China First Capital

A Gathering of Friends: Celebrating a Friendship Forged by a Successful PE Deal

Imperial portrait from China First Capital blog post

Of all the rewards of completing a successful financing, the most overrated are the pecuniary ones, and most underappreciated are the deep and lasting friendships that can result. I was reminded of this, vividly, on Friday. I shared a few very happy hours with the three other principals in the $10 million private equity financing we completed last November: Zheng Shulin, the owner and founder of Kehui InternationalElliott Chen, Kehui’s lawyer, and Ada Yu, a Vice President at the PE firm CRCI

We got together in Shenzhen to participate in a seminar at the Nanshan Venture Capital Club. The purpose was to give other entrepreneurs in Shenzhen a better understanding of the mechanics, timing and financial fundamental of pre-IPO PE investment in China. It was a very happy reunion. We hadn’t met as a group since last November. In the intervening months, Ada went on maternity leave and gave birth to twin daughters, while Mr. Zheng has been busy completing construction on the new factory in Jiangxi the PE investment enabled. The new factory will allow Kehui to more than double its output and become a dominant supplier of copper and aluminum-coated wires for use in electronics industry. 

There’s a nice symmetry here, of course: Ada’s twins and Mr. Zheng’s new factory got their starts at just about the same time last summer. That’s as far as I’ll go with the metaphor, since I’m sure Mr. Zheng will concede, despite his evident pride in his new factory, that Ada’s twins are the far more momentous creation. 

I was so happy and so moved by the whole experience on Friday, of being back together with Mr. Zheng, Elliott and Ada, and having a chance to “re-live” some of the experience in front of a crowd of about 70 at the seminar. Mr. Zheng shared one of the nicest stories from the closing: we were stuck at the final hurdle for over a month, waiting for government financial regulators in Jiangxi. They’d never before been asked to approve a foreign investment of this scale in their province, and so didn’t really know the rules or how to apply them. It looked like Jiangxi’s approval process could take months, and so cost Mr. Zheng the chance to get the new factory underway and meet surging orders. 

Mr. Zheng camped out in Nanchang, Jiangxi’s capital, to try to persuade the government officials.  I decided to visit CRCI’s office in Hong Kong to work out an agreement to advance the money ahead of the government’s final approval. CRCI’s partner agreed to do so, even though it could increase their risk in the deal. At the same moment I was dialing Mr. Zheng to give him the good news, he phoned me from Nanchang, Jiangxi’s capital, to say he’d just been given the final okay.  I returned to CRCI’s office a short time after, with Mr. Zheng, to sign the closing documents. The money arrived two weeks later.   

A big part of the credit belongs to Elliott Chen, since he both wrote the legal briefs, and spent the long hours explaining to Jiangxi officials how to apply the relevant national laws on foreign exchange transactions. A lesson here: in China, the national government in Beijing crafts very clear and often forward-thinking financial laws, but their implementation can be very hit-or-miss. Without Elliott’s work, we might still be waiting for Jiangxi Province to say Yes. 

Mr. Zheng, Elliott, Ada and I had some time to chat privately among ourselves. But, not nearly enough. Ada had to rush back to Hong Kong to take care of her twins, and the rest of us had business meetings to attend. For me, though, what most stands out is the deep feeling of friendship, forged by a common purpose to get an exceptionally talented entrepreneur the money he needed to take his business to the next level. 

While the ultimate success at Kehui will rightly belong to Mr. Zheng, all of us benefitted from our work on the financing. Elliott is now recognized as one of the best PE lawyers around. Ada is ready to resume her career at CRCI next week, knowing the Kehui investment is on track for a success as large as she could hope for. And, CFC is also on track to achieving the goal I set for it, of becoming the investment bank most proficient at capital-raising China’s best SME.


 

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Asian Venture Capital Journal reports on China First Capital partnership with Horwath

China First Capital article in Asia Venture Capital Journal

The Asian Venture Capital Journal’s latest issue includes a short article on China First Capital’s partnership with Horwath.

You can read it here: 

http://www.scribd.com/doc/15346001/Asian-Venture-Capital-Journal-Article-about-China-First-Capital-Horwath-Capital-China-Partnership

The reporter, Maya Ando,  contacted me originally by email, and ended up doing the “interview” by email as well. While the spontaneity and give-and-take of an in-person interview is lost, it’s a good journalist technique. It reduces the ever-present likelihood of errors and misquoting. Accuracy, not friendly banter,  should be the journalist’s goal, after all.  

I wish email interviews had been possible back in the Stone Age when I was a journalist for Forbes. Virtually no one had email. I remember spending days, even as a senior editor, trying to track down sources by phone or fax to check their facts. 

 

 

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A very flattering article in the Shenzhen Daily newspaper

 

Shenzhen Daily Article on Peter Fuhrman April 14, 2009

To my delight — and also somewhat to my embarrassment, given what a flattering article it is — the Shenzhen Daily this week published an article on me and my company, China First Capital.

The Shenzhen Daily is the local English-language paper in Shenzhen. The reporter, Cao Zhen, is originally from Hubei Province and studied in the UK. She has an expert grasp on the language, and asked some thoughtful questions.

As a once-upon-a-long-time-ago journalist, I particularly appreciated her preparation, fact-checking and patience with my rambling answers. 

Here’s the link:

http://paper.sznews.com/szdaily/20090414/ca2911919.htm

 

 

 

 

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Chinese Language Report on Private Equity in China 2009: 中国的私募股权投资与战略并购

Following on from the publication of the China First Capital report, 2009 Private Equity and Strategic M&A Transactions in China — A Preview , the Chinese version is now completed. It’s more than just a change in language.

It incorporates a different but complimentary perspective to the English report, one enriched by the deep knowledge, insights and experience of my China First Capital colleague, Amy Bai. 谢谢白海鹰。

Here’s the first section. 

China First Capital Chinese language report on Private Equity, Venture Capital in China 2009

 

 

  chinese-balance

 

危机创造机遇

2008 年对于中国是不平凡的一年。2008年带给我们骄傲和欢乐,也带给我们挫折和悲伤。北京奥运会使我们感到前所未有的骄傲和自豪。刚刚战胜了冰冻灾害的我们又遭遇了汶川大地震。

从经济领域来看,2008年同样也是不平凡的一年。在年初,上海、深圳和香港的股市都出现了长势良好的喜人景象。IPO形势大好。然而,在2008年夏,股市开始暴跌 ,IPO也开始枯竭。到年底,上海、深圳和香港的股市均下跌了60%左右。 

中国的私募股权投资和风险投资出现了与股市涨跌相应的波动变化。在年初,投资活动非常活跃。上半年,私募股权投资和风险投资在中国的投资总额超过了100多亿美元。随着金融风暴的影响,私募股权投资和风险投资也放缓了在中国的投资步伐。到去年底的时候,基本上已经停止了所有投资活动。 

中国,美国和全球其他国家均以前所未有的方式采取了一系列干预措施,以期稳定经济。然而, 

当我们跨入2009年时,全球经济进入衰退期已成为不争的事实。 

大家所关心的问题是,经济复苏期何时来临?何时开始新一轮的投资比较合适?我公司愿与您们分享就上述问题的一些观点和想法。 

作为中国首创投资的董事长,凭借在资本市场,私募股权投资和商业领域20余年的经验,我经历过数次商业周期,并且成功地带领我的企业幸存了下来。例如,我曾经担任美国加州一家风险投资公司的首席执行官,目睹了网络泡沫的破灭, 当时的情形和现在类似,所有的私募股权投资活动几乎都停止了。 但是,仅仅两年以后,交易活动和企业估值又呈现回升趋势。 

所以,我们认为,就整体投资环境而言,2008年的金融风暴将会继续影响中国经济的发展,中国目前仍旧会经受各种考验。但是,对于私募股权投资、风险投资和兼并收购而言,2009年是个充满着无限机会的一年。机会与风险并存。只要你抓住了机会,成功就近在咫尺。 

2009年,企业所有人和私募股权投资公司可以期待商业主题中的下列几点。 

行业整合与质的飞跃

2009年新年伊始,我们就感受到了中国经济所面临的严峻局面。经济增长速度减慢,成千的工厂倒闭和数以万计的人失业。中国许多经济领域已经出现了一种所谓超饱和状态,也就是很多企业在一个经济领域竞争,但是每个企业的市场份额都很小。这种情况下,中国企业进行合并的时机已经成熟。

在市场经济的自由竞争规律下,缺乏竞争力的企业会逐渐被淘汰。然而,具有竞争力的企业会不断赢取市场份额。并且,在良性循环下会不断发展壮大。产量不断提高,成本继续降低,从而,提高利润。企业将所赚取的盈余再度投到生产中以降低成本,进而形成一个良性循环。 

从消费者的角度来说,一个优秀的企业,由于其管理完善、生产效率高和销售策略适当,吸引着无数消费者。除此之外,强有力的主导品牌将会适时并购其他品牌。在这种状况下,企业间的合并已经成为不可避免的趋势。 

在中国,这种合并的势头刚刚开始。中国拥有仅次于美国的巨大的国内市场。在中国的许多纵向市场(包括金融服务,消费品,分销和物流,零售,时尚等),只要多争取一分的市场份额,销售收入就能增加上千万美元。 

通常,相对于企业所处行业,中国企业的规模都相对较小。在一些国营企业和半国营企业不占主导地位的区域,优秀民营企业抢先出击,兼并和收购其他区域内的竞争者,进而成为国内行业的领军企业。

对于投资者来说,这种帮助企业进行并购活动的机会将是空前的。企业在并购后的兴盛是投资者和企业共同期待的。即使在经济衰退期,并购案中 的优胜企业也会呈现销售收入和利润长期持续增长的现象。 

利润增长为IPO

重现提供了平台

 

在过去的五年里,对于投资中国市场的私募股权投资者和风险投资者来说,IPO无疑是最可靠的退出途径。 

下面的图显示,IPO交易量在2007年达到了高峰。在2008年初,IPO交易量继续呈现高增长趋势。然而,到2008年的下半年,IPO交易量急转直下,直到2009 年年初

 chart-1

 

 

众所周知, IPO市场与股票市场紧密相连。当股票市场整体表现不好时,企业发行新股票的欲望也会相应减弱。所以,只要中国股票市场和香港股票市场继续呈现薄弱趋势,IPO活动就不会呈现上升趋势。 

对于私募股权投资者和风险投资者来说,这意味着他们需要做出巨大的改变。 

为适应当前形势,私募股权投资公司和风险投资公司需要改变他们的投资方向。较之前而言,企业IPO前的短期投资机会已大大减少。换言之,私募股权投资公司或风险投资公司以18倍的估值投资于中国企业, 18个月后,再以20倍的价值发行上市的简单套利的机会已经一去不复返了。 

取而代之的是,在中国进行投资活动的私募股权投资公司应该从价值投资者的角度考虑他们在中国的投资,而不是从套利的角度去衡量他们在中国的投资。这说明了,私募股权投资公司在中国寻找目标企业时,应以企业的长远高回报为目标注入投资基金。 

企业的利润增长为中国市场的IPO重现提供了平台。具体而言,私募股权投资的重点应该集中在帮助企业提高运作效率和利润率上。 

这是一个值得强调的财务理念,尤其是在现今中国。企业估值归根结底是一个与公司盈利能力相关的函数,而不是一个投资者愿意为公司盈利能力而支付的价格函数。在市盈率倍数的公式中,“收益”部分是关键,而不是“价格”部分。在过去的五年时间里,IPO股票价格市盈率可谓差距巨大。IPO股票价格市盈率高至超过100, 低至少于5。 

对于中国市场来讲,情况可以瞬息万变。IPO股票价格市盈率很有可能出现回升趋势。什么时候会发生?我们无法给您一个准确的答案。但是我们可以确定的是,一个优秀的私募股权投资者想要投资于有明确目标和有能力实现目标的中国优秀企业。

 换言之,企业有计划和具体步骤去提升利润和利润率。那么,选择正确的中国企业进行投资,选择适当的额度进行投资和帮助企业提升整体价值,是私募股权投资公司和风险投资公司在未来几年内成功的关键所在。

 私募股权投资公司和风险投资公司提升企业价值的方式有很多。可以通过向企业提供市场营销,业务发展,金融工程,运营效率,企业治理,审计,战略兼并和收购等方面专业人才,来帮助企业迅速提高企业价值。

无论通过上述哪种方式,企业的收益都有可能被大大提高。关键点是,帮助企业保持强劲的利润增长态势。这样,在股市复苏的时候,IPO的时机再一次到来时,我们的客户企业会从中脱颖而出,赢得最高收益。 

2009年,一个有着投资重点和帮助企业成长的私募股权投资公司会脱颖而出。

 

 


AltAssets writes on China First Capital’s Report on Private Equity in China 2009

AltAssets is among the world’s leading sources for news and analysis on the global private equity industry. They just published a summary of my firms report, 2009 Private Equity and Strategic M&A Transactions in China — A Preview“. 

AltAssets is based in London, and provides news and research to more than 1,000 institutional investors and 2,000 private equity and venture capital firms worldwide.

Here is what they wrote about the China First Capital report:

 

altassets_logo

CHINA THE MOST ROBUST EMERGING MARKET FOR PRIVATE EQUITY AND VENTURE CAPITAL SAYS REPORT”


China continues to be the world’s most robust emerging market for private equity and venture capital finance, even in a difficult global economic environment, according to the Private Equity and Strategic M&A Transactions in China 2009 report just released by China First Capital, a boutique investment bank with offices in China, Hong Kong and the USA.

Peter Fuhrman, China First Capital’s chairman and the report’s author, said, “While the overall investment environment remains challenging and the effects of 2008’s turbulence are still being felt, 2009 will be a year of unique opportunity for private equity, venture capital and M&As in China.” 

China’s economy continues to grow, powered largely by successful small and medium private businesses, many of which are among the fastest-growing companies in the world. Private equity and venture capital investment in China will likely reach record levels in 2009, the report projects, with over $1bn in new investment into high-growth Chinese SMEs with strong focus on China’s booming domestic market. 

“In 2009, China should rightly be among the most attractive and active private equity investment markets in the world,” the China First Capital report predicts. “Many of the international private equity firms we work with are expecting to invest more in Chinese SMEs in 2009 than in 2008. Chinese companies raising capital this year will enjoy significant financial advantages over competitors, improving market share and profitability.” 

The report identifies five central trends that will drive the growth in private equity and venture capital investment in China’s SMEs in 2009. They are: the drive for industrial consolidation; profit growth helping to reignite the IPO markets for Chinese companies in China, Hong Kong and the USA; increased importance of convertible debt and other hybrid financings; opportunities for strategic M&As; well-financed businesses with strong balance sheets will enjoy sustainable competitive advantage in China’s domestic market. 

“The pathways to success in China are fewer and narrower than in recent years. But, for the entrepreneurs and private equity investors that can navigate their way in 2009, this will be a year of abundant opportunity,” Fuhrman added. 

Copyright © 2009 AltAssets

Requiem For A Tough Year – 2008 Was the Most Challenging Time in a Generation in China

tang-bowls

As the Chinese National Congress meets this week in Beijing to plot the course of the Chinese economy in 2009 and beyond, it’s worth reflecting what an exceptional, juddering year 2008 was. Sure, the Olympics stole most of the headlines, and provided the lasting images of Chinese progress and triumph. But, those images also dulled, in many respects, our perceptions of the brunt force of the economic blows China sustained during 2008. Make no mistake, 2008 was a year of challenge, disruption and dislocation not seen in China for a generation or more. 

The year started with the worst winder storms in decades. This was followed, just months later, by the cataclysmic Wenchuan Earthquake in Sichuan. Beyond the colossal loss of life and destruction, the earthquake had a much broader, unprecedented social impact across China. There was an enormous outpouring of national compassion and grief. While wholly positive as an expression of China’s rightful growing self-confidence, this vast prolonged period of national mourning also had a very direct and negative impact on economic activity. For weeks if not months, as I saw firsthand, there was a tangible unwillingness to spend as freely, to enjoy life as unabashedly as in the years previously. It was as if much of China received some intimation of their own mortality in the wake of the Sichuan Earthquake. 

Next came an accelerated fall in property values across much of China. Alongside this, the stock market fell sharply. These two, the property and stock markets, are the main stores of wealth for many middle class Chinese. People felt poorer because they were poorer. The fall of both property and share prices wiped away billions of dollars in national household wealth. People in their hundreds of millions were suddenly poorer, as household net worth plummeted, and Chinese pulled back even more strongly from their spending. Then, in late summer, came the financial tsunami in the USA, with the credit crisis, the collapse of Lehman Brothers, and the intensifying recession. 

Any basic college economics textbook – to say nothing of common sense — could foretell the next step: a fall in overall confidence levels among Chinese consumers. This further muffled already depressed levels of personal spending. 

We’re now well into the first quarter of 2009, and my own sense, after spending these last three weeks in China, is that the cumulative impact of all of 2008’s bad news is still being felt, acutely. However, my sense is that the worst may indeed be over, and that 2009 will be a year of rebuilding and reasserted economic confidence in China. 

Of course, when talking about general economic trends in the world’s third largest economy, a lot of the clarifying detail gets lost. But, we have a real sense, in our day-to-day work, of just what an extraordinarily difficult year 2008 was for even the best Chinese businesses. Our firm, China First Capital,  has focused on serving China’s middle market private Small and Medium Enterprises (SMEs), assisting them with capital-raising strategic M&A and other financial transactions.

Unlike traditional investment banks reliant mainly on short-term transactions, China First Capital’s role as financial and strategic advisor to Chinese SMEs often begins at early stages of corporate development and continues through the capital raising process from private equity to a successful IPO and beyond to global leadership. 

Even our strongest clients had a tough time in 2008. In one example, a business that is one of China’s leading consumer fashion brand, maintained outstanding growth last year in overall revenue, with domestic sales rising by 30%.  That’s mainly testament to the company’s no less outstanding management and brand-positioning. But, the bottom line was less stellar. Profit margins were squeezed, and the company earned half as much in 2008 as it expected to as late as July 2008. That represents a shortfall against plan of almost $6mn. That equates, of course, to having less money to invest in building on that growth rate in 2009.  

They remain a great company, and there’s little doubt 2009 will be a better year. But, when we met with them recently, the company’s financial management are still reeling from the brutal effects of 2008. If nothing else, it drives home as little else can the importance of fortifying the company’s balance sheet, which has been overly-reliant on retained earnings and short-term bank loans to finance growth. This client, like the Chinese economy, has weathered the once-in-a-generation turmoil of 2008. Better days lie ahead — my bet is sooner, rather than later.  

Private Equity and Strategic M&A Transactions in China 2009: A New Dawn

China First Capital, a boutique investment bank, releases comprehensive analysis of five key trends for 2009 in Private Equity, Venture Capital and M&A markets in China.jpg

My firm, China First Capital, just completed our annual report on Private Equity, Venture Capital and Strategic Mergers and Acquisitions in China. I had the biggest hand in writing it, so the opinions expressed are my own. My view, overall, is one of realistic optimism. China will continue to be the world’s most robust emerging market for private equity and venture capital finance, even in a very difficult global economic environment. A big reason for this is the continuing strong performance of many private SME companies in China, especially those focused on the domestic market, rather than exports. 

China First Capital has a special affinity for these strong private SMEs. They are the only companies we choose to work with. There a few reasons for this. A big one is my personal conviction that the most important predictor of a success in private equity investing is putting money into a company with a truly outstanding boss. Ideally, the boss will also be the entrepreneur who founded the company. 

You can do all the spreadsheet modeling and projections you want, but nothing else matters quite as much as the quality and drive of the leadership at the top. In many of the good Chinese SMEs, the boss is a first-class business strategist and opportunity-seeker. Give him a dollar and he’ll bring you back five. In many of China’s larger state-owned, or partially state-owned companies in China, the boss is often more a political animal, appointed to the job as much for skills as a bureaucratic infighter as for talents at managing a business. Give him a dollar and he’ll come back in a while and ask you to lend him another three. 

SMEs, no surprise, usually run circles around their state-owned competitors in China. That’s a big reason we choose to work exclusively for SMEs. Another reason: we prefer long-term partnerships with our clients rather than one-off deal-making of larger investment banks. We act as a financial and strategic advisor to Chinese SMEs in a long-term process that often begins at early stages of corporate development and continues through the capital raising process from private equity to a successful IPO and beyond to global leadership. 

Thanks to these Chinese SMEs,  China should be among the most attractive – and active – private equity investment markets in the world in 2009. Many of the international private equity firms we work with are expecting to invest more in Chinese SMEs in 2009 than in 2008. Indeed, private equity and venture capital investment in China will likely reach record levels in 2009, the report projects, with over $1 billion in new investment into high-growth Chinese SMEs with strong focus on China’s booming domestic market.

Chinese companies raising capital this year will enjoy significant financial advantages over competitors, improving market share and profitability.

The report, titled “Private Equity and Strategic M&A Transactions in China 2009”, identifies five central trends that will drive the growth in private equity and venture capital investment in China’s SMEs in 2009. They are:

  1. the drive for industrial consolidation;
  2. profit growth helping to reignite the IPO markets for Chinese companies in China, Hong Kong and the USA;
  3. increased importance of Convertible Debt and other hybrid financings;
  4. opportunities for strategic mergers and acquisitions;
  5. well-financed businesses with strong balance sheets will enjoy sustainable competitive advantage in China’s domestic market.

Here’s the report’s first section. I’ll add more of it in later posts.

 

 Overview  chinese-balance

       

Turbulence creates opportunity

2008 was a year of extremes in China. Extremes of joy and pride, during the Beijing Olympics. Extremes of sadness and shock following the Sichuan earthquake. Even the climate reached extremes, during China’s crippling winter storms early in 2008. 

Financially, 2008 was also a year of extremes. The stock markets in Hong Kong, Shanghai and Shenzhen rose strongly in the first months of the year, and IPOs were plentiful. By mid-year, the markets began plunging, and IPOs dried up. By year-end, Shenzhen, Shanghai and Hong Kong were all down 60% for the year. 

China’s private equity and venture capital investments followed a similar turbulent course, beginning strongly, with over $10 billion invested in Chinese companies in the first half of the years, and then the pace of new investments slowed to a crawl.   

Governments in China, the USA and around the world intervened in an unprecedented fashion to stabilize the economy and the credit markets. As we enter 2009, there is no longer any doubt that the world economy is in recession. 

The question now is when will the recovery begin and when will be a good time to begin investing again? I want to offer a personal perspective to our valued relationships, both clients and the private equity firms we work with. As Chairman of China First Capital,  Ltd, with over 20 years of experience in the capital markets, private equity and business analytics, I’ve survived my share of business cycles. One example, I was CEO of a California venture capital company during the Dot-Bust years, the last time private equity investing came to a similar standstill. Within two years, deal activity and valuations resumed their upward momentum. 

My view: the overall investment environment in China remains challenging and the effects of 2008’s turbulence are still being felt. But, 2009 will be a year of unique opportunity for private equity, venture capital and mergers and acquisitions in China. Tough times can be the best time to make money. 

Consolidation and “flight to quality”

 

 

The Chinese economy is under significant strain as 2009 begins, with growth decelerating, factories closing by the thousands and unemployment rising. Many areas of China’s domestic economy are “over-saturated”, with too many companies competing with small market shares. China is ripe for consolidation. 

In the freely competitive markets, the weakest companies will perish. The stronger competitors will be able to add market share and enjoy the virtuous cycle of increasing volumes lowering unit costs, thus boosting profits that can be re-invested to lower still further costs of production.

Chinese consumers will respond as well, and reward with more of their money the better managed companies with the most efficient manufacturing and distribution. Out of this, stronger dominant brands will emerge, and this too will push for greater consolidation.

This process is just beginning in China. China’s domestic market is huge, second only to the US. In many vertical markets (including financial services, consumer goods, distribution and logistics, retailing, fashion), each point of additional market share in China can equate to tens of millions of dollars in additional revenue.

Chinese companies are still, most often, small-in-scale relative to the size of the industries they serve, particularly in areas where private companies, rather than those with partial or complete state-ownership, predominate Strong regional companies will acquire competitors elsewhere in China to become national powerhouses.   

For investors, the opportunities will be unparalleled to back the Chinese companies that will thrive during this process of consolidation.  The winners will be able to increase revenues and profits strongly and sustainably, even in a weak economy.

 

 

 

 

 

 

 

 

 

 

 

China M&A: 2008 Is A Record Year, And The Strong Growth Will Continue

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Even as IPO activity all but came to a standstill in 2008, China’s M&A market reached an all-time high in 2008, with almost USD$160 billion in deals completed, according to Thomson Reuters. This makes China the biggest M&A market in Asia, for the first time ever. 

This is an important development, and I expect China’s role as Asia’s largest M&A market will continue into the future, despite the current economic slowdown. The reasons: M&A deals in China will continue to make business and financial sense. China’s M&A activity in 2008 was almost equally split between purely domestic deals – where one Chinese company buys or merges with another – and the cross-border acquisitions where Chinese and foreign firms join together – either with the Chinese firm buying into the overseas business, or the foreign firm taking a stake in a Chinese one.  

I see huge scope for growth in both areas. China’s economy, though growing more slowly now than in recent years, is still expanding. Despite its vase size (China is now the world’s third-largest economy, trailing only Japan and the US) Chinese companies are still, most often, small-in-scale relative to the size of the industries they serve, particularly in areas where private companies, rather than those with partial or complete state-ownership, predominate. China’s private sector is filled with minnows, not whales. 

The result: there is ample room for consolidation in virtually every industry. Smaller firms will continue to merge, to gain both market share and scale economies. Strong regional companies will acquire competitors elsewhere in China to become national powerhouses. 

The M&A market, more than IPO activity, tends to holds up well even during sour economic times, or when stock markets fall. As share prices drop, the lower valuations make it cheaper for acquirers to act. We had evidence of this recently in the US, where one of the biggest M&A deals of all-time was recently announced: Pfizer’s planned acquisition of Wyeth Labs

In China, valuations for both quoted and private companies are lower than they were a year ago. That lowers the cost of acquiring a competitor. The cheapest way to build market share, at this point in China, will often be to buy it. 

All M&A transactions have risk. Very often, the planned-for gains in efficiency never materialize from combining two similar businesses. In China, the complexities go above and beyond this. There is due diligence risk – the difficulty of getting accurate financial information about an acquisition target – and management risk as well.  Good Chinese companies are  usually owned and run by a single strong Chairman, with scarce management talent around him. In a merger, the boss of the acquired company will often step aside, leaving a big hole in that company’s management, and so making it harder for the acquiring company to integrate its new acquisition. 

How to do M&A right in China? Good deal-structure and good advice are crucial. Structure can anticipate and resolve some of the larger post-acquisition headaches. Advice is important to make sure that the price and strategic fit are right. Just as China’s SMB’s need specialized merchant banks to serve their needs in raising capital, these SMBs, as they grow, will also need competent M&A advisors to identify target companies, manage the DD, do the valuation work, help negotiate the price, and assist with post-acquisition integration. 

Last year was a strong one for M&A in China. But, the future should be even brighter, once current economic uncertainty begins to abate.  Looking ahead, I see a real possibility that China’s M&A market will overtake America’s as the world’s largest. I’m planning for my company to play a part in this. 

A New Year of Challenges and Opportunities in China’ Private Equity Industry

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Looking purely at the economic news from China of late, this has not been the happiest of Chinese New Years. The Chinese government is estimating that 16% of the huge migrant labor force of 200 million will have no job to return to after the New Year.  Factories are continuing to close, or cut employment, across the country. Guangdong province, where China First Capital has its base in China, is particularly hard hit, because it’s still the primary production base for much of China’s better private factories. While factories are being moved out of Guangdong to less expensive, inland locations like Jiangxi, overall industrial employment in factories in Guangdong is still huge, and hugely reliant on migrant labor. There’s no solid date, but ten million or more workers may have lost their jobs in Guangdong over the last six months. 

The picture is no less bleak in terms of projections for corporate profits in China in 2009. Larger companies are reporting profit falls of over 50% in 2008, and forecasting even worse results this year. This matters crucially in China. Over 40% of total economic output is generated by business investment. This, in turn,  is intimately tied to corporate profits, since most of that business investment is financed out of retained profits. According to a recent report in the Wall Street Journal, “official statistics show that 63% of investment in China last year was financed by what are called “internally generated” funds, which include retained profits. That’s up from just below 50% a decade ago.” 

In other words, as corporate profits decline, they take Chinese GDP growth with them. This falling economic output, in turn, influences consumer sentiment, and so takes personal spending down with it. 

Good economic news is a scarce commodity this Chinese New Year. But, I see one bright glimmer of hope here. Chinese companies have been excessively reliant on retained earnings and expensive bank debt to finance their growth, rather than equity capital. The difficult economic environment, in China and indeed worldwide, provides a good opportunity for better Chinese companies to reorient their method of financing capital investment and growth. It’s the right time to take on equity capital, and use it as a platform to continue to invest and grow, even if corporate profits are in cyclical decline. 

The Chinese companies that can raise equity finance will enjoy a significant financial advantage over competitors, and so be able to gain market share. Adding equity finance lets a company both lower its overall cost of capital, and also increase the amount of capital it can put to work in its business. Both of these factors equate to a very real competitive advantage. 

Equity investors, principally PE firms, will need to change their orientation as well. The opportunities to do shorter-term “pre-IPO” financing are far fewer than they were, because stock market valuations are way down and IPO activity has slowed to a crawl. So, the simple arbitrage of a PE firm buying into a Chinese company at a valuation, say, of 10x and selling out 18 months later in an IPO at 20x are gone. 

Instead, PE investors in China need to think more like value investors, and less like arbitrageurs. This means looking for opportunities to deploy capital into good businesses offering high rates of return on that invested capital. Equity investment is then used to expand output, lower unit costs, gain market share, and so expand both profits and profit margins. Build profits and valuation will take care of itself. If a Chinese company can put equity capital to work well, and accelerate profits in 2009 and beyond, that business will be worth a lot more money when the IPO market revives than if it simply cut back on investing to ride out the bad times. 

This year is going to be difficult, challenging, but also potentially highly rewarding for all of us participating in the financing of private companies in China. It’s a year when good companies should be able to get even better. And smart-money PE firms will make far more, over the medium-term, than fast-money valuation arbitrageurs ever did. 

 

The future of PE in China — Big PE vs. Small PE

I never much liked the term “Private Equity” since it serves two very different meanings and even more different business models. That difference has never been more stark than it is today. There is what I like to call “Big PE” and “Small PE”. One is hurting, and the other is still thriving. Luckily for China First Capital, we focus working with the part of the PE industry that’s still in good shape.  

In Big PE, large-scale, multi-billion-dollar deals are done by famous firms of the likes of Kohlberg Kravis Roberts, Blackstone and Carlyle. In Small PE , another group of PE firms thrive by finding great companies, at an earlier stage in their development, and backing them with growth capital. 

Big PE targets larger, often publicly-traded companies, or divisions of these larger firms. Using a slug of equity to support a large pile of bank debt, these private equity deals are based on acquiring a controlling interest in a company, and can deliver outstanding results by tossing out tired and underperforming management teams, tightening up on operating efficiencies, investing for growth. In 1-3 years, if things go well, the Big PE firm exits the now-improved business through either a trade sale or primary stock market listing. 

What matters most here essentially is finding a poorly-run business, with a bad capital structure and often worse management. (To take one recent example among many, think of Cerberus’s purchase of Chrysler’s from Daimler.) Ideally, a Big PE firm can turn things around quickly after buying control, and get an exit where the debt is paid off, and the underlying equity gets a very high rates of return. 

There are two big problems now in Big PE: the drying up of credit, and the shrinking valuations put on the businesses spiffed up for sale by the PE firms.  The recession compounds the problems, since the deals are built on leverage, and the bank debt will often have aggressive covenants attached to it. Those covenants (generally targeting  operating metrics like increasing EBITDA) are much harder to achieve in a down economy. Covenants get breached, deals need to be restructured with the Big PE firm pouring in more of its own capital, and the time and value of an exit go in the wrong directions: it takes longer to make less. 

Not a good business to be in at the moment. 

Then there’s Small PE, which has never looked sounder. The core skill-set here never goes out of fashion. It’s the ability to find a great company with the potential to grow far larger. Small PE firms invest their own money, for a minority stake in a business. They then provide what help they can to management, and if they’ve chosen their portfolio investments well, will wait confidently for the optimal moment to achieve a very solid return on each individual investment.  

In other words, Small PE is not built on complex financial engineering, but on good, old-fashioned “stock-picking”. 

Last month, David Rubenstein, the co-founder and managing director of Carlyle Group, one of the biggest of the Big PE,  gave a presentation in Tokyo titled “What Happened? What Will Happen? A Look At The Changing Investment And Private Equity Worlds” . Rubenstein, who has made over a billion dollars personally in the PE industry, tried to summarize all the tectonic forces destabilizing Big PE. There’s a lot of alarming stuff in his presentation. The key line: “The Credit Crisis Has Dislocated the Private Equity Industry “. (If anyone would like a copy of the Rubenstein presentation, email me at peter@chinafirstcapital.com)                                                                                                                                          

Rubenstein’s prediction, which I share: Deals: Smaller, Less Frequent, More Overseas”. In particular, Rubenstein foresees more PE firms raising money to invest in Asia. The fact he cites: Asia private equity fundraising has increased but remains small at 9.2% of the $331 billion raised by U.S. PE funds in 2007 considering that the combined GDP of the above countries is 93% of the GDP of the U.S. 

No question, Big PE will now try to act more like Small PE. The problem they’ll face is that they’re not well structured to find, assess and invest in smaller-sized deals. My guess is that the good PE firms already operating in Asia – the ones we work with regularly at China First Capital – will  be able move quicker and smarter than their new Big PE rivals. Here I means firms like China Renaissance Capital, (www.crcicapital.com) which has a great record of finding strong middle-market companies in China, investing wisely and at fair valuations, and then working alongside management to create the operating conditions for an ideal exit. 

Rubenstein’s talk included a table showing the 2008 year-to-date performance of a number of the most well-known Big PE.  All the following have lost money this year. What you see here is a cumulative loss of many tens of billions of dollars:

􀂃 Tosca Fund – 62%

􀂃 Templeton Emerging – 50%

􀂃 Kensington/Citadel  –37%

􀂃 Satellite Overseas  -30%

􀂃 Marathon Global Equity – 20%

􀂃 Canyon Value Realiz. –20%

􀂃 Goldman Sachs Investment Partners –16%

􀂃 Deephaven Global –15%

􀂃 Millenium Global HY –14%

􀂃 Cantillon Europe –13%

􀂃 Zweig-Dimenna Intl. –8%

􀂃 Harbinger Offshore -5%

􀂃 Cerberus Intl. –3%

􀂃 Viking Global Equities –2%

The good Small PE firms are having far better years. My own prediction is that this performance gap will only widen over the next two years, as the deal pipelines for Asian PE firms we work with remain very strong. Big PE has to re-learn their approach, and try to master a new set of skills. All the while, they’ll be losing out on many of the best opportunities in Asia to their smaller, more nimble and more experienced rivals. 

It’s hard to find a dancing elephant. The reason: it’s hard to teach the elephant the steps. 

Ideally Matched: Client and Investor

I’m just back in Shenzhen from a visit to a client in Kunshan, near Shanghai. For me personally, it was a particularly poignant trip. 

It’s the first time I’ve been back to Jiangsu since 1982, when I left Nanjing University. Thinking as much with my stomach as my head, I immediately on arriving at 9:30pm on Wednesday night cajoled Nina, my partner, to go on a late-night search of great Jiangsu food. I eventually lost count, but by the time I left, I must have had enough xiaolongbao to feed a nursery school.

 As thoroughly enjoyable as this “Jiangsu homecoming” was, it was not even close to being the highpoint of the trip. We spent two full-days with our client, in meetings with a very select number of Private Equity firms. The meetings, from my standpoint, were truly outstanding – a text-book example of how great businesses and a great institutional investors should interact.

In fact, our client and the PE investors were, to my eye, as well-matched as this pair of Tang Dynasty horses. 

As I told one of the PE partners afterward, I’ve been in a lot of initial meetings between companies and PE or VC firms. But, never was I involved in a investment meeting that was conducted at such a uniformly high level, with both company and investor executing at the highest level of accomplishment and professionalism. 

For the PEs, this was the second-round of meetings, following earlier ones in Shenzhen, with our client’s CFO, that focused primarily on the company’s financial performance. Our client’s core leadership and ownership, however, are both based in Kunshan. So, there was even more to discuss in this second round meeting. 

For our client, this was on-the-job training. They’ve built an enormously successful business, with sales this year in excess of $120 million, and a strong likelihood of becoming, within five years, a multi-billion dollar enterprise. But, the client has done all this without equity finance, using only retained earnings and bank debt. So,  they’d never before presented themselves to sophisticated and experienced equity investors.  They don’t come any more sophisticated and experienced that these particular PE investors, with track records, both as individuals and as firms, that put them at the top of their profession. 

Our client more than exceeded our highest expectations, preparing exhaustively and answering comprehensively. 

China First Capital works to find the right investor for its clients. Not the investor offering the highest valuation, or the quickest path to IPO. We give this a lot of thought, matching the strengths of our client to the strengths of a particular PE firm. Done right, it’s transformational for both company and investor: a case of the total value created not being just larger than the sum of the parts, but exponentially so. 

It’s early yet in the process. We’re planning on several more meetings with PE firms. But, I left Kunshan even more optimistic about our client’s future, building a great partnership with a PE investor. 

It may not sound like it, but it’s meant to be my highest compliment to both our client and the PE firms we met with this week:  the xiaolongbao were good. The meetings were better. 

The Ten Questions Every Laoban Should Answer Before Seeking PE Funding

One of the supreme satisfactions of my work – and I’m fortunate that my job offers quite a few – is the time spent advising laoban (“business owner” in Chinese) on the value of private equity investment. These owners are entrepreneurs, not financial engineers. So, the world of private equity deal-making and finance is often entirely unfamiliar. As I tell these laoban, in my less-than-fluent Chinese, “you have already done the hardest thing possible in business, by taking an idea, adding little or no capital, and created in China, the most competitive market in the world, a successful business of significant size and fantastic prospects.” Compared to this, anything will appear easy, including closing a round of equity capital from one of the leading private equity or venture capital firms. 

Now, of course, closing a PE investment round is anything but easy. It involves, at a minimum,  a sizable amount of time, stamina, senior-level attention, perseverance, transparency, thoroughness and commitment to building a fully-aligned partnership with an outside investor.  I’ve seen it from both sides, both as a CEO and as a venture capitalist. The process can seem like breaking rocks with a spoon. 

But, it’s always rewarding and inspiring for me to see how quickly our laoban start mastering the intricacies of raising capital. They climb the steep learning curve fast. But, it is still a learning curve, and I’ve often made the process harder by doing an inadequate job preparing them for their first meetings. In fact, there ought to be a typically wise four-character Chinese proverb, or chengyu, to describe it: “Good students. Poor instructor.” 

I’ll admit to being a poor instructor. But, an improvable one? I’d like to think so. 

Together with my colleagues at China First Capital, I’ve put together a list of ten questions laoban should expect to hear in a first meeting with a PE firm. The purpose: to give the laoban a quick sense of the scope and rigor of the PE investment process.   

Of course, in any first meeting with a professional PE firm, there will be many more than ten questions. It’s unlikely any PE would ask all – or even the majority – of the ten on the list. 

But, these owner-entrepreneurs are all outstanding problem-solvers. If they weren’t, they wouldn’t be running and owning the sort of businesses of interest to good PE investors. 

So, the questions are really just a catalyst, to get the laoban to think about how a sophisticated investor will evaluate his business. In other words, to see his business from the outside looking in. This is like refraction, where shifting the angle changes the quality of the light. 

Here are the ten questions.  There are no right answers, of course. Only a right mindset.      

 

  1.  How much of your equity are you selling?
  2. What will you use this equity investment for?
  3. When do you hope to complete this fund‐raising?
  4. When will you IPO?
  5. What are you looking for besides capital from an investor?
  6. How do you think you can double or triple your profits?
  7. How much is your valuation?
  8. Who are your competitors and what are your competitive edges?
  9. Can you please explain your strategy for growing faster than your competitors?
  10. Please give me brief summary of the jobs and the past experience of the most important members of your management team?

Are Chinese Private Equity valuations too low?

Not long ago, just to ask the question would invite ridicule. But now, after the almost-halving of Chinese share prices so far in 2008, it’s more than appropriate to ask, “Are Chinese company valuations too low?”

My answer? Yes, they are too low.

According to the MSCI index, the current average PE ratio of all quoted Chinese companies is 16X, equal to Japan’s, and lower than the 18X average for US-quoted companies. In other words, investors are willing to pay more, on average, for a company’s earnings stream in the US than in China. And yet, of course, profit growth in China is, on average much higher.

It’s not at all remarkable to find Chinese companies whose profits are growing by over 40% a year. In fact, among our clients at China First Capital, that’s the norm, rather than the exception. Some clients’ profits double year after year. Not very many, if any,  US companies can match that rate of growth, for the simple reason that the overall US economy is stagnant, while China’s continues to roar along at a +10% growth rate. Corporate profits form a part of the calculation of gdp growth, and it’s historically true that corporate profits just about everywhere grow faster than the underlying economy.

That’s what makes the current PE valuation for China something of a conundrum. PE ratios are an expression, after all, of collective sentiment on the future rate of corporate profit growth. Clearly, China’s is now, and will likely remain for quite some time, higher than not only the US’s, but the rest of the world’s.  

It’s not hard to find good reasons for this steep drop in Chinese valuations this year. Bad news has come not as single spies, but as entire regiments in 2008. Natural disasters (the worst winter weather in 50 years, and then the horrific earthquake in Sichuan), the steady appreciation of the renminbi effecting China’s export competitiveness, the slowdown of the US economy, the end of pump-priming government spending in the run-up to the Olympics, the global rise in oil prices, and a near-doubling in inflation to +7% all contributed to investors loss of confidence, and with it, a decline in China’s share values.

But, this look like a classic case of a market overcorrecting. The decline in share prices, and with it China’s average PE ratio, certainly seem excessive.  The fundamentals are still very solid for very many Chinese businesses. Corporate profits, though under pressure in China as elsewhere, can sustain themselves at very high rates of growth. China’s best companies are improving margins, improving efficiency, quality and productivity, and focusing on the fast-growing Chinese domestic market.  In other words, good companies in China do exactly what the good ones in the US do – get stronger and leaner when times get tougher.

It seems to me that valuations will rise again soon, maybe not to the dizzy heights of a year ago, but to a level reflecting this one fundamental truth – nowhere else on the planet will corporate profits on a whole grow as fast, for as long into the future, as they will in China.