Chinese SME

How the Bad IPO Deals Happen: Exploiting the Lack of Information and Knowledge to Bamboozle Chinese SMEs

Leave a Comment / June 17, 2009

Qing Dynasty official statue, from China First Capital blog

In recent years, a large percentage of all OTCBB IPOs have been for Chinese SME companies. This is largely because too many Chinese SME fall too easily into the pit of investment vipers – the lawyers, accountants and self-described “investment bankers” and “private equity investors” that promote these OTCBB listings, reverse mergers and other schemes concocted by advisors generally for their own self-enrichment.

Once caught in the trap, the prospects for the SME are generally pretty bleak. They’ll be bled of badly-needed cash to pay the advisors, bankers and lawyers their fees, and later, by the costs of remaining a listed company. The bosses come to learn that a “US IPO” isn’t at all what it’s cracked up to be when it takes place on OTCBB: there are no celebratory news reports, no huge sums flowing into their personal or corporate bank accounts, no boost in company prestige or brand awareness. At best, it turns out to be a very expensive lesson. At worst, it’s the transaction that leads to the company’s premature demise.

Of course, by the time the SME realizes the scale of the mistake it made by agreeing to IPO on OTCBB, the advisors, lawyers and bankers are all long gone. I’ve heard from a Chinese lawyer friend that these advisors will change their mobile phone numbers after the IPO so the SME boss can no longer contact them.

Indeed, the distinguishing characteristic of these advisors and bankers is their disregard for the future condition of the Chinese SMEs once they’ve done the OTCBB transaction. They have no stake in the long-term success of the company, because they cash out at IPO, and move onto their next victim, er client.

It is not unusual that advisors earn millions of dollars from these OTCBB deals. It may be the most successful and durable investment banking racket of all time. Hundreds of Chinese companies have been ensnared over the last seven years.

How has it gone on for so long? For one thing, the OTCBB is not regulated in any real sense of the word. So, the SEC has little or no power to crack-down. The larger factor, though, is the complete lack of adequate scrutiny by the Chinese SME bosses. They put their business’s future in the hands of a bunch of guys with a proven talent (and mile-long rap sheets) for destroying companies, not building them.

I’m constantly amazed that great Chinese SME bosses I’ve met will do no independent due diligence on financial advisors. They don’t ask for a full track record of past deals, or partner bios, or a list of satisfied past customers to consult. Everything is taken at face value, and appropriately enough, the common result is a very large loss of face for the Chinese boss, after these bad deals have closed, and the damage is calculated.

Even if a Chinese boss wanted to do some proper due diligence, it’s by no means simple. There’s a notable lack of good, current information about the OTCBB in Chinese. Chinese journalists don’t ever seem to write about it, perhaps because these IPOs take place outside China. I did a search of OTCBB on China’s main search engine, Baidu.com, and the top results included information that’s three to four years old, and a site called OTCBB.com.cn that offers very little information, and seems to be owned and run by the kind of advisory firm that specializes in (you guessed it) doing OTCBB listings of Chinese companies. You won’t find anything too useful here.

It doesn’t take a lot of digging, assuming one can speak some English and knows where to look, to discover information that should start alarm bells ringing loud enough to wake the dead. For example, the Chinese government doesn’t recognize the OTCBB as a legitimate stock market for many transactions. Here’s a kernel of disclosure language from the SEC filing of a Chinese company that listed on OTCBB. (Underlined for emphasis:)

“The stock portion of the purchase price of Weihe to Weihe’s stockholders because the delivery of shares of the Company’s common stock in connection with the acquisition of Weihe is not permitted pursuant to applicable PRC law, so long as the Company is listed and traded on the OTCBB, rather than an exchange recognized by the applicable PRC governmental authorities, such as Nasdaq, AMEX and the NYSE.”

Imagine for a second you’re a lawyer, working with a Chinese SME on a proposed OTCBB listing. You must know this fact, that the Chinese government doesn’t recognize that stock market as legitimate. What do you do? Do you exercise your duty-of-care, and tell the client of the danger of an OTCBB listing? Or, do you just gloss over it, so that the deal will go through and you’ll earn big legal fees?

No prizes for guessing which course many of the lawyers take who advise Chinese SME on OTCBB listing. This is why it’s not, in my mind, exaggerating to say that these advisors are often a disgrace to their professions.

What can be done about all of this? It’s already too late for hundreds of Chinese companies that went down this road. For the other thousands of good SME bosses, however, access to better information in Chinese is obviously going to be important, to give them a solid basis to decide which kind of capital markets transaction to pursue.

I’ve done my share lately of cursing the darkness in this blog, remonstrating against the advisors, lawyers and bankers who’ve grown rich off promoting OTCBB and Pink Sheet listings, reverse mergers and SPAC deals. It’s time I also lit a candle.

Together with my colleagues at China First Capital, we’ve been working on a Chinese-language publication called “如何选择上市的时机和地点” or “When and Where to IPO”. It discusses at some length the problems with listing on OTCBB, or doing other kinds of rushed IPOs.

We’ll be completing it this week, and once done, we’ll do our utmost to make it as widely available as possible, in print and online.

 

 

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Size Matters – Why It’s Important to Build Profits Before an IPO

Leave a Comment / June 9, 2009

Qing Dynasty plate -- in blog post of China First Capital

Market capitalization plays a very important part in the success and stability of a Chinese SME’s shares after IPO. In general, the higher the market capitalization, the less volatility, the more liquidity. All are important if the shares are to perform well for investors after IPO.

There is no simple rule for all companies. But, broadly speaking, especially for a successful IPO in the US or Hong Kong, market capitalization at IPO should be at least $250 million. That will require profits, in the previous year, of around $15mn or more, based on the sort of multiples that usually prevail at IPO.

Companies with smaller market capitalizations at IPO often have a number of problems. Many of the larger institutional investors (like banks, insurance companies, asset management companies) are prohibited to buy shares in companies with smaller market capitalizations. This means there are fewer buyers for the shares, and in any market, whether it’s stock market or the market for apples, the more potential buyers you have, the higher the price will likely climb.

Another problem: many stock markets have minimum market capitalizations in order to stay listed on the exchange. So, for example, if a company IPOs on AMEX market in the US with $5mn in last year’s profits, it will probably qualify for AMEX’s minimum market capitalization of $75 million. But, if the shares begin to fall after IPO, the market capitalization will go below the minimum and AMEX will “de-list” the company, and shares will stop trading, or end up on the OTCBB or Pink Sheets. Once this happens, it can be very hard for a company’s share price to ever recover.

In general, the stock markets that accept companies with lower profits and lower market capitalizations, are either stock markets that specialize in small-cap companies (like Hong Kong’s GEM market, or the new second market in Shenzhen), or stock markets with lower liquidity, like OTCBB or London AIM.

Occasionally, there are companies that IPO with relatively low market capitalization of around RMB300,000,000 and then after IPO grow fast enough to qualify to move to a larger stock market, like NASDAQ or NYSE. But, this doesn’t happen often. Most low market capitalization companies stay low market capitalization companies forever.

Another consideration in choosing where to IPO is “lock up” rules. These are the regulations that determine how long company “insiders”, including the SME ownerand his family, must wait before they can sell their shares after IPO. Often, the lock up can be one year or more.

This can lead to a particularly damaging situation. At the IPO, many investment advisors sell their shares on the first day, because they are often not controlled by a lock up and aren’t concerned with the long-term, post-IPO success of the SME client.  They head for the exit at the first opportunity.

These sales send a bad signal to other investors: “if the company’s own investment advisors don’t want to own the shares, why should we?” The closer it gets to this time when the lock up ends, the further the share price falls. This is because other investors anticipate the insiders will sell their shares as soon as it becomes possible to do so.

There are examples of SME bosses who on day of IPO owned shares in their company worth on paper over $50 million, at the IPO price. But, by the time the lock up ends, a year later, those same shares are worth less than $5mn. If it’s a company with a lot market capitalization, there is probably very little liquidity. So, even when the SME bosshas the chance to sell, there are no buyers except for small quantities.

The smaller the market capitalization at IPO, the more risky the lock-in is for the SME boss. It’s one more reason why it’s so important to IPO at the right time. The higher an SME’s profits, the higher the price it gets for its shares at IPO. The more money it raises from the IPO, the easier it is to increase profits after IPO and keep the share price above the IPO level.   This way, even when the lock up ends, the SME boss can personally benefit when he sells his shares.

Of all the reasons to IPO, this one is often overlooked: the SME boss should earn enough from the sale of his shares to diversify his wealth. Usually, an SME boss has all his wealth tied up in his company. That’s not healthy for either the boss or his shareholders. Done right, the SME boss can sell a moderate portion of his shares after lock in, without impacting the share price, and so often for the first time, put a  decent chunk of change in his own bank account.

We give this aspect lot of thought in planning the right time and place for an SME’s IPO. We want our clients’ owners and managers to do well, and have some liquid wealth. Too often up to now, the entrepreneurs who build successful Chinese SMEs do not benefit financially to anything like the extent of the cabal of advisors who push them towards IPO. 

 

 

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How to Time an IPO – the Right Path to the Stock Market for a Strong Chinese SME

Leave a Comment / June 4, 2009

Ching Dynasty snuff bottle in China First Capital blog post

 

The timing of IPO is the most important question for all Chinese SME preparing for a public listing. Unfortunately, the correct answer is often the one most rarely heard. Instead, many investment bankers and advisors in China tell the SME boss that an IPO should be scheduled “as soon as possible”.

This is often music to the bosses untrained ears, since they’re wrongly assuming that the proceeds of an IPO will go directly into their pockets – a misconception these same investment bankers and advisors can literally cash in on. They’ll tell the SME boss the “bad” news — that the IPO proceeds must go to the company not to his personal bank account, and that the boss won’t be able to sell any of his own shares for a year or more after the IPO – towards the end of the expensive pre-IPO planning process, when it’s usually too late to pull out, without losing a huge amount of money.

This is if they bother to mention it at all. I’ve heard of instances where the Chinese boss is never told directly by his investment bankers, lawyers and advisors, but only finds out if his staff prepares a Chinese translation of the SB-2 prospectus used in OTCBB listings.

So, if not “right away”, what is the correct answer to the question: “when should a Chinese SME IPO”? Of course, circumstances will differ for each company. But, as a general principle, an IPO should come at the apex of an SME’s growth curve, when the company is achieving its historical highest return on equity and return on investment. This way, the SME will get a fuller value for its shares when it does list them publicly.

This also explains why pre-IPO private equity can have such a key role to play in the process. The purpose: put more capital to work than the company can generate internally, or can borrow from banks. This equity capital is then invested where it will earn the highest return over a two to three year period – for example, increasing production and improving economies of scale, or accelerating the pace of opening new distribution outlets.

The PE firm will also help improve efficiencies – in their role as risk-sharing partner with the SME boss – that can lead to significant improvement in net margins. In most cases, the pre-IPO PE capital can result in a doubling of profits. Done right, the pre-IPO capital will result in only modest level of dilution for existing owners – usually no more than 25%. It’s like switching on the after-burners: the SME can speed up its growth, improve its margins, seize large available market opportunities, and so position itself for a far more successful IPO in two to three years’ time.

An IPO has one great value above everything else: it will be the cheapest and most efficient way for an SME to raise the capital it needs to expand its business. The shares will likely be valued at multiples two times higher than a pre-IPO PE investor will pay. Since the amount of capital raised will be a multiple of profits, the higher the profits at IPO the better.

To illustrate this, let’s imagine a company with profits last year of RMB75 million. It has its IPO now, at a PE of 15 and its market capitalization at IPO is RMB 1,125,000,000. The company sells 25% of its shares in the IPO, and so it raises RMB 281,250,000. If instead the company waits another year, it raises a RMB50 million of pre-IPO private equity to help push its profit growth. A year later, profits have reached RMB120 million. If the company now has its IPO, at the same PE of 15, and sells 25% of the shares, it will raise RMB450,000,000 or 60% more.

Let’s  assume  the company continues to maintain a high return-on-investment, after IPO. If so, the more money raised at IPO, the higher profits should be able grow in the future. This is perhaps the most important predictor of overall share performance after IPO. By waiting to IPO, so that its size and profits would be larger, this company will be able to raise much more at IPO and so continue generate higher profits for many years into the future.

A company can IPO only once. So, it is important to raise the optimal amount during this one IPO. If a company IPOs too early, it will sacrifice its ability to finance its growth in the future. Many of the most successful IPOs in China were for private SME companies that had pre-IPO investment from private equity companies: Baidu, Alibaba, Suntech, Belle. That isn’t a coincidence. It’s the result of the sort of smart IPO-planning that is too rare in China.

 

 

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Voices From the Abyss: the Crooked Dealmakers Write Back, Offering to Work Together — and Why I’ll Always Say No

May 30, 2009
One of the earliest bonds issued in China     One of first bonds issued in China

 

My last two posts have elicited an unusual amount of feedback. The posts deal with the underhandedness, deceit, negligence and shameless greed of so many of the advisors, lawyers and investment bankers doing IPOs of Chinese companies outside China. 

It’s always nice to get mail. Well, mostly. A lot of the comments and emails were complimentary. But, probably half of the email traffic came from various ethically-challenged financial advisors, brokers, lawyers and fixers asking to work with me on their different China IPO schemes. All of them were, from what I could tell, the sort of transactions I railed against in my recent posts – particularly OTCBB listings, reverse mergers. In other words, the same people I would like to see neutered wrote to see if I wanted to go whoring around with them. 

I even got invited to a reverse merger conference in Las Vegas — hard to decide which part I’d least prefer, the conference or the setting.

In one sense, this is more than a little depressing. Either these guys hadn’t understood what I wrote, or figured I would be a useful shill for them somehow: “Look, we even convinced that guy Fuhrman who criticized OTCBB listings to get in on the game.” If so, they seriously miscalculated. 

There is another, more hopeful explanation for these wildly off-target emails. I know that times have gotten very tough for this whole crowd who made all the money wrecking what were often quite promising Chinese SME companies by convincing them to do bad IPO deals. The stock market, of course, is still limping, and most IPO activity (both the good and the debased) has all but dried up. 

Perhaps, then,  these emails to me are a last dying gasp, a tangible sign that the low practices that flourished over the last ten years are doomed. That would be great news, that bad advisors are contacting me as a last resort, because they’ve tried everything else and failed to revive a once-lucrative franchise fleecing good Chinese companies. 

You know what they say about things that sound too good to be true… We’ll see. 

For the record, as well as for those who may harbor any lingering hope I might be able to revive their business doing OTCBB listings or reverse mergers, I wanted to set out, clearly, what it is we do:

  • We only work with some of China’s best, fully-private SME
  • We only work with them on the basis of a long-term partnership, and we will only succeed financially, as a firm, if our SME clients do so. To assure this is the case, we take a significant part of our fees in shares that are likely to be illiquid for 3-5 years
  • We focus on raising our SME clients pre-IPO capital from any of the 50 or so Top Tier Private Equity firms active in China, and providing other financial advisory services over the longer-term, including subsequent capital-raisings, M&A work
  • In most cases, our clients will remain private for at least 2-3 years from the time we begin working with them
  • We are never involved in any kind of “rush to market” IPO, or any deal involving an OTCBB listing, reverse merger, SPAC, PIPEs

Now, I can imagine what a few of my recent email correspondents must be thinking, “What a dope. Why would anyone bother with this ‘high integrity’ stuff when you can make a fortune pushing Chinese companies through the IPO meat grinder?” 

That sort of approach, of grabbing fees while mutilating your client,  is so far removed from what I built China First Capital to do that it’s like asking a ballerina to enter a demolition derby. I’m lucky (or crazy, take your pick), but I didn’t start CFC with the primary motive of making money. I started it for three reasons:

(1) to have a chance, after achieving some career success elsewhere, to give something back to China, a country that’s been the deep and abiding love of mine since I was a little boy;  (2) to work alongside world-class founder/entrepreneurs, and help them get the financing they need to go farther and faster, and so become industry leaders in China over the next 10-20 years; and (3) to provide Chinese SMEs with at least one alternative to the sort of noxious advisory firms that have preyed on them for over 10 years. 

It’s demanding work. We refuse to cut corners, or get involved with a deal because there’s easy money to be made. We view our clients as our partners, not as a meal ticket.  In all these ways, I know I come from a different planet than the guys who arrange OTCBB deals, reverse mergers, or other quickie IPOs.

There’s another difference: I feel profoundly lucky every day to do what I get to do. I doubt they do. 

 

 

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Built to Fail – Case Studies on Chinese SME Companies Damaged By Greed, Deception and Crooked Investment Banking

Leave a Comment / May 27, 2009

Qing Dynasty Lacquer in China First Capital blog post

My last post dealt with the often-unprincipled conduct of the advisors, bankers and lawyers who created many of the disaster stories among Chinese SME companies seeking a stock-market listing. It’s not a topic that will win me a lot of friends and admirers among the many advisors, lawyers, and investment banker-types still active, sadly, sponsoring OTCBB and reverse merger deals in China. In my experience, they tend to put the blame elsewhere, most often on Chinese bosses who (in their view) were blinded by the prospect of quick riches and so readily agreed to these often-horrible transactions. 

There’s some truth to this, of course. But, it’s a little like a burglar blaming his victim for leaving a second-story window unlocked. Culpability – legal and moral – rests with those who are profiting most from these bad IPO deals. That’s the advisers, bankers and lawyers.  They are the ones getting rich on these deals that, too often, leave the Chinese company broken beyond repair. 

The bad IPO deals are numerous, and depressingly similar. I don’t make any effort to keep tabs on this activity. I usually only learn specifics if I happen to meet a Chinese SME boss who has had his company crippled by doing an OTCBB listing or reverse merger, or an SME that is in the process of doing a deal like this. 

Here are a few “case studies” from among the companies I’ve met. They make for depressing reading. I’m omitting the names of the companies and their advisers.  The investment bankers on these deals deserve to be publicly shamed (if not flogged) for what they’ve done. But, the stories here are typical of  many more involving crooked investment bankers and advisers working with Chinese SME. The story lines are sadly, very familiar. 

COMPANY 1

A Guangdong electrical appliance company, with 1,500 employees, had 2008 revenues of $52mn, and net profit of $4mn, did a “reverse merger” in 2007 and then listed its shares on the OTCBB. Despite the company’s good performance (revenues and profits grew following the IPO), the share price fell by 90% from $4.75 to under 5 cents. At the IPO, the “investment advisors” sold their shares. The company also raised some cash, about $8mn in all.  But, quickly, the share price started to fall, and the market capitalization fell from high of $300mn to under $4mn. The company’s management didn’t have a clue how to manage a US publicly-traded company (none spoke English, for one thing), and so started making regulatory mistakes and had other problems with filing SEC documents. The company’s management, still with much of the $8mn raised in the IPO in its corporate bank account,  then started selling personal assets at wildly inflated prices to the company, and so used these related party transactions to take most of the remaining cash from the business into their pockets. No surprise, the company’s auditors discovered problems during its annual SEC audit, and then resigned.

The company’s share price is so low it triggered the “penny stock” rules in the US, which limit the number of investors who are allowed to buy the shares.

 

COMPANY 2

An agricultural products company with $73 million in 2008 revenues chose to do a “reverse merger” in the US, to complete a fast IPO early in 2009. The company got the idea for this reverse merge from an investment adviser in China who promised to raise $10 million of new capital as part of the reverse merger. The agricultural products company believed the promise, and spent over $1 million to buy the listed US shell company, including high fees to US lawyers, accountants and advisers.   

After buying the shell and spending the money, the company learned that the advisor had failed to raise any new capital. The company now has the worst possible situation: a listing on the OTCBB, with no new capital to expand its business, a steadily falling share price, and annual costs of being listed on the OTCBB of over $500,000 a year. At this point, no new investor is likely to invest in the company, because it already has a public listing, and a very low share price.

Because of this reverse merger, the company’s financial situation is now much worse than it was in 2008, and the company’s founder effectively now has no options to finance the expansion of his business which, up until the time of this reverse merger, was thriving.

 

 COMPANY 3

In 2008, an outstanding Guangdong SME manufacturing company signed an agreement with a Guangdong  “investment advisor” and a small US securities company that specializes in doing “Form 10 Listings” of Chinese SME on the OTCBB. They told the company’s boss they were a “Private Equity firm”. The investment advisor and the US securities company were working in concert to take as much money from this company as possible. Their contract with the company gave them payments of over $1.5 million in cash for raising $6mn for the company, a fee of 17%, and warrants equal to over 20% of the company’s shares. The $6mn would come from the securities company itself, so it could claw back a decent chunk of that in capital-raising fees, and also grab a huge slug of the equity through warrants. 

The securities company quickly scheduled a “Form 10” IPO for summer of 2008, and arranged it so the shares to be sold would be the warrants owned by this securities company and the Chinese investment advisor. So, according to this scheme, the Chinese SME would have received no money from the IPO, and all the money (approximately $10 million) would have gone direct to the securities company and the advisor.

The securities company deliberately misled the SME founder into thinking his shares would IPO on NASDAQ. Further, they gave the founder false information about the post-IPO performance of the other Chinese SME they had listed through “Form 10 Listings” on the OTCBB. Most had immediately tanked after IPO. 

In this case, the worst did not happen. I had met the boss a few months earlier, through a local bank in Shenzhen, and liked him immediately.  Before the IPO process got underway, I offered him my help to get out of this potentially terrible transaction. This was before I’d set up China First Capital, so the offer really was one of friendship, not to earn a buck. I promised him if he could get out of the IPO plan, I’d raise him money at a much higher valuation from one of the best PE firms in China. 

The boss was able to cancel the IPO plan, and I started China First Capital with the first goal of fulfilling my promise to this boss.  CFC quickly raised the company $10mn in private equity from one of the top PE companies , and the valuation was over twice the planned IPO valuation from the “investment advisor” and the securities company. This SME used the $10mn in pre-IPO capital to build a new factory to fill customer orders. 2009 profits will double from 2008. The company is on path to an IPO in 2011, and at that time, the valuation of the company will likely be over $300mn, +7X higher than at the time of PE investment.

 

 

 

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

Leave a Comment / May 14, 2009

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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Our Partnership to Serve China’s SMEs — China First Capital and Horwath Look to Change the Game in China

1 Comment / September 29, 2009

China First Capital blog post -- Han mirror

China First Capital (CFC) this week announced that we’ve established a strategic partnership with Horwath Capital China (HCC), part of Crowe Horwath, one of the ten-largest international accounting firms. HCC is led by David Yu, a very impressive individual and fast becoming a good friend. David qualified both as a lawyer and a CPA, and has built HCC into a powerful financial services firm, based in Beijing, and focused largely on providing China’s SME businesses with accounting, legal and other strategic advisory services.

I wanted to spell out more of what lies behind this partnership – why we’re doing it, the strategic intent, the scale of the opportunity, and the ambitious goals we hope it will achieve. Through the partnership, our aim is to raise the level of financial services available to China’s best SMEs, to meet their specific needs. That’s a tall order, and we’re cognizant of the challenges. It’s now down to both companies to make this a reality.   

HCC are an optimal partner for China First Capital, and so we’re genuinely pleased and honored to be working with them. CFC and HCC both share that same focus on Chinese SMEs, and for the same good reason: both firms see that many of China’s best SMEs will emerge over the coming years as some of China’s most successful and dominant private companies. They won’t be “Small or Medium” for long.  

While China’s largest and most internationally-known companies tend to be partly state-owned (China Mobile, CNOOC, Sinopec), the private sector is where China’s economic future resides. By some estimates, over 70% of China’s GDP is generated by private companies. Twenty years ago, the percentage was less than 10%. That’s a remarkable transformation, unparalleled in modern economic history. Another key differentiator: China’s economy has privatized without privatization. In other words, this shift from state-owned to privately-owned economy happened not primarily because state firms were privatized. That’s the route taken in Europe, most famously in the UK, where during the 1980s, Margaret Thatcher sold to private investors previously nationalized companies like British Petroleum, British Telecom, British Gas.  

In China, privatization has played a very minor role in lowering the government’s share of GDP. Instead, China created legal and economic circumstances where private companies could form, compete and prosper.   And prosper they have. With few exceptions, the best and fastest-growing companies in China are now private ones, the SMEs that China First Capital and Horwath both work with. These SMEs are still smaller in scale than the state-owned giants. But, that will change.  

The strategic rationale behind our partnership with Horwath is to “change the game” in corporate finance and advisory services in China. The partnership’s explicit goal is to be the first in China to deliver to these strong SMEs the highest international standards of corporate financial advisory work. Together, we offer SMEs a complete platform including capital-raising, audit and M&A advisory, to assist in their continued growth, and eventual IPO listing on public stock markets.  

No other firm can offer this range of services to SMEs, at a uniformly high international level. The big investment banks and accounting firms charge too much, and generally won’t work with smaller firms. Domestic firms tend to be weak in areas such as private equity capital-raising and implementing international accounting standards that structure a Chinese company for a successful IPO.  

Just as important is what we won’t do. We won’t push a Chinese SME to go public before the right moment; we won’t put earning fees ahead of the best interests of the client. Sadly, in China, there are many, many precedents of unscrupulous or unprofessional “investment advisors” who have damaged or destroyed Chinese SMEs by pushing them to IPO too early, on the wrong market (example, the US Over-the-Counter Bulletin Board) or via an ill-structured “reverse merger”. The advisors make millions, and the SMEs never recover. 

Both David Yu and I share a similar purpose here: we think these great Chinese SMEs should have access to financial advisory services that are of a similarly high caliber to what larger companies now use.  We are not chasing fees. If so, we’d go after larger companies. We both see an opportunity to work with some outstanding SMEs that are on the verge of becoming industry leaders. If we do our part with this partnership between CFC and HCC, the SMEs reach that next level of success more quickly and efficiently than they would otherwise.

That’s the measure of success for us — not that CFC and HCC will increase their own fee income. If that happens, it should only be a result of the one thing that really matters to us: that our SME clients grow faster and stronger than their peers. 

 

 

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China’s State-Owned Banks’ Missed Opportunity Opens the Way for Some Global Banks to Prosper

Leave a Comment / May 4, 2009

If ever there were a case of “a chart tells a thousand words”, it’s this one, courtesy of The Economist and Macquarie Research:

SME bank lending

At ground level here in China, it’s easy to see some of the more obvious signs of the financial distortion this chart portrays. In August last year, in the face of gathering worldwide economic slowdown, the Chinese government relaxed earlier controls on bank lending, basically instructing the state-owned banks to keep the economy and employment growing by expanding credit to businesses. Later in the year, the government lowered interest rates to further spur lending. 

My worry at the time was that most of this increase in bank lending would be channeled to the least deserving customers: the many clapped-out large state-owned enterprises, rather than the far more numerous thriving private sector companies short of cash. This would more or less defeat the purpose of the government pump-priming, since the lending would only allow some of the country’s least competitive most loss-making manufacturers to stay in business that much longer, at the expense of their better private-sector competitors. As a job-saving mechanism, it would likely be equally flawed, since most of the new lending would sustain for a little while longer bad jobs in bad businesses that should be allowed to wither. Failure is rewarded and success penalized. 

Well, the worries appear to have been very well-founded. The most deserving borrowers, China’s dynamic entrepreneurial Small & Medium Enterprises (SME), mainly came away empty-handed when all this new lending was being handed out. As the chart shows, overall bank lending to SMEs didn’t even crack 10% of total lending at four of the largest state-owned banks. With the exception of the more entrepreneur-friendly China Merchants Bank, which also happens to be the only bank on the list not owned by the central government, the large Chinese banks continued their past (bad) habits of stuffing bank loans into the tottering state-owned giants. 

The eventual outcome, of course, will be a lot more write-offs and non-performing loans inside these state-owned banks. For an abject lesson in bank lending policy, it’s hard to outdo this: the government-owned banks make loans to other government-owned bodies, which then default, causing losses at the government-owned banks that then need to be recapitalized by – you guessed it – more money from the government. 

There’s an even more malign effect: it’s actually getting harder – not easier – for China’s best-performing SMEs to obtain credit. These are the companies that are producing products consumers want, expanding employment, servicing their loans, making profits and paying taxes. The private sector now accounts for over two-thirds of China’s total economic output, and private SMEs represent the bulk of this. 

The Macquarie chart suggests the credit system of China state-owned banks is largely broken: borrowers least able to repay are those granted most of the lending. There are lots of losers in this, but no one is affected more adversely by this than the owners of China’s best SMEs. They are being locked out of the market for bank lending by Chinese banks. 

That leaves one possibility: SMEs finance their expansion through equity, rather than debt. This investment capital will come from outside the realm of China’s state-owned banks. Instead, it will largely be provided by the 100 or so private equity and venture capital firms now active in China. They have raised over $30 billion to invest in China, and the SMEs are a favorite target. 

Of course, not all SMEs will be able to raise equity. It’s generally an option only for the higher-performing SMEs with significant scale and significant presence in China’s domestic market. My company is an international investment bank working exclusively with Chinese SMEs, to help them raise equity finance from the best sources active in China, mainly the top private equity and venture capital firms.  The challenge for us, as for the private equity firms, is that too few of China’s best SME bosses know that they can access private equity investment and so escape from the perils of undercapitalization. 

For the SMEs that can raise money from international investors, this is not just the best option – but also often the only option – to finance growth. An injection of equity will deliver both the resources to grow more quickly and sizable competitive advantage against under-capitalized competitors. 

An additional advantage: by raising equity, an SME will strengthen its balance sheet and so be more likely to succeed in borrowing from one of the very good international banks with operations in China and a focused expertise on lending to Chinese SMEs: Citibank, Standard Chartered, ABN-AMRO foremost among these. I know the management in Shenzhen of all three banks. They are very well-run and very well-connected among SMEs across China. The three international banks bridge the huge gap created by Chinese state-owned banks failures to make adequate lending available to SME customers. 

For Citibank and ABN-AMRO, their current performance in China, founded on their strong presence in SME lending, is one of the only bright spots for two organizations that could do few things right elsewhere recently. Together, they lost over $30 billion last year, and Citibank is now a ward of the US government. 

Everything ABN-AMRO and Citibank did so spectacularly wrong in other countries, they do spectacularly right in China – they focus on the right clients, the right kind of products (loans to growth companies) and having steady bankers, not deal-makers, at the top.  If Citibank and ABN-AMRO are ever to recover their lost luster globally, they should learn from the example of their China operations. The banks represent two of the brightest hopes for the future financing of China’s SME entrepreneur class. 

In China today, there is no larger financial need – and no larger financial opportunity for investors – than to put additional finance into strong fast-growing private SMEs. This will allow them to grow most immediately into the leaders in China’s domestic market, and eventually, for some, into publicly-traded global businesses. 

China’s state-owned banks, meanwhile, will likely continue on their wayward path of lending to companies with more political clout than business ability. It’s a losing strategy for them. But, it’s one that creates ideal conditions for well-managed international banks in China, with the skills, market knowledge and focus to lend to SMEs (take another bow Citibank, Standard Chartered, and ABN-AMRO), to prosper alongside their SME clients.  

 

 

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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

Leave a Comment / March 24, 2009

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

 

 

概  览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”

在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的

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。

 

 


American and Chinese entrepreneurs: they are very different, but the best are equally good at making their investors rich

Leave a Comment / March 27, 2009

han-dynasty-coin

Held each year in Los Angeles, the technology conference organized by the investment bank Montgomery & Co. is one of the best of its kind, anywhere. It brings together about 1,000 people from the top American venture capital and private equity firms along with senior management at some of the most accomplished privately-owned technology companies in the US. It provides a very focused snapshot of some of the strongest new tech business models and where venture capital and private equity firms are looking to invest this year.  

I was at the conference from start to finish, in meetings and panels. It was a great gathering in every respect, with a level of optimism that runs counter to much of the economic gloom that dominates the headlines. One reason: good technology can thrive in bad times. Corporate budgets are getting squeezed and each purchase is more tightly scrutinized. This means that many new tech solutions, offering good or better performance at lower price, have a great opportunity to gain market share against more lumbering competitors. 

I saw some interesting companies with interesting business models, in particular several that were focused on SaaS (“Software-as-a-Service”) solutions that can dramatically lower for businesses large and small the cost (both hardware and software) of implementing enterprise software. SaaS makes so much sense because companies can switch to a powerful software solution, but without the need to buy and install any of the software or hardware to run it. It’s all done using an internet browser as the main interface. The software is hosted and managed on a central server by the company that developed it. Users pay a monthly or annual fee to use the software. 

SaaS is an area where I have a special interest. I’m lucky enough to be CEO of Awareness Technologies (www.awarenesstechnologies.com), which develops and sells SaaS-based corporate security software. Awareness also has as its founders two of the best entrepreneurs I’ve ever met, Ron and Mike. They are superstars.

Great entrepreneurs are rare, even in a conference of hot technology companies. Of the 100 tech companies at the Montgomery conference, very few – by my very unscientific study — seemed to have a great entrepreneur at the controls. Most are venture-backed, and so tend to have very experienced professional managers at the top. Often, the founding entrepreneurs have been pushed out, or given different roles, after the venture capital money arrives. One obvious reason for this: the venture capital and private equity partners are usually from similar backgrounds as the professional managerial class, with gold-plated resumes and MBA degrees from the best universities in the US.  Institutional investors often look for a safe pair of hands, and not a visionary, to run a company once their money is committed. This is sometimes the right choice.

That’s the usual pattern in the US. I was struck, not surprisingly, by the differences in China. Great entrepreneurs are no less rare, but it’s almost impossible for me to imagine a situation where the founder of a Chinese company is pushed aside by the venture capital or private equity firm after its put its money in. That would, in most cases, be sheer madness. First, there is no large “professional managerial class” in China at this point, with experienced managers who have run successful businesses previously, and then either sold them or led them to IPO.

Second, and perhaps even more important, good Chinese companies, in my experience and to an extent rarely seen in the US, are one-man shows. There is usually as boss and owner one superbly talented, charismatic, driven and shrewd individual, who saw a market opportunity and seized it. Against unimaginable odds – including the severe ack of capital, continually changing regulations, predatory officials, the primitive market economy of ten years ago in China, and the fiercest competitors – these successful Chinese business owners managed to build large and thriving companies. Single-handedly. There is usually no “management team” to speak of — just one man of outsized abilities and an equally outsized will to succeed.

Another difference with the US: the best entrepreneurs in China, and so the best investment opportunities for venture capital and private equity firms,  aren’t likely in the technology business. They most often are in what are considered, in the US, old-line, low-growth businesses like manufacturing, retailing, branded consumer goods. In the US, companies in these sectors find it nearly impossible to raise money from venture capital and private equity companies. In China, it’s where most of the VC and PE investment goes.

It’s what makes China such an interesting place to be for venture capital and private equity, and why I feel so lucky to have a business there in that field. China has both the most sophisticated global investors and the most well-run, entrepreneurial smokestack industries.

Of the 100 companies at the Montgomery conference, I can’t think of a single one that runs a factory and manufactures a tangible product. The guys who run these companies are almost certainly all college graduates, often with advanced degrees, looking for money to complete or market a website, a software application, an internet advertising platform. In China, conversely, a conference filled with some of the better, more promising private companies would have 100 men, most with only a high-school education, looking for money to expand their factories, fulfill more customer orders and so double their revenues and profits in the next year or  two.

As someone who has spent a big part of his life managing technology and venture capital businesses, I see great opportunities to make money investing in both China and the US. The big difference is that in the US, the biggest risks for venture capital and early stage private equity investors tend to be technological, that the company you’ve invested in may not succeed because its product or service doesn’t work as planned, or isn’t as good as a competitor’s. In China, technology risk is usually minimal. The big risk for venture and private equity firms is that the rules may change, and the company you’ve invested will not be able to freely operate in the domestic market in China.

How do I manage risk personally? I try to eliminate it, by working with the best entrepreneurs. I’m confident Awareness Technologies will widen its technological lead, become the dominant SaaS-based security software company and make its investors a ton of money. Equally, I’m confident the Chinese companies we work with at China First Capital will become dominant in their industries in China and make their investors a ton of money. Along the way, the men running these Chinese businesses will continue to do what they’ve always done: find ingenious ways to stay one step ahead of competitors and any changes in the country as a whole.

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

Leave a Comment / March 14, 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 firm‘s 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

1 Comment / March 14, 2009

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

Leave a Comment / March 8, 2009

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.

 

 

 

 

 

 

 

 

 

 

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