傅成

China’s IPO Freeze to Melt in Midwinter

Leave a Comment / December 2, 2013

Kesi embroidery

IPOs are returning to China. The China Securities Regulatory Commission this weekend announced its long-awaited guidelines on a new, somewhat liberalized process for approving IPOs. The rush is now on to get new IPOs approved and the money raised before Chinese New Year, which falls on January 31st, less than two months from now. Ultimately, the CSRC hopes to clear within one year the backlog of over 800 Chinese companies now with IPO applications on file. Thousands of other Chinese companies are waiting for the opportunity to submit their IPO plans. The CSRC stopped accepting new applicants almost 18 months ago.

From what I can tell, the CSRC has concluded, rightly, its old IPO approval process was broken beyond repair. The regulator used to take primary responsibility for determining if a Chinese company was stable enough, strong enough, honest enough to be trusted with the public’s money. No other securities regulator took such a hands-on, the “buck stops with me” approach to IPO approvals. The CSRC now seems prepared to pass the buck, in other words, to put the onus where it belongs, on IPO applicants, as well as the underwriters, lawyers and accountants.

This should eliminate the moral hazard created by the old system. Companies, as well as their brokers and advisors, had a huge amount to gain, and much less to lose, by submitting an application and hoping for a CSRC approval. They could cut corners knowing the CSRC wouldn’t. For the successful IPO applicants who got the CSRC green light, valuations were sky-high, and so were underwriting and advisory fees.

Going forward, the CSRC seems determined to switch from security guard to prosecutor. Rather than trying to detect and prevent all wrongdoing, it is now saying it will punish severely companies, and their outside advisors, where there’s a breach in China’s tough securities laws. The CSRC’s powers to punish any wrongdoing are significant. Heaven help those who end up being convicted of criminal negligence or fraud. As I noted before,  there are no country club prisons in China for white collar offenders.

While baring its sharp teeth, the CSRC is also now using its more soothing voice to tell retail stock market investors they will need to do more of their own homework. It wants more and better disclosure from companies. It hopes investors will read before buying. And, the CSRC also hopes the stock market will itself begin to provide investors will clearer signals, through share price movements, on which companies may not be suitable for the more risk-averse.

Up to now, companies going public in China did so with a kind of “CSRC Warranty”. That’s because the CSRC itself said it had already done far more detailed, forensic scrutiny of the company than just reading through its public disclosure documents. The approval process could take two years or more, with company execs, lawyers and accountants being called frequently to meetings at the CSRC headquarters to be grilled. All this to give comfort to investors that nothing was awry.

The warranty has effectively been revoked. This may make some investors more nervous, but it represents a significant and positive breakthrough for the CSRC.

It needs to lighten its grip. Markets need regulation, need rules and effective mechanisms for punishing bad actors. But, the CSRC took on too much responsibility for assuring the orderly functioning of China’s stock market. This was always going to be difficult. China’s stock markets are far more prone to speculative frenzy than stock markets in the US, Europe. Shares on the Shanghai and Shenzhen stock markets are bought and sold mainly by retail investors, or as the Chinese say, “old granddads and grannies” (老爷爷老奶奶）. Institutional investors are a minority. As for investment fundamentals, on China’s stock market there are mainly just two:  “Buy on rumor. Sell on rumor”.

Over the last year, I’ve written about problems at the CSRC that helped cause and prolong this long freeze in IPOs. The CSRC’s first instinct back in 2012 was to try to toughen its regulation, toughen its own internal systems and procedures for rooting out fraud. It then switched tracks, and decided to let the market play more of a role.  This is a major concession, as well as important proof that China’s larger process of economic transformation, of freeing rather than freezing markets, is headed in the correct direction.

As if on cue, this past week’s Wall Street Journal last week digested a section from the Nobel Prize acceptance speech by economist Friedrich Hayek.

“To act on the belief that we possess the knowledge and the power which enable us to shape the processes of society entirely to our liking, knowledge which in fact we do not possess, is likely to make us do much harm…Even if such power is not in itself bad, its exercise is likely to impede the functioning of those spontaneous ordering forces by which, without understanding them, man is in fact so largely assisted in the pursuit of his aims. ”

I’m delighted China’s IPO market is going to re-open. My own prediction here a couple of months ago was that it IPOs would resume around now, rather than next month. This just goes to show all forms of market timing — whether it’s trying to guess when a stock price has hit its peak or when a stock market itself will change course, and its once omnipotent regulator change its entire approach — is a fool’s errand.

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Hong Kong IPO Today for China First Capital Client Hydoo

Leave a Comment / October 31, 2013

Hydoo Prospectus

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Welcome good news today from Hong Kong’s capital markets. The Chinese commercial real estate developer Hydoo (Chinese name 毅德) successfully IPOs on the Hong Kong Stock Exchange, raising over USD$200mn in new capital. With IPO channels for Chinese companies mainly blockaded, it’s especially welcome to see a Chinese private sector company raising so much from the stock market.  In this case, the delight is greater because Hydoo is a client of China First Capital. We acted as Hydoo’s investment bankers raising USD$80mn from Chinese private equity firm Hony Capital.  Hony’s 2011 investment, based on today’s IPO price, is now worth USD$150mn.

In addition to Hony, China’s giant financial services group Ping An also invested before IPO.  In total, Hydoo raised USD$140mn (Rmb 860mn) of institutional capital before IPO. Over 60% of the IPO shares (worth over $120mn) were sold by underwriters ahead of time to so-called “cornerstone investors“, including two large Chinese SOEs, Huarong and China Taiping Insurance, as well as retailer Suning (in which Hony owns a share).

I’m happy for Hony and the other investors, but happier still for Hydoo founders, particularly its chairman, Wang Zaixing, known to friends and family  as “Laowu”, literally “Venerable Fifth”. He is the fifth-born of ten children all of whom played a part in building Hydoo. The family is originally from Chaozhou in Guangdong, and speak the distinctive Chaozhou dialect. But, they ended up after 1949 in Ganzhou, Jiangxi Province.

The business Laowu started 18 years ago is now worth over $1 billion. The first time I met him, I told Laowu my goal as his investment banker, and my emphatic expectation,  was that his company would be worth at least that much at the time of its IPO. Another priority of mine was that he and his family members would still hold majority control after IPO.  That too has been achieved.  They hold almost 60% of the now publicly-traded business.

For me, Laowu personifies in many ways the large economic changes China has undergone in the last 30 years. He started life as a long-distance truck driver and from that humble start saw and grasped an opportunity to build wholesale trading centers for the emerging army of small businesspeople in China.

I first met Laowu and his company in 2009. The business was then called Haode (豪德). It was then still an old-school Chinese family business. There was no corporate structure in the traditional sense. Laowu and his brothers, sister and nephews would pair up, or act independently, to do individual large wholesale trading centers around China. When I met them, the family had already done 19 such projects. All had done very well. At the time, I’d never met a Chinese private company as profitable over as many years as Haode.

Over the last three years, the company has been transformed into a more professional enterprise. Hydoo provides a useful excellent template for how a Chinese family-owned business can make this transition to a publicly-traded company. Part of that process was splitting up the family’s existing business between a group that would follow Laowu and become shareholders of Hydoo, and five other siblings who chose not to participate, but remain active in some cases building their own wholesale trading centers.

As the IPO prospectus puts it,  this division was “a complex, delicate process involving the allocation of assets or interests in the existing businesses among a group of closely connected family members, who decided to split up into two independent groups with diverging goals going forward. Under the special circumstances, no written agreements were entered into in respect of the Family Allocation and no valuation appraised by independent valuers was undertaken when negotiating the Family Allocation. Instead, the Wang Family Group placed their focus on more subjective, personal factors.”

Me and my firm played a small part by advising Laowu and his siblings on the pros and cons of being part of a company planning for an IPO. But, as you’d expect, most of this was done within the private confines of a large, closely-knit family.  Along the way, though, I gained a deeper appreciation of the unique ways Chaozhou people do business.

Chaozhou natives are rightly famous both in China and throughout much of Southeast Asia for their business acumen. They are often described by other Chinese as “the Jews of China”.  As a Jew in China, I tend to think the description flatters my people. Chaozhou people seem to have an instinctive and unsurpassed talent for making money and entrepreneurship. Look around the world at the most successful Chinese business people, including the leading business families in Thailand, Indonesia, Singapore, Malaysia and Hong Kong, and a large percentage, including Asia’s richest magnate, Li Ka-shing, Thailand’s richest businessman Dhanin Chearavanont  and Indonesia’s top tycoon, Mochtar Riady, are either from Chaozhou or are descended from people who immigrated from there.

As this suggests, Chaozhou people are able and willing to uproot themselves and chase opportunities. Laowu didn’t leave China, but in building Hydoo, he did venture far afield from where he and his family were raised. He saw very early and profited richly from an economic shift within China that few others noticed 15 years ago. At the time, much of China’s economic growth was centered in southern China, and large coastal cities like Shanghai, Shenzhen, Xiamen. Laowu looked inland, especially in Shandong Province, one thousand miles north of Chaozhou.

As the economies of Shanghai and big southern coastal cities began to cool, inland areas, led by Shandong, began to boom. Shandong’s GDP growth, over the last ten years, has been among the highest of any part of China. Shandong is a huge market to itself (population 95mn) as well as a vital crossroads for commerce between north and south, east and west in China. Laowu built large wholesale parks to accommodate thousands of small traders, creating new clusters of small-scale commerce and entrepreneurship.

When you visit one of these centers, you get the impression that half of Shandong’s gdp is going in and out the doors. It’s crowded and vibrant. Even the smallest traders own their own small shop inside the Hydoo centers. That’s Hydoo’s model: they build the buildings, and as they do, sell off most of the units to thousands of individual small traders. Hydoo helps them get mortgages and often acts as guarantor on the loans. This lets thousands of small businesspeople become property-owners. As the Hydoo centers thrive (and they all do, as far as I know) the value of the real estate rises.

I know of no other businessman in China that has done as much as Laowu to build wealth and provide an entrepreneurial hub for such a large number of people in China. Hydoo is now spreading across more areas of China. It’s is building huge new wholesale parks in Sichuan, Hunan, Guangxi, Gansu.

I see Laowu infrequently these days. But, I’m as impressed now as I was when I first met him by his accomplishments. He and his family founded a business back when China was a different and less developed place. They stuck with it, kept reinvesting and now, through today’s IPO,  own shares worth more money than I can imagine. But, more important for me is that they still own the business, still own the majority and so answer to no one else. As an entrepreneur who helped create and sustain so many other entrepreneurs, Laowu deserves nothing less.

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Better and Worse Investment Ideas For China’s Future

Leave a Comment / October 16, 2013

–tablescreen Where is China headed and how to make money by getting there first? If you were to ask professional China investors, almost without exception you’ll be offered an identical vision of the China of 2020 and beyond:  retired Chinese in their tens of millions living in assisted-living housing spending their days on their smartphones buying clothes, playing games and booking European vacations.

It follows, the pros will tell you, that the best places to put your money today are with Chinese companies building retirement and assisted living housing, mobile apps and online shopping websites. Indeed, these are the sectors getting by far the most attention and seeing the most substantial flows of new investment capital these days.

I happen to think the “smart money” is wrong and here’s why. First, in my experience across 30 years of business life, whenever you get so much agreement about where the future is headed and where money should be staked, the predictions usually prove wrong and the money usually lost.

In this case, the basic analysis is fine. Yes, China is getting older and yes it needs more places to house and care for the elderly. And, yes, Chinese will buy more stuff online since prices are often much lower than in shops. But, only a fraction of the projects now receiving funding will be successes.

The assisted living, online shopping and mobile services businesses already seem over-invested. And yet the money keeps pouring in. It reminds me very much of the last “can’t miss” investment idea in China: group shopping. Two years ago, PE and VC firms poured billions into at least a dozen different group shopping sites in China Most, if not all of that, will be lost.

There are formidable hurdles in the way of all three of the currently-favored business models. For assisted living and retirement housing, it’s not clear Chinese retirees in significant numbers will want to move into these kinds of places, even if their kids are paying. Nor is it clear how these projects will make equity investors money, since Chinese banks remain loathe to lend money to any kind of real estate project.

Online shopping? Great business, but all the companies getting investment have to compete with a few powerhouses with huge market shares. The list includes Alibaba’s Taobao business, Yihaodian (part-owned by Wal-Mart), Amazon China, 360buy.com. I see little reason to believe these newer PE-backed entrants will make any serious dent against these competitors.

As for mobile services, yes Chinese have all switched en masse to smartphones. And, yes, they use the mobiles to do lots of stuff online, including shopping, chat, games. Problem is, in the overwhelming number of cases, Chinese don’t pay for any of it. In my view, they never will. Any investment predicated on the theory that eventually Chinese will start paying fees to mobile service-providers is usually based on not much more than a hope and a prayer. Nothing solid.

So, where else to put money now to be best-positioned for the China of 2020? I can think of two places. One is organic foods and the other is health supplements and what are called “functional foods” in the US.

As of now, both are tiny industries in China, a fraction of their size in the US and Europe. My guess is that the market in China will eventually dwarf those two other places. I’ve read about a few PE investments in these industries. But, in general, the so-called “smart money”  has stayed out.

So, why do I think organic, “functional foods” and supplements will become huge businesses in China? In general, the same forces will prevail in China that have propelled the growth of these industries in the US and Europe: a wealthier population, more interested in their health, more distrustful of traditional commercially-prepared foods, and also more interested to improve their health, fitness and life expectancy by exercising, eating well (including vitamins and supplements) while keeping away from doctors.

In China, this distrust of commercial foods and commitment to a more healthful lifestyle, though still in a comparatively early stage,  is already strong, deep and widespread. So is the lack of trust in the quality of medical care received from doctors.

As anyone who lives in China can attest, there are very good reasons for all of this. Food scandals are common. There seems to be a lot of unhealthy and unhygienic food circulating.  Doctors don’t enjoy a very high standing any longer. They are often seen as fee-grubbing predators, ever willing to make phony diagnoses as a way to put more money in their pockets from their share of fees paid for tests, medicines, surgery, hospital care.

In short, the conditions couldn’t be riper for the development of organic foods, and health supplements of all kinds. Chinese traditional medicine shares quite a few principles in common with the OTC health supplements sold in the US. Chinese, in a way Westerners generally do not, have always accepted that Western pharmaceuticals should often be taken as a last resort. They worry greatly about side effects. If there’s a more “holistic” way to treat a condition, Chinese will often prefer it.

China, as of today, has no vitamin and supplement shops like GNC in the US, nor do mainstream pharmacies give such products any shelf space. When you can find them, vitamins are sold at very high prices in China, usually at least double the US level. There are no good domestic brands, no winning products or packaging formulated specifically for Chinese consumers.

One data point: it’s more and more widely known in China that fish oil is beneficial for digestion and circulation. And yet, it’s hard to find the product anywhere in China. When you do, it is usually stuff imported from the US, in old-looking packaging, with English-language  labels, and prices three to four times higher than in America.

Whether the world has enough cod livers to meet future Chinese demand for fish oil is another story. But, I’m confident the China market should eventually rival the US’s in size.

As for organic and healthy foods, China has lots of conventional supermarkets. But, so far no one has tried to follow the path blazed by Whole Foods Market in the US. Nor are there large, established organic food brands like Organic Valley, Applegate.

It will all happen. When, and which investors will make the big money is hard to say. Even now, the demand for genuine organic fruits, vegetables and dairy outstrips the available supply. There’s yet no real standard in China for what can be called organic, and so Chinese consumers often view products labeled that way with suspicion. That too represents a business opportunity in China — providing standards and credentials for the organic farming industry.

The lesson here: in China, the best business opportunities are often hiding in plain sight, often unseen by professional investors. Nowhere is contrarian investing more warranted and more potentially profitable.

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Jiuding Capital: China’s “PE Factory” Breaks Down

Leave a Comment / June 12, 2013

Less than 18 months ago, Harvard Business School published one of its famed “cases” on Kunwu Jiuding Capital (昆吾九鼎投资管理有限公), praising the Chinese domestic private equity firm for its ” outstanding performance ” and “dazzling investment results”. (Click here to read abridged copy.) Today,  the situation has changed utterly. Jiuding’s “dazzling results”, along with that HBS case, look more like relics from a bygone era.

Jiuding developed a style of PE investing that was, for awhile, as perfectly adapted to Chinese conditions as the panda is to predator-free bamboo jungles in Sichuan. Jiuding kept it simple. Don’t worry too much about the company’s industry, its strategic advantage, R&D or management skills. Instead,  look only for deals where you could make a quick killing. In China, that meant looking for companies that best met the requirements for an immediate domestic IPO. Deals were conceived and executed to arbitrage consistently large valuation differentials between public and private markets, between private equity entry multiples and expected IPO exit valuations.

Jiuding’s pre-investment work consisted mainly of simulating the IPO approval process of China’s securities regulator, the CSRC. If these simulations suggested a high likelihood of speedy CSRC IPO approval, a company got Jiuding’s money. The objective was to invest and then get out in as short a period as possible, preferably less than two years. A more typical PE deal in China might wait four years or more for an opportunity to IPO.

Jiuding did dozens of deals based on this investment method. When things worked according to plan, meaning one of Jiuding’s deals got quickly through its IPO, the firm made returns of 600% or more. After a few such successes, Jiuding’s fundraising went into overdrive. Once a small domestic Renminbi PE firm, Jiuding pretty soon became one of the most famous and largest, with the RMB equivalent of over $1 billion in capital.

Then, last year, a capital markets asteroid wiped out Jiuding’s habitat.  The CSRC abruptly, and without providing any clear explanation, first slowed dramatically the number of IPO approvals, then in October 2012, halted IPOs altogether. This has precipitated a crisis in China’s private equity industry. Few other PE firms are as badly impacted as Jiuding. The CSRC’s sudden block on IPOs revealed the fact that Jiuding’s system for simulating the IPO approval process had a fatal flaw. It could not predict, anticipate or hedge against the fact that IPOs in China remain not a function of market dynamics, but political and institutional policies that can change both completely and suddenly.

If Jiuding made one key mistake, it was assuming that the IPO approval system that prevailed from 2009 through mid-2012 was both replicable and likely to last well into the future. In other words, it was driving ahead at full speed while looking back over its shoulder.

Jiuding’s deals are now stranded, with no high probability way for many to achieve IPO exit before the expiry of fund life. That was another critical weakness in the Jiuding approach: it raised money in many cases by promising its RMB investors to return all capital within four to six years, about half the life cycle of a typical global PE firm like Carlyle or Blackstone.

Jiuding’s deals, like thousands of others in China PE,  are part of a backlog that could take a decade or more to clear. The numbers are stupefying: at its height the CSRC never approved more than 125 IPOs a year for PE-backed companies in China. There are already 100 companies approved and waiting to IPO, 400 more with applications submitted and in the middle of CSRC investigation, and at least another 2,000-3,000 waiting for a time when the CSRC again allows companies to freely submit applications.

Jiuding’s assets and liabilities are fundamentally mismatched. That’s as big a mistake in private equity as it is in the banking and insurance industries. Jiuding’s assets –  its shareholdings in well over a hundred domestic companies — are and will likely remain illiquid for years into the future. Meantime, the people whose capital it invests,  mainly rich Chinese businesspeople, will likely demand their money back as originally promised, sometime in the next few years. There’s a word for a situation where a company’s near-term liabilities are larger than the liquidatable value of its assets.

In the Harvard Business School case, Jiuding’s leadership is credited with perfecting a “PE factory”,  which according to the HBS document “subverted the traditional private equity business model.”  They might as well have claimed Jiuding also subverted the law of gravity. There are no real shortcuts, no assembly line procedure, for making and exiting successfully from PE investments in China.

In an earlier analysis, written as things turned out just as the CSRC’s unannounced block on IPOs was coming into effect, I suggested Jiuding would need to adjust its investment methods, and more closely follow the same process used by bigger, more famous global PE firms. In other words, they would need to get their hands dirty, and invest for a longer time horizon, based more on a company’s medium term business prospects, not its likelihood of achieving an instant IPO.

Jiuding, in short, will need to focus its investing more on adding value and less on extracting it. Can it? Will it? Or has its time, like the boom years of CSRC IPO approval and +80X p/e IPO valuations in China,  come and gone?

 

 

Smithfield Foods – Shuanghui International: The Biggest Chinese Acquisition That Isn’t

1 Comment / June 14, 2013


It is, if voluminous press reports are to be believed, the biggest story, the biggest deal, ever in China-US business history. I’m talking about the announced takeover of America’s largest pork company, Smithfield Foods, by a company called Shuanghui International. The deal, it is said in dozens of media reports, opens the China market to US pork and will transform China’s largest pork producer into a global giant selling Smithfield’s products alongside its own in China, while utilizing the American company’s more advanced methods for pork rearing and slaughtering.

One problem. A Chinese company isn’t buying Smithfield. A shell company based in Cayman Islands is. Instead of a story about “China buying up the world”, this turns out to be a story of a precarious leveraged buyout deal (“LBO”) cooked up by some large global private equity firms looking to borrow their way to a fortune.

The media, along with misstating the facts, are also missing the larger story here. The proposed Smithfield takeover is the latest iteration in the “take private” mania now seizing so many of the PE firms active in China. (See blog posts here, here, here and here.) With China’s own capital markets in crisis and PE investment there at a standstill, the PE firms have turned their attention, however illogically, to finding “undervalued assets” with a China angle on the US stock market. They then attempt an LBO, with the consent of existing management, and with the questionable premise the company will relist or be sold later in China or Hong Kong. The Smithfield deal is the biggest — and perhaps also the riskiest —  one so far.

This shell that is buying Smithfield has no legal or operational connection to Henan Shuanghui Investment & Development (from here on, “Shuanghui China”) , the Chinese pork producer, China’s largest, quoted on the Shenzhen stock exchange. The shell is about as Chinese as I am.

If the deal is completed, Shuanghui China will see no obvious benefit, only an enormous risk. Its Chinese assets are reportedly being used as collateral for the shell company to finance a very highly-leveraged acquisition. The abundant risks are being transferred to Shuanghui China while all the profits will stay inside this separately-owned offshore shell. No profits or assets of Smithfield will flow through to Shuanghui China. Do Shuanghui China’s Chinese minority shareholders know what’s going on here? Does the world’s business media?

Let’s go through this deal. I warn you. It’s a little convoluted. But, do take the time to follow what’s going on here. It’s fascinating, ingenious and maybe also a little nefarious.

First, the buyer of Smithfield is Shuanghui International, a Cayman holding company. It owns the majority of Shuanghui China, the Chinese-quoted pork company. Shuanghui International is owned by a group led by China-focused global PE firm CDH, with smaller stakes owned by Shuanghui China’s senior management,  Goldman Sachs, Singapore’s Temasek Holdings, Kerry Group, and another powerful PE firm focused on China, New Horizon Fund.

CDH, the largest single owner of Shuanghui International,  is definitively not Chinese. It invests capital from groups like Abu Dhabi’s sovereign wealth fund , CALPERS, the Rockefeller Foundation, one big Swiss (Partners Group) and one big Liechtenstein (LGT) money manager, along with the private foundation of one of guys who made billions from working at eBay. So too Goldman Sachs, of course, Temasek and New Horizon. They are large PE firms that source most of their capital from institutions, pension fund and endowments in the US, Europe, Southeast Asia and Middle East. (For partial list of CDH and New Horizon Fund Limited Partners click here. )

For the Smithfield acquisition, Shuanghui International (CDH and the others) seem to be putting up about $100mn in new equity. They will also borrow a staggering $4 billion from Bank of China’s international arm to buy out all of Smithfield’s current shareholders.  All the money is in dollars, not Renminbi.

If the deal goes through, Smithfield Foods and Shuanghui China will have a majority shareholder in common. But, nothing else. They are as related as, for example, Burger King and Neiman Marcus were when both were part-owned by buyout firm TPG. The profits and assets of one have no connection to the profits or assets of the other.

Shuanghui International, assuming it’s borrowed the money from Bank of China for three years,  will need to come up with about $1.5 billion in interest and principal payments a year if the deal closes. But, since Shuanghui International has no significant cash flow of its own (it’s an investment holding company), it’s hard to see where that money will come from. Smithfield can’t be much help. It already has a substantial amount of debt on its balance sheet. As part of the takeover plan, the Smithfield debt is being assumed by Morgan Stanley, Shuanghui International’s investment bankers. Morgan Stanley says it plans then to securitize the debt. A large chunk of Smithfield’s future free cash flow ($280mn last year) and cash ($139 mn as of the first quarter of 2013) will likely go to repay the $3 billion in Smithfield debts owed to Morgan Stanley.

A separate issue is whether, under any circumstances, more US pork will be allowed into China. The pork market is very heavily controlled and regulated. There is no likely scenario where US pork comes flooding into China. Yes, the media is right to say Chinese are getting richer and so want to eat more meat, most of all pork. But, mainly, the domestic market in China is reserved for Chinese hog-breeders. It’s an iron staple of China’s rural economy. These peasants are not going to be thrown under the bus so Smithfield’s new Cayman Islands owner can sell Shuanghui China lots of Armour bacon.

Total borrowing for this deal is around $7 billion, double Smithfield’s current market cap. Shuanghui International’s piece, the $4 billion borrowed from Bank of China, will go to current Smithfield shareholders to buy them out at a 31% premium.  Shuanghui International owns shares in Shuanghui China, and two of its board members are Shuanghui China top executives, but not much else. So where will the money come from to pay off the Bank of China loans? Good question.

Can Shuanghui International commandeer Shuanghui China’s profits to repay the debt? In theory, perhaps. But,  it’s highly unlikely such an arrangement would be approved by China’s securities regulator, the CSRC. It would not likely accept a plan where Shuanghui China’s profits would be exported to pay off debts owed by a completely independent non-Chinese company. Shuanghui International could sell its shares in Shuanghui China to pay back the debt. But, doing so would likely mean Shuanghui International loses majority control, as well as flooding the Shenzhen stock market with a lot of Shuanghui China’s thinly-traded shares.

Why, you ask, doesn’t Shuanghui China buy Smithfield? Such a deal would make more obvious commercial and financial sense. Shuanghui China’s market cap is triple Smithfield’s. Problem is, as a domestic Chinese company listed on China’s stock exchange, Shuanghui China would need to run the gauntlet of CSRC, Ministry of Commerce and SAFE approvals. That would possibly take years and run a risk of being turned down.  Shuanghui International, as a private Caymans company controlled by global PE firms,  requires no Chinese approvals to take over a US pork company.

The US media is fixated on whether the proposed deal will get the US government’s go ahead. But, as the new potential owner is not Chinese after all — neither its headquarters nor its ownership — then on what grounds could the US government object? The only thing Chinese-controlled about Shuanghui International is that the members of the Board of Directors were all likely born in China. The current deal may perhaps violate business logic but it doesn’t violate US national security.

So, how will things look if Shuanghui International’s LBO offer is successful?  Shuanghui China will still be a purely-Chinese pork producer with zero ownership in Smithfield, but with its assets perhaps pledged to secure the takeover debts of its majority shareholder. All the stuff about Shuanghui China getting access to Smithfield pork or pig-rearing and slaughtering technology, as well as a Smithfield-led upgrade of China’s pork industry,  is based on nothing solid. The pork and the technology will be owned by Shuanghui China’s non-Chinese majority shareholder. It can, if it chooses, sell pork or technology to Shuanghui China. But, Shuanghui China can achieve the same thing now. In fact, it is already a reasonably big buyer of Smithfield pork. Overall, China gets less than 1% of its pork from the US.

If the deal goes through, the conflicts of interest between Shuanghui International and Shuanghui China will be among the most fiendish I’ve ever seen. Shuanghui China’s senior managers, including chairman Wan Long, are going to own personally a piece of Smithfield, and so will have divided loyalties. They will likely continue to manage Shuanghui China and collect salaries there, while also having an ownership and perhaps a management role in Smithfield. How will they set prices between the two fully separate Shuanghuis? Who will watch all this? Isn’t this a case Shuanghui China’s insiders lining their own pockets while their employer gets nothing?

On its face, this Smithfield deal looks to be among the riskiest of all the  “take private” deals now underway. That is saying something since several of them involve Chinese companies suspected of accounting frauds, while the PE firms in at least two cases (China Transinfo and Le Gaga) doing the PE version of a Ponzi Scheme by seeking to use new LP money to bail out old, severely troubled deals they’ve done.

Let’s then look at the endgame, if the Smithfield deal goes through. Shuanghui International, as currently structured,  will not, cannot, be the long-term owner of Smithfield. The PE firms will need to exit. CDH, New Horizon, Goldman Sachs and Temasek have been an indirect shareholders of Shuanghui China for many years — seven in the case of CDH and Goldman.

According to what I’m told, Shuanghui International is planning to relist Smithfield in Hong Kong in “two to three years”. The other option on the table, for Shuanghui International to sell Smithfield (presumably at a mark-up) to Shuanghui China, would face enormous, probably insurmountable,  legal, financial and regulatory hurdles.

The IPO plan, as of now, looks crackpot. Hong Kong’s IPO market has basically been moribund for over a year. IPO valuations in Hong Kong are anyway far lower than the 20X p/e Shuanghui International is paying for Smithfield in the US. A separate tactical question for Shuanghui International and its investment bankers: why would you believe Hong Kong stock market investors in two to three years will pay more than US investors are now paying for a US company, with most of its assets, profits and revenues in the US?

But, even getting to IPO will require Shuanghui International to do something constructive about paying off the enormous $4 billion in debt it is taking on. How will that happen? Shuanghui International is saying Smithfield’s current American management will stay on. Why would one assume they can run it far more profitably in the future than they are running it now? If it all hinges on “encouraging” Shuanghui China to buy more Smithfield products, or pay big licensing fees, so Shuanghui International can earn larger profits, I do wonder how that will be perceived by both Shuanghui China’s minority investors, to say nothing of the CSRC. The CSRC has a deep institutional dislike of related party transactions.

Smithfield has lately been under pressure from some of its shareholders to improve its performance. That may have precipitated the discussions that led to the merger announcement with Shuanghui International. Smithfield’s CEO, C. Larry Pope, stands to earn somewhere between $17mn-$32mn if the deal goes through. He will stay on as CEO. His fiscal 2012 salary, including share and option awards, was $12.9mn.

Typical of such LBO deals, the equity holders (in this case, CDH, Goldman, Temasek, Kerry Group, Shuanghui China senior management, New Horizon) would stand to make a killing, if they can pay down the debt and then find a way to either sell or relist Smithfield at a mark-up. If that happens, profits will go to the Shuanghui insiders along with the partners in the PE firms, CALPERS, the Rockefeller and Carnegie foundations, Goldman Sachs shareholders and other LPs. Shuanghui China? Nothing, as far as I can tell. China’s pork business will look pretty much exactly as it does today.

In their zeal to proclaim a trend — that of Chinese buying US companies — the media seems to have been blinded to the actual mechanics of this deal. They also seem to have been hoodwinked by the artfully-written press release issued when the deal was announced. It mentions that Shuanghui International is the ” majority shareholder of Henan Shuanghui Investment & Development Co. (SZSE: 000895), which is China’s largest meat processing enterprise and China’s largest publicly traded meat products company as measured by market capitalization.” This then morphed into a story about “China’s biggest ever US takeover”, and much else besides about how China’s pork industry will now be upgraded through this deal, about dead pigs floating in the river in Shanghai, about Chinese companies’ targeting US and European brands.

China may indeed one day become a big buyer of US companies. But, that isn’t what’s happening here. Instead, the world’s leading English-language business media are suffering a collective hallucination.

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

Leave a Comment / May 28, 2013

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

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

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

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

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

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

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

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

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

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

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

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

 

 

China PE value-added: Empty promises? AVCJ

Leave a Comment / December 5, 2014

Fin

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Author: Tim Burroughs

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

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

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       –China value-add: Empty promises?

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

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

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

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

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

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

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

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

More…–

 

Blackstone Leads Latest Chinese Privatization Bid — New York Times

Leave a Comment / December 14, 2014

NYT

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Download complete text

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MAY 21, 2013, 7:07 AM

Blackstone Leads Latest Chinese Privatization Bid

By NEIL GOUGH

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

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

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

More…

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Shenzhen: A beacon for private enterprises — China Daily

Leave a Comment / June 24, 2016


 

–A beacon for private enterprises

2013-04-20

By Hu Haiyan and Chen Hong ( China Daily)

Shenzhen bears a superficial resemblance to Shanghai. There are dozens of multinationals and gleaming skyscrapers casting their shadows over narrow lanes. Their respective economic performances last year were also similar: Shenzhen’s GDP hit 1.3 trillion yuan ($210 billion), gaining by 10 percent from 2012. Shanghai GDP reached 2 trillion yuan, increasing by 7.5 percent from 2011.

Both are testing grounds for China’s economic reform policies. Still, for Peter Fuhrman, 54, Shenzhen is a private-sector city, a city that has its face pointed toward the future.

In 2009, Fuhrman moved to Shenzhen from California. The chairman and CEO of China First Capital, an international investment bank and advisory firm focused on China, he is always struck by how similar Shenzhen and California are.

“Both are places where new technologies, and valuable new technology companies, are born and nurtured. I treasure the role Shenzhen has played over these last 30 years in helping architect a new China of renewed purpose and importance in the world,” Fuhrman says. “It is impossible to imagine a US without California. It is so much the source of what makes America great. Shenzhen, too, is a major source of what makes China great, what makes this country such a joy for me to live in. “

More…

Download PDF version.

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China’s GPs search for exits — Private Equity International Magazine

Leave a Comment / May 24, 2013

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Chinese GPs are running low on exit options, but the barriers to unconventional routes – like secondary sales to other GPs – remain high.

By Michelle Phillips

China’s exit woes are no secret. With accounting scandals freezing the IPO route both abroad and domestically, the waiting list for IPO approval on China’s stock exchanges has come close to 900 companies.  Fund managers have at least 7,550 unexited investments worth a combined $100 billion, according to a recent study by China First Capital. However, including undisclosed deals, the number of companies could be as high as 10,000, says CFC’s founder and chairman Peter Fuhrman.
CITIC Capital chief executive Yichen Zhang told the Hong Kong Venture Capital Association Asia Private Equity Forum in January that because many GPs promised high returns in an unrealistic timeframe (usually three to five years), LPs were already starting to get impatient. He also predicted that around 80 percent of China’s smaller GPs would collapse in the coming years. “The worst is yet to come,” he said.
What ought to become an attractive option for these funds, according to the CFC study, are secondary buyouts. Even if it lowers the exit multiple, secondaries would provide liquidity for LPs, as well as potentially giving the companies an influx of cash, Fuhrman says.

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Secondaries offer solution for US capital locked in China — AltAssets

Leave a Comment / May 24, 2013

The future of private equity and venture capital in China is threatened by a huge overhang of illiquid investments. US institutional investors and pension funds are at risk in a market that until recently was a source of significant investment profits. Private equity secondaries offer a potential way out, according to China First Capital.

China’s private equity industry, having grown in less than a decade from nothing into a giant rivaling the private equity industry in the US, is in the early stages of a unique crisis that could undermine the remarkable gains of recent years, according to a newly-published research report by China First Capital, an international investment bank. Over $100bn in private equity and venture capital investments is now blocked inside deals with no easy exit. A significant percentage of that capital is from limited partners, family offices, university endowments in the USA.

Private equity firms in China are running out of time and options. Exit through trade sale or M&A, a common practice elsewhere, is almost nonexistent in China. One viable solution, the creation of an efficient and liquid market in private equity secondaries in China where private equity firms could sell out to one another, has yet to develop. As a result, private equity general partners, their limited partner investors and investee companies in China risk serious adverse outcomes.

Secondary deals will likely go from current low levels to gain a meaningful share of all private equity exits in China, China First Capital said.

In all, over $130bn is now invested in un-exited private equity deals in China. The un-exited private equity and venture capital deals are screened and analysed across multiple variables, including date, investment size, tier of private equity firm, industry, price-earnings ratio.

Secondary deals potentially offer some of the best risk-adjusted investment opportunities, as well as the most certain and efficient way for private equity and venture capital firms to exit investments and return money to their limited partners, the report finds. The most acute need for exit will be investments made before 2008, since private equity firms generally need to return money to their limited partners within five to seven years. But, more recent private equity and venture deals will also need to be assessed based on current market conditions.

Over the course of the last twelve months, first the US stock market, then Hong Kong’s, and finally China’s own domestic bourse all slammed the door shut on IPOs for most Chinese companies. As a result, private equity firms can’t find buyers for illiquid shares, and so can’t return money to their Limited Partners.

“Many private equity firms are adopting what looks to be an unhedged strategy across a portfolio of invested deals waiting for capital markets conditions to improve,” according to China First Capital’s chairman and founder, Peter Fuhrman. “The need for diversification is no less paramount for exits than entries,” he continues. “Many of the same private equity firms that wisely spread their LPs money across a range of industries, stages and deal sizes, have become over-reliant now on a single path to exit: an IPO in Hong Kong or China. By itself, such dependence on a single exit path is risky. In the current environment, with most IPO activity at a halt, it looks even more so. ”

Secondary activity in China will differ significantly from secondaries done in the US and Europe, he added. Buyers will cherry-pick good deals, rather than buying entire portfolios, and escape much of the due diligence risk that plagues primary private equity deals in China. Sellers, in many cases, will be able to achieve a significant rate of return in a secondary sale and so return strong profits to their limited partners. Private equity-invested companies stand to benefit as well, since a secondary transaction can be linked to a new round of financing to provide additional growth capital to the business. In short, secondary deals in China should be three-sided transactions where all sides come out ahead.

But, significant obstacles remain. The private equity and venture capital industry in China has grown large, but has not yet fully matured. The industry is fragmented, with several hundred older dollar funds, and several thousand Renminbi firms launched more recently, some fully private and some state-owned with most falling somewhere in between.

Absent a significant and sustained surge in IPO activity in 2013, the pressure on private equity firms to exit through secondaries will intensify. According to the report, no private equity firm is now raising money for a fund dedicated to buying secondaries in China. There is a market need. As a fund strategy, private equity secondaries offer Limited Partners greater diversification across asset types and maturities in China.

Private equity has been a powerful force for good in China, the report concludes. Entrepreneurs, consumers, investors have all benefited enormously. Profit opportunities for private equity firms and Limited Partner investors remain large. Exit opportunities are the weak link. A well-functioning secondary market is an urgent and fundamental requirement for the future health and success of China’s private equity industry.

Copyright © 2013 AltAssets

 

Direct Secondary Investment Opportunities in China Private Equity

Leave a Comment / February 26, 2013

 

As detailed follow-up to our report on the current challenging crisis of unexited PE investments in China, China First Capital has prepared a new research note. You can download the abridged version by clicking here.

This note provides far more detailed data and analysis on the unexited PE deals: by industry, original deal size, currency, round, and most importantly, “tier of PE”. This should give a more concrete understanding of the current opportunity in direct secondaries in China, as well as numerical challenges all GPs active in China will face exiting.

China First Capital is currently the only firm with this data and analysis. In addition to this note, we will also share in coming weeks three others research notes:

1. Secondary deals modeled on prospective IRR and hold periods
2. Risk-scoring metrics for primary and secondary deals in China
3. Portfolio analytics specific to primary and secondary investments in China

Beyond this work, shared as a service to our industry, to help facilitate the development of an efficient and liquid exit channel of direct secondaries in China, everything else will remain our confidential work product to be deployed only for clients that retain us. An introduction to our secondaries services is available by clicking here.

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China Securities News: 中国首创投资董事长：二级市场并购有望发力

Leave a Comment / February 22, 2013

 

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

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

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

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

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

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