China Private Equity

If your Chinese is up to it –  or perhaps if you want to see how well-designed the best Chinese newspapers are – click here to see the story today in China Securities News (中国证券报) that includes both an interview with me and excerpts from our Chinese-language report on the crisis in Chinese private equity.

Unlike the sorry situation in the US and elsewhere, newspapers in China are still thriving. The leading papers, including China Securities News, have large nationwide readership and distribution, with the large profits to match. And no, the contents are not fiercely censored. If they were, no one would buy them.

I’m quite chuffed this paper devotes so much space to our report and its conclusions. It’s an affirmation of what a great job my China First Capital colleagues did in preparing the Chinese version. My own modest hope is that this article, together with several others that have appeared recently in other mainstream Chinese business publications, will help catalyze a more active discussion of the current crisis in the PE industry in China. There is, as my interview emphasizes, a lot at stake for China.

The sudden stop of both IPOs and new private equity investment in China means that private companies are being denied access to much-needed capital to finance growth. This is already beginning to have serious impact on China’s private sector and the economy as a whole. I foresee no significant change coming anytime soon. For private entrepreneurs, these are dark days indeed. Keep in mind, China’s private sector now accounts for over half of gdp — and it’s the “half” that provides most of new jobs as well as just about every product and service ordinary Chinese enjoy spending money on.

As a lot of non-Chinese speakers have heard, the Chinese words “crisis” and “opportunity” share a common root (危机，机会）. There is much wisdom in this. The current crisis in China PE is also perhaps the best opportunity ever for stronger PEs to find and close great investments, through purchases of what we call “Quality Secondaries”.

Investment opportunities don’t get much riper than this one.

A stagnant exit market is likely to cause problems for firms that ventured into China in the boom years

Statistics rarely tell the whole story. However, as China celebrates the Year of the Snake, the most recent figures for private equity exits in the country make sobering reading for those who were convinced that the surge in private equity in the world’s most populated nation was the ticket to easy returns. In the final quarter of 2012, there was no capital raised by sponsors through primary initial public offerings of companies they backed, no capital raised through sales to strategic buyers and just $30 million from secondary buyouts, according to data from Dealogic.
That collapse in the exit market is creating a huge backlog of businesses in private equity hands that could force many companies to the wall and drive a shakeout in the industry, losing investors billions in the process. Global private equity firms, from large buyout specialists TPG Capital and Carlyle Group to mid-market players like 3i Group, all flooded
into the Chinese market raising capital from international investors for deals on the expectation of outsized returns as the economy opened and boomed. They were joined by thousands of domestic players that raised capital in local currency from the growing band of China’s wealthy individuals eager to get a slice of the market.

Incredible Success

Peter Fuhrman, chairman and CEO of investment bank China First Capital, said: “In the course of the last five years China has grown into the largest market by far for the raising and deploying of growth capital in the world. It has been an incredible success story when it comes to talking investors into opening up their wallets and allocating much-needed capital to thousands of outstanding Chinese entrepreneurs.” More…

China’s once-booming private equity industry is facing a logjam as a dearth of exit possibilities is slowing the flow of new deals in the sector, analysts and industry executives say.

The volume of private equity activity slowed dramatically last year, with some $17 billion invested in more than 700 companies, down from more than $30 billion invested in more than 1,700 companies in 2011, according to China First Capital, a Shenzhen-based investment advisory firm. Virtually all deals in China are minority equity investments in fast-growing private companies rather than buyouts of public companies as in the West. The industry was virtually nonexistent in China at the start of the 2000s but grew rapidly as Western investors rushed to participate in the country’s economic boom.

“You had an industry that grew very quickly but is not yet fully matured,” says Peter Fuhrman, chairman and CEO of China First Capital. “The PE firms raised huge money from LPs around the world and now face the challenge of not being able to exit their investments before the life cycle of their funds run out,” Fuhrman says. More…

-

I can’t say I ever articulated it as a goal, because it always seemed too far-fetched. But, I did achieve something today I truly value. I had an article published in a leading Chinese newspaper under my own name. Well, not the name my parents gave me, but my Chinese name, 傅成, which is how I’m generally known here. You can click here to see the article. The title, IPO黄金时代一去不返 私募股权行业危机重重, can be translated as “With the Golden Age of IPOs Over,  the Chinese PE Industry is in Crisis”.

It’s an article about problems with unexited PE investments in China, and the block on IPOs for Chinese companies. It appears in the country’s only major national business daily, called 21st Century Business Herald, in English, or 21世纪报纸 in Chinese. Calling it the “Wall Street Journal of China” is a little bit of a disservice, since it enjoys more of a dominant position, both in reputation and in its area of financial reporting, than even the Journal. And I give way to no one in my complete admiration of the WSJ. It is the only newspaper I read and value.

I’ve been an occasional online columnist for 21st Century Business Herald for a couple of years. This may have made them more comfortable when dealing with my rather unusual request, to publish in the daily paper’s news pages under my name an article I submitted to them. This isn’t something Chinese newspapers, especially the major ones, would generally ever do. Media is sensitive in China, extremely well-monitored. I’m just a guy who runs a small advisory firm 1,500 miles from Beijing, and have had no other form of official vetting.

After a day of deliberating, I got word they’d agreed to run the story. I never spoke directly to any of the editors at the newspaper. I wasn’t allowed to. One of the team that manages the online columns acted as middleman.

It was important to me to have the article, as submitted, published, under my name. The article touches on a topic that I think is both important, and little understood — that the block in IPO exits, and the simultaneous cut-off in most new PE funding for private companies in China, is beginning to do real harm to the private sector economy in China. I wanted to make that point, directly and clearly, and not have it be massaged in any way.

I’m a guest in China, and feel extraordinarily privileged to live and work here. There’s nothing in my story critical of government policies, nor should there be. This crisis in China PE industry is largely of its own making.  Yes, the sudden stop of all IPOs does harm to PE investors. But, for years now, China’s PE industry has been overly-reliant on IPO as its one means of exit. Money flooded in and, even at the best of times, only a trickle leaked out through IPO. Now the trickle has been plugged shut. PE firms, their investors and the entrepreneurs they backed are all in serious peril. PEs may lose their LPs money, which would be very unfortunate. But, the real suffering is likely to be borne by the entrepreneurs, who may actually be doing a great job running their business, but now have a desperate unhappy investor inside and so no way to raise the additional capital they need to keep growing. They face a kind of slow asphyxiation.

Another reason I wanted the article to be published under my name was to try to make sure my company got some credit for the work we’ve done over six months to calculate and assess the scale of the problem of unexited deals in China. The article was published this morning. By lunchtime, electronic versions were popping up all over the Chinese internet, on most of the major financial news websites. In almost all cases, these repackaged versions all deleted my name and that of China First Capital. Pretty much par for the course in China. “Journalistic ethics” are two words not frequently paired in China. The pirated articles now discuss the findings of our research without ever mentioning who actually compiled it. If I were a reader, I’d wonder, “why should I believe any of these numbers when the article doesn’t tell me who the source is?” But, I guess Chinese readers aren’t that fussed.

As readers of this blog clearly will have noticed,  me and my company have gotten rather a lot of English-language press attention lately. But, not a single one of those articles, or the whole lump combined, gives me even a fraction of the satisfaction and joy I had this morning holding a Chinese newspaper and finding my article in the middle of page 15.-

-

The chairman of research firm China First Capital discusses China’s growing exit problem, and its possible impact on private equity in 2013.

A growing concern for private equity in China is the lack of IPO exits. How do you see that playing out in 2013?

“I don’t expect any substantial improvement or change in the problems that are blocking IPO exits domestically and internationally. And because the China private equity industry is significantly over-allocated to IPO exits, along with diminishing fund life, [this] will be a time of increasing difficulty for GPs. At the same time, the inability to exit will also continue to prevent [GPs] from doing new deals, and that is where the greatest economic harm will be done. Of course I don’t trivialise the importance of the $100 billion that’s locked away in unexited PE investments, but the real victims of this are going to be the private entrepreneurs of China. At this point, over half of all [China’s] GDP activity is generated from the private sector. The private equity money and the IPO money is what [businesses] need to grow, because private companies in China basically can’t borrow. They need private equity money and IPO proceeds to continue to thrive. “  More…

-

From humble beginnings in 2000, the past decade has seen the Chinese private equity (PE) market blossom into a global powerhouse. However, according to a new report released by investment bank China First Capital (China First), the Chinese market is in the formative stages of a crisis which could undermine all of the extraordinary strides it has made in recent years.

The report, ‘Secondaries: A necessary and attractive exit for PE deals in China’, notes that while there have been nearly 10,000 deals worth a combined $230bn completed within the Chinese market between 2001 and 2012, around 7500 of those deals remain ‘unexited’. This has left approximately $130bn of PE and venture capital investment locked inside Chinese companies with very few exit options available. More…

-

-

With China’s IPO gusher now reduced to a trickle, prospects for some of the privately-owned companies which have traditionally boosted much of China’s economic growth could be at risk.

So says Peter Fuhrman, founder and chief executive at China First Capital, a boutique investment bank and advisory firm. His firm has just released a new report warning that new private equity investment has basically come to a halt in China since the middle of last year.

Fuhrman talked to WiC this week about the reasons for the slowdown, and why he would like to see more investors considering alternative exits, including sales in the secondary market. More…

-

-

-

Venture Capital Financing in the US

(Source; The Wall Street Journal)

-

They are the best-paid gamblers in the world, the General Partners at private equity and venture capital firms. They are paid to take risks, to make bets, with other people’s money. And for this, they usually get a guaranteed high annual retainer, a salary that generally puts them in the top 1% of all wage-earners in their country, and also a share of profits earned from putting others’ money at risk. In other words, their life is on the order of “heads I win, tails I win” compensation. They make a handsome salary, have all their expenses covered, are unlikely ever to get fired, and also usually get to claim 20%-25% of the profits from successful deals.

Given those incentives, and the fact the guys with the money (your fund’s LPs) are paying you to find great opportunities and bet on them rather than sit on your hands, you would assume that GPs would want to keep the flow of new deals moving along at a reasonable pace. In fact, inactivity is, next to losing all the LPs money on bad investments, the surest way for a PE fund to put itself out of business. And yet this do-nothing strategy is now common across China’s private equity industry. For the better part of a year, deal-making has all but dried up.

From a recent high of around 1,200 PE deals closed in a single year in China,  in 2012 the total tumbled. My surmise is that the number of new PE deals closed in China last year was down at least 75% from 2011. The activity that took place did so almost entirely during the first half of the year. An industry now holding over $100 billion in capital and employing well over 10,000 people, including some of the most well-educated and well-paid in China, ground to a halt during 2012.

Let me offer up one example. I won’t name them, since I know and like the people running this shop: a fund that is among the biggest of all China-focused PEs, with over $4 billion in capital, made a total of three investments in all of 2012. Two of them were in “club deals” where they threw money into a pot along with a bunch of other funds. Though they keep a full-time staff of 100, funded by the management fee drawn from LPs money, this firm closed only one deal that they actually initiated. At a guess, these guys have an annual management fee in excess of $50mn, and during 2012, their headcount more than doubled.

In any other line of work, a company that decreased its output to about zero, while significantly increasing its expenses, would be on the fast-track to insolvency. But, not in the PE industry in China. It’s currently the norm. Now, of course, those same PE firms will say they are keeping themselves busy monitoring their previous investments, rather than closing new ones. Yes, that’s necessary work. But, still, the radical slow-down in PE activity in PE is without precedent elsewhere in the PE and VC world.

Look, for example, to the VC industry in the US. In good years and bad, with IPOs plentiful and nonexistent, VC firms keep up their dealmaking.  These two charts at the top of the page show this quite clearly. Across a six-year cycle of capital markets boom and bust, the number of new VC investments closed stayed relatively constant at between 600-800 per quarter. In other words, VC workloads in the US stayed relatively stable. They kept channeling LP money into new opportunities. The dollar amounts fluctuated, peaking recently during the run-up to the highly-anticipated IPOs of Linkedin, Facebook, Groupon and Zynga.  Valuations rose and so did check size. But, deal flow stayed steady, even after Linkedin, Facebook, Groupon and Zynga’s share prices nosedived following IPOs.

This is the picture of a mature industry, managed by experienced professionals who’ve seen their share of stock market up and down cycles, heard thousands of pitches for “sure things” that raised some money only to later crash and burn. Some VC firms crashed and burned with them. But, overall, the industry has kept its wits, its focus and its discipline to invest through bad times as well as stellar ones.

The contrast with China’s PE industry is rather stark. There are perhaps as many as 5,000 PE and VC firms in China. No one knows for sure. New ones keep getting formed every week. The more seasoned of the China PE and VC firms have a history of about 10 years. But, the overwhelming majority have been in this game for less than five years. In other words, today there is a large industry, well-financed and with control over a significant amount of the growth capital available in the world’s second largest economy, that was basically created out of nothing, over just the last few years.

Obviously, these thousands of new PE firms couldn’t point to their long history of identifying and investing in private companies. But, LPs poured money in all the same. They were investing more in China — in the remarkable talents of its entrepreneurs and the continued dynamism of its economy — than in the track record of those doing the investing. That seems a wise idea to me. As I’ve mentioned more than once, putting money into China’s better entrepreneur-led companies is certainly among the better risk-adjusted investment opportunities in the world.

If anything, the opportunities are riper and cheaper than a year ago, as valuations have come down and good companies with significant scale (revenues above $25mn) have kept up a rate of profit growth above 30%. In the US VC industry, this would be a strong buy signal. Not so in China. Not now.

PE firms are collecting tens of millions of dollars from LPs in management fees, but not putting much new LP money to productive use by investing in companies that can generate a return. Nor are they actively exiting from previously-made investments and returning capital to LPs. This situation can’t last indefinitely.  For people handed chips and paid to gamble, it’s unwise to spend too much of the time away from the casino snoozing in your high roller suite.

-

With the door to initial public offerings in China largely shut, private-equity firms invested there are having a tough time cashing out. The alternative—selling to another buyout firm or a company looking to expand via acquisition—remains rare in a market where buyers are relatively few.

Private-equity firms are sitting on more than $130 billion of investments in China and are under pressure from investors to find an exit, Shenzhen-based advisory firm China First Capital said in a report last week.

Gary Rieschel, founder of Shanghai-based Qiming Venture Partners, said, “There needs to be a broader number of choices in buyers” in China. More…

In the current difficult market environment for private equity in China, secondary transactions provide a valuable way forward.  Staging successful IPOs or M&A will remain severely challenging. This is the conclusion of a proprietary research report recently completed and published by China First Capital. An abridged version is available by clicking here.  You can also visit the Research Reports section of the China First Capital website.

Secondaries potentially offer some of the best risk-adjusted investment opportunities, as well as the most certain and efficient way for private equity and venture capital firms to exit investments. And yet these secondary deals still remain rare. As a result, General Partners, Limited Partners and investee companies, as well as China’s now-large private equity industry,  are all at risk from serious adverse outcomes.

This new CFC research report is a data-driven examination of the potential market for secondary transactions in China, the significant scope for profit on all sides of the transaction, as well as the no less significant obstacles to the development of an efficient, liquid, stable long-term market in these secondary positions in China.

The report’s conclusion is that secondaries have the potential to benefit all three core constituencies in the China PE industry — GPs, LPs and investee companies. The universe of deals potentially available for secondary exit is large, over 7,500 unexited investments made in China by PE firms since 2000.

However, the greatest potential for both PE sellers and buyers across the short to medium term is in a group of select companies CFC terms “Quality Secondaries“. These are PE investments that fulfill four criteria:

1. unexited and not in IPO approval process, domestically or internationally
2. investee companies have grown well (+25% a year) since the original round of PE investment, and have continuing scope to expand enterprise value and achieve eventual capital markets or trade sale exit in 3-6 year time frame
3. businesses are sound from legal and regulatory perspective, have effective corporate governance, and a majority owner  that will support secondary sale to another PE institution
4. current PE investor seeks secondary exit because of fund life or portfolio management reasons

CFC’s  analysis reveals that the potential universe of “Quality Secondaries” is at least 200 companies. This number will likely grow by approx. 15%-25% a year, as funds reach latter stage of their lives and if other exit options remain limited.

At the current juncture, in this market environment, and assuming “Quality Secondary” deals are done at market valuations, these investment represent some of the better values to be found in growth capital investing in China.  DD risk is significantly lower than in primary deals, and contingent risks (opportunity costs, and legal risks of pursuing other non-IPO exits) are lower.

Despite the current lack of significant deal-making activity in this area, secondaries will likely go from current low levels to gain a meaningful share of all PE exits in China.

The secondaries market in China will have unique factors compared to the US, Europe and elsewhere. There will likely be limited investor interest in any secondary deal involving a Chinese company or a portfolio that has underperformed since PE investment, or could otherwise be characterized as a  “distress” situation.

Quality Secondaries transactions in China will involve PE investors “cherry-picking” good companies at fair valuations.  The primary motivation for selling PEs is misalignment between its remaining fund life and the time required and risk inherent in achieving  domestic or offshore IPO or trade sale exit during that shortened time frame.

In contrast with secondary deals done outside China, we do not expect to see much activity involving the sale of all or most of a PE firm’s portfolio of investments. Specialist secondary firms operating elsewhere (e.g. Coller Capital, Harbourvest) do not currently have the experience or manpower in China to take on the complexities of managing and liquidating all or most of an existing portfolio of minority investments.

Rather, we expect those PEs with strong operating performance in growth capital investing in China to exploit favorable market conditions by becoming active buyers of Quality Secondaries.   GPs that prefer larger deals, (+USD25mn/Rmb200mn), should be particularly interested in Quality Secondaries, since company scale and investment amount will likely be larger, on average, than primary deals in China.

Selling PEs can pursue exit strategies based on option of selling either part or all of a successful unexited deal. A part liquidation in Quality Secondary transaction can mitigate risk and return capital to LPs while still retaining future upside. A full exit through secondary can increase fund’s realized IRR and so assist future fundraising. Importantly, a selling PE needs to act before pricing leverage is transferred mainly to buyers — generally this means secondary deals should be evaluated and priced in market when fund still has minimum of two years left of active period.

While clearly the most acute need for exit will be investments made before 2008, more recent investments need also to be assessed based on current market conditions. Many GPs are adopting what looks to be an unhedged strategy across a portfolio of invested deals waiting for capital markets conditions to improve.

In particular, much of this “wait and see” approach is based on the hope that Hong Kong’s once-vibrant, now-moribund IPO market for Chinese companies returns to its earlier state. The US stock market will certainly remain off limits to most Chinese companies for a long time to come. Exit through China’s domestic stock market is now seriously blocked by bureaucratic slowdowns and an approval backlog that even under optimistic scenarios could take three to five years to clear.

The need for diversification is no less paramount for exits than entries. Many of the same PEs that wisely spread their LPs money across a range of industries, stages and deal sizes, have become over-reliant now on  a single path to exit: the Hong Kong IPO.  By itself, such dependence on a single exit path is risky. In the current environment, it looks even more so.

The flood of Chinese IPOs in Hong Kong basically came to a halt a year ago.  When they do resume, it may prove challenging for all but the best and biggest Chinese companies to successfully issue shares there. What will become of the other deals? How will GPs and LPs profit from investments already made? That’s the focus on this new report, titled, “China Secondaries:  The Necessary & Attractive Exit For Private Equity Deals in China“.

-

It is imperative for the private equity industry in China to develop an efficient, liquid market for secondaries. Our goal is both to facilitate an active dialogue, as well as help bring this about. Only by breaking the current logjam of no exits in China PE can money again start to flow in significant amounts to capital-hungry private companies. No less than the future fitness of China’s entrepreneurial private sector is at stake.

In the last several days, along with the Wall Street Journal article posted yesterday, five other financial media (New York Times, Bloomberg, AVCJ, PEI, CNN Money) published stories on this topic, referencing research results from China First Capital. I’m pleased to share them.

Private Equity in China: Which Way Out?

HONG KONG — Welcome to the private equity game in China: you can buy in anytime you like, but you can never leave. At least, that is how it is starting to seem for many of the firms that bought in big during the boom of last decade.

Starting from a base of almost nothing in 2000, global private equity funds and their start-up local counterparts rushed into the Chinese market – completing nearly 10,000 deals worth a combined $230 billion from 2001 to 2012, according to a report released this week by China First Capital, a boutique investment bank based in the southern city of Shenzhen.More…

Private-equity funds in China are still holding 82 percent of the companies they’ve invested in since 2007, as the frozen market for initial public offerings keeps them from exiting, a study showed.

Funds hold 6,584 companies after disposing of 1,445 and seeing 20 go bankrupt, according to a report from China First Capital, a Shenzhen-based firm that advises on private equity and mergers. Investors still hold companies valued at $94.3 billion, compared with a total of $194.7 billion, according to public data compiled by the firm and its own research. More...

At least 200 private equity portfolio companies in China are attractive targets for potential secondary buyers and the number is likely to grow 15-25% per year as funds come to the end of their lives and find that exit options are still limited.

These companies represent the cream of a much larger pool of investments that are as yet un-exited by Chinese PE investors, according to a proprietary study by specialist investment bank China First Capital. It estimates that more than 7,500 portfolio companies remain in private equity firms’ portfolios from investments made since 2000.  More…

As other exit avenues for private equity dry up in China, GP-to-GP secondaries could be the only option for the 7,500 unexited portfolio
companies, according to a recent study from China First Capital.

China has 7,550 unexited private equity investments totaling $100 billion that will soon have to be realised through routes other than the traditional IPO, according to a recent study from China First Capital.
As fund lives begin to expire, Peter Fuhrman, chairman and chief executive of CFC, believes the standout option will be GP-to-GP secondary transactions. This is especially true for RMB funds, which have a three-to-five year life rather than the ten years typical with US dollar funds. More…

China’s stalled market for new share listings is severely limiting the ability of private equity funds to cash out their
investments in the country, according to a new research report from China First Capital.
The Shenzhen-based investment bank analyzed more than 9,000 private equity and venture capital deals completed in
China since 2001, and found that more than $100 billion — much from the U.S. — remains invested. More…

-

-

Article from Wall Street Journal January 8, 2013

-

China was once one of the few bright spots globally for private equity. Now it’s a quagmire – and investors are going to have to change the way they approach the market.

That’s the finding of a new report by Shenzhen-based private equity advisory China First Capital (pdf). According to the company’s own research, there have been about 9,000 private equity deals completed in China over the past decade, but in more than 7,500 of those instances – or $130 billion worth of investment – investors still haven’t managed to cash out.

“Over the last 18 months, first the U.S. capital markets, then Hong Kong’s and finally China’s Shanghai and Shenzhen domestic stock markets have dramatically lowered the number of IPOs of Chinese companies,” writes Peter Fuhrman, China First Capital chairman, in the report. “It seems more likely than not that the golden age of Chinese IPOs, when over 350 companies were listing each year across public markets in the U.S., Hong Kong and China, is now over.”

It’s not a turn of events that will be easily remedied. A wave of fraud allegations leveled by auditors and short sellers against a number of small Chinese companies listed in the U.S. has destroyed investor confidence in the sector and all but frozen new IPOs. Listings in Hong Kong dropped off in 2012 owing to that market’s poor performance, but even if it recovers many private-equity-invested companies are too small to clear the Hong Kong bourse’s listing requirements. And in mainland China, the regulator has all but stopped new listings in Shanghai and Shenzhen for fear that new offerings would divert liquidity and drive lower two of the world’s most underperforming markets.

Analysts tip China’s domestic IPO market to come back to life this year. PricewaterhouseCoopers expects a combined 200 IPOs raising between 130 billion yuan ($20.7 billion) and 150 billion yuan on the Shanghai and Shenzhen stock exchanges in 2013, it said in a report. But that’s not going to clear the private equity backlog.

About 100 companies have already been cleared by the China Securities Regulatory Commission to list their shares, but are waiting for the market to improve. A further 800 companies have already filed IPO applications and are waiting for regulator’s nod. And according to Mr. Fuhrman, an additional 600 or 700 companies could be ready to apply as soon as the regulator signals it’s fully ready to take new applications. With many funds needing to return cash to their investors in the not-so-distant future, waiting for an IPO slot to open up is looking like the financial equivalent of a Hail Mary.

Traditionally, IPOs have been the preferred way for private equity investors in China to get their money out of companies they invested in. That’s in part because during the golden years of 2006 and 2007, sky-high IPO prices would result in a killing for investors that got in early. But it’s also because finding another company willing to buy the company you’ve invested in – a popular exit for private equity investors in developed markets – is seldom an option in China. Private equity investors usually take only a minority stake in Chinese companies, often because the entrepreneur who founded the firm is unwilling to relinquish control.

“To achieve [a] trade sale exit, the [investor] would need to persuade the majority owner, usually the person running the company, to sell out,” said the report. “Even in cases where that is possible, there is not an active market for corporate control in China. Few deals have been successfully concluded where a private entrepreneur, alongside a PE minority investor, has sold the business.”

The answer to this investment exit quandary might be secondary deals, whereby one private equity fund sells its stake in a company to another private equity fund, or in some cases sells its entire stable of companies to another fund. So far there have been very few such deals in China, but Mr. Fuhrman thinks they could be the way of the future.

“Despite the current lack of significant deal-making activity in this area, secondaries will likely go from current low levels to gain a meaningful share of all PE exits in China,” says the report.

Secondary deals are usually unpopular among investors that give their money to private equity funds. Large investors who have allocated money to a number of private equity shops see them as a waste of their money, particularly if one fund they’ve invested in sells to another fund they’ve invested in – all the more so if it’s at a higher price.

Secondary deals overseas often involve distressed assets – the kind a private equity fund is willing to sell at a loss just to be rid of them. But the deals Mr. Fuhrman foresees coming to the table in China would be of much higher quality, with funds forced to sell because they’re due to return cash to investors rather than because of any underlying problem with the investment.

The current quagmire is a problem that’s been building for some time, and private equity funds have so far proven reluctant to embrace secondary deals as an exit. But with the chances of getting an IPO done looking less like a bottleneck and more like the eye of a needle, major changes might be forced upon funds and the way they do business.

– Dinny McMahon

-

-

Illustration from 中国企业跨境并购交易要点和流程浅析  or

 ”What you need to know and do to complete an M&A deal”

-

Like the smart tv or a cheap fuel-efficient automobile, China M&A is the good business idea whose time never seems to arrive. There’s basically no one in the Chinese business community, or inside Wall Street investment banks, who doesn’t agree that China’s future must include a lot more M&A deals, both cross-border and domestic. Domestic industries are highly fragmented and in need of consolidation. Chinese manufacturers need to acquire brands and technology from abroad to keep growing at home and offshore.

Think of the China M&A market as a huge pile of dry sticks soaked in gasoline. You throw a lighted match on it, expecting it to explode into a spectacular bonfire. And then… nothing. M&A activity in China remains so subdued, particularly for an economy China’s size, it is almost an irrelevancy. Can this, will this, change? I’m certainly among those who think it must, and not because it promises to someday bring in fat fees for investment bankers. M&A needs to develop as a routine means to let some entrepreneurs (and the PE investors who backed them) exit, and allow others to accelerate growth and grab market share. Both should end up benefiting China’s economy.

So, where exactly are the stumbling blocks on the path to an efficient and dynamic market for corporate control in China? There are more than just a handful, and include psychological and national factors, as well as more typical business reasons. But, one of the key problems is actually a very practical, and very solvable, one — the fact most Chinese companies don’t often have a clear understanding of how to select and assess an acquisition target, and then how, if the will is there to do something,  to actually take control of another company.

Our most recent Chinese-language research paper offers some guidance here. For those with the requisite Chinese skills, you can download a copy by clicking here or visiting the Research Reports section of the China First Capital website. The research paper is titled ” 中国企业跨境并购交易要点和流程浅析“, which I’d loosely translate as  ”What you need to know and do to complete an Offshore M&A deal” .

The main readership is the +4,000 Chinese company bosses and senior management of both private sector and SOE companies we have in our database. We’re also sharing it with those whose work sometimes involves facilitating or regulating M&A deals — partners at law firms, accounting companies, PE firms, brokerage houses and government officials. This adds about another 2,000 to the list of people we sent it to.

We have a reasonable amount of experience in  – and we hope knowledge of  – M&A involving Chinese companies, representing both sellers and buyers, cross-border and pure-play Chinese domestic transactions. In other words, all four quadrants on the M&A map in China.

The contents grew directly out of our client work. It’s light on theory. We’re not trying to compete with McKinsey or business school professors. Instead, we emphasize practical steps and offer a rather stripped-down timetable of how an M&A deal might go from concept to close. Investment banks, for reasons of self-interest as well as business efficiency,  are always telling companies why and how they should do M&A. You’ll need to believe me that this wasn’t our motive. I’ve been on both sides of M&A deals as a CEO and board member in the US, both as seller and buyer of companies. Now, I sit in the middle, as a banker in China. I wanted to provide a short operational guide to Chinese CEOs on when and why M&A might make sense.

A common thread among Chinese companies looking to buy is to use M&A as a way to beef up their company’s in-house technology. One example: a client of ours  is already China’s leader in the auto electronics industry but is well behind European, American, Japanese and Korean companies in developing systems to make using a mobile phone in your car both safe and efficient. That’s a very big market opportunity in China, which is now the world’s largest auto and mobile phone market by rather large margins. This client wants to buy, rather than build, to save time, and also make sure any product they eventually try to sell to their Chinese customers works smoothly, from the beginning.

This client found a good target in Europe but then got bogged down in technology DD — how to evaluate not just the obvious stuff like patents, but the trickier domain of “company know how”.  What can be learned, what can be transferred, what can walk out the door and into the arms of a competitor? So, another area our research paper tries to both explain and systematize is the process of technology due diligence. I doubt our simplification would satisfy the partners at McKinsey or the Big Four accounting firms who often get called into do this work, and make huge sums along the way. Our operative principle here is “better to light a candle than curse the darkness”. Again, we wanted to keep it practical, for busy folks mainly engaged in running companies. With few exceptions, I’ve yet to meet a Chinese company with a specialist in-house team to do M&A.

The Chinese word for M&A is 并购 , which joins together the characters for “to combine” and “to purchase”. Theoretically, it’s an appropriate choice of words. At this point, however, with M&A still very much in its infancy in China, the main requirements are “to understand” and “to execute confidently”.  I hope this research paper goes some way towards making both more common, more certain.

China First Capital (中国首创） has a new website. Actually two, Chinese and English. Please have a look by clicking here or navigating to www.chinafirstcapital.com

Putting together the new text for the website, in two languages that share little in common in terms of grammar, word order and the logic with which ideas are expressed,  was an enjoyable and intricate challenge, both for me and my CFC co-workers. It also functioned as a kind of stay-at-home corporate retreat across two weekends, time outside of the office thinking rather deeply about what actually takes place there every day. Don’t get me wrong. I’m very hands-on, and keep myself and my co-workers fixed to a precise strategic direction. We don’t gravitate away from our nucleus: as the website puts it, “we actively assist the fundraising activities of China’s private companies, state-owned enterprises and financial sponsors. We are equally active in M&A, domestic as well as cross border transactions both inbound and outbound.”

Doing these things is actually a lot more intuitive and straightforward than explaining them in text on a website. The writing took a lot of wrong turns, and required a lot of revision.  I wanted to stay away from the kind of self-promoting puffy and imprecise language that appears on so many company websites. I’m not sure I succeeded fully, or even in part. A lesson I’ve learned over the last 25 years, having tried both, is: it’s easier as a journalist to write about someone else’s company than it is as a boss to write about one’s own.

The two websites look similar, but aren’t mirror images. The Chinese website is not a translation. It actually has more content, more pages, more pictures, more description. The reason is, the Chinese website is mainly aimed at our core client base, domestic Chinese entrepreneurs and the senior management of SOEs. Investment banking, private equity, capital markets all have rather shallow roots in China. Twenty-five years ago, none of these things existed in any practical sense in China. So, part of the Chinese website’s purpose is to place CFC’s activities in a broader context of explaining how companies get funded, both by institutional investors like PE firms and by stock markets,  and how and why they can accelerate growth through acquisitions.

Company websites in China are also a rather new phenomenon.  Five years ago, when I started the company, few domestic private Chinese companies or PE firms had a corporate website. Today, more do. Most are pretty awful. They function mainly as a kind of online business card. The usual style is to include a rather bland letter from the chairman, drab photos of the different wall plaques awarded by government agencies, and a button that says “English”, that if clicked on, often leads to a blank page or, in some cases, to a site whose content bears no relationship to the Chinese company’s.

It’s rare for me to meet a Chinese company boss who spends much time online, let alone uses web search to locate potential business partners or opportunities. But, this too is starting to change. Recently, the CFO of one of China’s largest domestic cookie and cracker companies sent an email to our catch-all email address saying he’d learned about our business, read through our website, and wanted to discuss retaining us to raise capital. Within the space of a few weeks, we were able to lock in the mandate. One nice perk: lots of free snacks, salty and sweet, to nibble on in the office.

The English-language website serves a different purpose and a different audience.  It’s mainly visited by the private equity firms we work with, as well as people looking to get hired. It also is a convenient way for me to try to answer the question I get most often from friends and family in the US, “Just what exactly are you doing over there in China?”

Anyone with even a rudimentary knowledge of Chinese will quickly see that the English website homepage says CFC has four main business areas, while the Chinese site lists only three. A sign of strategic or linguistic confusion? No. I’ve been spending quite a lot of time recently building up CFC’s research and database on current PE investments that may be suitable for exit through a secondary transaction, the kind of deal where one PE sells its investment to another. We’ve done deal work in this area of “secondaries”, and expect to focus far more on such transactions in the future. The English-language site seems a more suitable place to mention this activity. To my knowledge, there isn’t a recognized Chinese word for “secondaries”, nor will such deals be of much practical interest to domestic entrepreneurs.

As the website says, “Working with people we genuinely like, trust and respect is what makes our business lives worthwhile.” This goes also for the talented Guangzhou-based American website designer who worked on our new site. He prefers to remain anonymous, as he did this during his limited weekend spare time. His superiors don’t like him moonlighting. I’m quite pleased he did.