, most vibrant international financial center. It’s quite another to achieve this, or even make significant headway, as Shanghai has done. So many of the factors aren’t under the control of government authorities. They can only create the legal and tax framework. In the end, the process is driven by individual decisions made by thousands of people, who commit to learning English and mastering the basics of global finance. All are staking their careers, at this point, on Shanghai’s future as a financial center. 

It’s a version of what economists like to call “network effects”: the more individuals who commit to building Shanghai as a financial center, the more each benefits as the goal comes closer to fruition. On Friday, in Shanghai, I could see this process vividly displayed in front of me, of how widespread knowledge of English has become: of the 200 or so people who heard my talk, at a glance 99% were Chinese, and only a handful needed to use the translation machines.

My talk was titled “Trends in Private Equity: China as #1”.  In Chinese, it’s “私募股权投资：中国成为第一”

The basic theme was how “decoupled” China has become from private equity and venture capital investment in the rest of the world.  China is in the ascendant, and will remain that way, in my opinion, for the next ten years at least. It will be years before the PE and VC industries in the US reach again the size and significance they enjoyed a year ago. China, meanwhile, is firing on all cylinders.

There are many reasons for China’s superior current performance and future prospects. In my talk, I focused on just a few, including principally the rise over the last decade of a large number of outstanding private SME. They are now reaching the scale to raise successfully private equity and venture capital funding.

It’s another example of positive network effects: the Chinese economy is undergoing a shift of breathtaking significance: from dependence on the public sector to reliance on the private sector, or in my shorthand, “from SOE to SME”. The more successful SME there are, the more embedded this change becomes, and the more favorable overall circumstances become for newer SME to flourish. 

Here’s one of the slides from my PPT that accompanied the talk: 

—  Global Private Equity: in trouble everywhere except China
全球私募股权投资：除了中国以外的其它市场都陷入困境

—  Recession; Credit Crisis; Over-leveraged ; closing IPO window

—  经济衰退，信贷危机，杠杆率过高，几近停止的IPO

—  Most PE firms dormant, can’t raise new equity or new debt; industry contracting

—  PE公司无法进行股权和债权融资，几乎处于休眠状态，行业萎缩

—  China is the exception:  strong economic fundamentals; shift from export to domestic market;  shift from state-owned to private sector;  rise of world-class SME

—  中国的独特之处：强劲的经济增长，从出口导向到关注国内市场的转变，经济从国有企业到私营企业的迁移， 富有成为世界级企业潜力的中小企业

 For anyone interested, the whole speech is available, in Chinese, at http://news2.eastmoney.com/090717,1117,1134998.html

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Readers of this blog will know I’m a big fan of Jim Zukin, a founding partner of the investment bank Houlihan, Lokey, Howard and Zukin. We met again for lunch last week, in Los Angeles. 

I’ve had the pleasure of meeting, and befriending, quite a few smart, and highly successful businessmen and entrepreneurs. It’s probably been the most rewarding part of my career. But, even among such pretty stellar company, Jim Zukin stands out. I’m truly awestruck – which is not a quality I often exhibit — by his intellect, his charisma, his business savvy, his warmth and humor, his love for his family, his clear and incisive thinking on the largest issues of our time. 

Jim is also much, much better at investment banking than I will ever be. I tend to be somewhat stubborn and used to being in charge. But, Jim’s judgment as an investment banker is so much more thoroughgoing than my own, that he is one of the very few people I’ve known who, metaphorically,  I would follow unquestionably into battle. Like a good junior officer, I would,  “Salute, shut up, and do what I was told.” 

Jim shares with me a deep affection for China, and a great delight in doing business there. He spotted big potential opportunities for his firm in China several years ago, and personally traveled there frequently to get Houlihan Lokey’s office started and on a solid footing, which is where it is today. Jim is one of those people who seems to know more about more things than should be possible, let alone for a guy who’s also occupied with “minor” tasks like staying very close to his five kids and grandchild, while helping to run the thriving global investment bank he founded. 

Among the things Jim understands well (better than anyone I’ve run across) the remarkable moment in financial history we’re now living through – the US is struggling to rebuild its banking sector and recover from a serious credit crisis and recession, while China is awash in liquidity. Most experts look at this and see just one dimension – that China’s government will continue to use its massive foreign exchange reserves to buy US government debt, thereby providing some additional stability to US interest rates and the dollar. 

Jim Zukin sees beyond this – indeed well beyond the current horizon –  to another important aspect of the financial symbiosis between the US and China. Chinese companies, as Jim sees it,  now have the scale, the ambition, the growth potential and the financial resources, to acquire assets in the US. This could have transformational effects for the Chinese companies able to acquire businesses in the US, and no less of an impact on parts of the ailing US industrial base. China could, and should, become a buyer of quality Middle Market companies in the US. There are good reasons why: because these US assets will help the Chinese firm accelerate its growth,  improve distribution and customer base in the US, upgrade technology. One other reason: US Middle Market companies are comparatively cheap, at the current valuation multiples (often around 5x)  and dollar-renminbi exchange rate. 

Jim sees this opportunity earlier and more clearly than most of us. He does so, in part,  because he holds more substantive knowledge and insight about the US, China and the financial tsunami that has changed the world over the last year. He condensed some of this knowledge and insight into a Powerpoint called “The Great Unwind and Its Impact”. 

I recommend it as essential reading, for anyone who wants to understand better the current financial crisis and some longer-term impacts on China and the US.  There’s a large amount to chew on in Jim’s report, not just the section on China. It shows a breadth of understanding that help explain why Jim was able to build a perennially successful investment banking firm, as well as perhaps the only one that’s come through the current financial crisis stronger than ever. 

You can view it here:

http://www.scribd.com/doc/15194564/The-Great-Unwind-and-Its-Impact-By-Jim-Zukin

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