China - The Deal

EYES ON WO R L D M A R K E T S
The Next Phase
China in the Driver’s Seat
A More Level Playing Field Means More Growth Ahead for M&A in China
Advising Chinese Middle-Market Companies
Prax Capital: The Future of Private Equity in China
Product Quality in China: A Simple Solution
The Great Call of China
China’s New Government—and Individual—Investors
Real Estate for a Growing China
Are Rmb-Denominated Private Equity Funds in China Here To Stay?
China’s Anti-Monopoly Law Passes Go
Private Equity and M&A Activity in China
A supplement of
Winter 2007
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application of a well-tested set of differentiated capabilities that address strategic, operational and
financial objectives. We understand that these objectives must be aligned for long-term success and
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EYES ON WORLD MARKETS
CHINA
CONTENTS
5
China in the Driver’s Seat
8
A More Level Playing Field Means More Growth Ahead for M&A in China
Now an established economic powerhouse, China breaks new financial ground—while more
firmly directing foreign investors within its borders.
Lawrence Chia, Deloitte managing partner of M&A Transaction Services, China, and
Alan Alpert, senior partner of M&A Transaction Services at Deloitte Tax LLP, weigh in
on what to expect in the year ahead.
10
Advising Chinese Middle-Market Companies
12
Prax Capital: The Future of Private Equity in China
13
Product Quality in China: A Simple Solution
14
Real Estate for a Growing China
15
The Great Call of China
16
China’s New Government—and Individual—Investors
18
Are Rmb-Denominated Private Equity Funds in China Here To Stay?
Former U.S. Senator Adlai Stevenson III and Leo Melamed, chairman emeritus of the Chicago
Mercantile Exchange, discuss their new 50-50 U.S.-China joint venture advisory firm, and their
Chinese clients’ goals.
China Managing Partner Jeff Yao says that backgrounds in industry rather than finance,
and willingness to volunteer services to Chinese entrepreneurs, are helping to win the
competition for deals.
Francis Bassolino, managing director for the China operations of Alaris Consulting, examines
the reasons for China’s manufacturing woes and questions if prices are high enough to support
the production of quality products.
China Real Estate Opportunities plans to build, renovate and manage commercial properties
across China for the long term, says Managing Director Richard David.
Donald W. Tang, vice chairman of Bear Stearns, shares his thoughts about the prospects for
financial service firms in China.
Cadwalader, Wickersham & Taft LLP’s Mark Roppel explains why China Investment Corp.
is an important development for global private equity, and why China’s individual investors
are soon to be an international force.
Philip Anderson and Bolei Zhan of INSEAD’s Rudolf and Valeria Maag International Center
for Entrepreneurship uncover the advantages and risks associated with Rmb funds, along with
some lessons that can be learned.
20
China’s Anti-Monopoly Law Passes Go
22
Private Equity and M&A Activity in China
Practical Law Company’s Sara Catley analyzes China’s first comprehensive Anti-Monopoly
Law and its implications for foreign investors.
Graphical data from Asian Venture Capital Journal shows the unstoppable growth of Chinarelated M&A and private equity transactions.
C H I NA Publisher’s Letter
Dear Readers,
This year-end issue of The Deal’s Eyes on World Markets series may be our best look at China yet, with articles
taking full stock of the dimensions of China’s emergence onto the world stage. Our lead story highlights
ways China’s economic success has lured investors and changed their risk calculations—we also profile a
groundbreaking China fund of funds firm and detail the ways that investors are facing continued government
scrutiny of their deals in China.
Next, Deloitte’s Lawrence Chia and Alan Alpert review why, exactly, 2008 is likely to be another strong year
for China M&A and private equity. In the article following, former U.S. Senator Adlai Stevenson III and Leo
Melamed, the founder of financial futures and former head of the Chicago Mercantile Exchange, then share their
insights on the new Chinese clients seeking strategic and financial assistance.
From there, profiles of Prax Capital and China Real Estate Opportunities reflect the different ways Western
and Chinese practices are merging on the ground in China. Then Alaris’s Francis Bassolino examines how due
diligence needs to change in China to ensure that products made there are safe. Meanwhile, Mark Roppel, partner
at Cadwalader, Wickersham & Taft LLP, discusses how China Investment Corp. and Chinese interest in overseas
investment through Qualified Domestic Institutional Investor schemes could change global finance significantly.
Rounding out the issue, Bolei Zhan and Philip Anderson of INSEAD profile the intriguing new prospect of
Rmb-fundraising by international firms for private equity investments in China. PLC then summarizes the key
provisions to China’s first comprehensive Anti-Monopoly Law and its implications for foreign investors.
Finally, we present data on recent M&A and private equity transactions from Asian Venture Capital Journal.
I would like to thank all our expert contributors who make this a comprehensive overview of China dealmaking.
Look out for us in 2008, when our expanded lineup of Eyes on World Markets reports uncover the new realities,
dynamics and dealmakers shaping emerging markets throughout every corner of the globe.
Sincerely,
Lisa Balter Saacks
VP Publisher, International & Custom Media
The Deal LLC
Eyes on World Markets: China is a sponsored supplement
produced by the Custom Media division of The Deal LLC.
105 Madison Avenue, New York, NY 10016
107– 111 Fleet Street, London England EC4A 2AB
www.TheDeal.com
VP Publisher, International & Custom Media: Lisa Balter Saacks
European Sales: Graeme McQueen, Managing Director
Editor & Writer: Catherine Gelb
Editor & Project Manager: Marielena Santana
Design & Production: Paul Colin, Cezanne Studio
For more information on The Deal’s custom media supplements and reports,
contact Lisa Balter Saacks at +1.212.313.9326 or email [email protected]
EYES ON WORLD MARKETS
CHINA
in the Driver’s Seat
By Catherine Gelb
A
s 2007 draws to a close,
China’s economy is still
growing at more than 11
percent according to official
figures. While economic slowdown
looms in the United States, and
uncertainty pervades markets in Europe,
investors are looking to China as a new
global economic force.
A global force it is. China’s trade surplus
with the world reached over $210 billion
in October according to China’s Ministry
of Commerce, higher than the over $177
billion surplus registered for the full
year in 2006. China’s foreign exchange
holdings reached over $1 trillion in
September, according to China’s statistics
bureau. These inflows have combined
to give China’s government, companies
and individuals cash to invest at home
and abroad. Of course, they have also
put pressure on China’s currency, the
renminbi (Rmb), and sparked calls
for China to right global financial
imbalances.
According to the International Monetary
Fund, China’s gross domestic product
growth accounts for nearly a fifth of
global growth by market weights—and
more than a third if purchasing-powerparity measures are used.
“The Chinese economy is clearly growing
strongly and should continue to do so,”
says Mark White, a director at Hong
Kong-based KGR Capital, which recently
launched a China fund of funds (see
sidebar, next page).
So, China’s growth story is here to
stay, and irresistible. What happens in
China now affects global capital flows.
Investors are taking notice.
Cross-border and domestic
transactions branch out
Data from Asian Venture Capital Journal
reveal both the scale and the size of
recent investment activity. Private equity
capital under management increased by
$5 billion just in the first half of 2007.
M&A volume has ranged between $15
and $20 billion in each of the three full
quarters of 2007. Deals are increasing in
size and domestic M&A is on the rise.
Foreign investors are looking at a
wider spectrum of industries than ever.
Observes Maurice Hoo, partner at Paul
Hastings, “Several years ago there was
an initial rush to invest in Internet and
then in media companies. Today, you see
a much wider range of deals” in sectors
related to economic growth such as
retail, energy (especially alternative) and
resources. One example that generated
excitement in the private equity industry
this year was the buyout of Shuanghui
Group, the Henan-based meat processor
represented by Paul Hastings, by
Goldman Sachs Group Inc. and CDH
Investments.
Changing risk assessments—and norms
Against this backdrop, risk assessments
among investors are changing.
One of the risks being reevaluated is
that of China’s currency. Hoo notes that
because of the persistent strength of the
Rmb, “investors perceive less currency
risk.” Though convertibility is still an
issue, analysts agree that the value of the
Rmb is not a bubble, even if the domestic
stock market might be. Thus, valuation
is now analyzed separately from that of
the currency. “Quite a few investors want
deals denominated in Rmb,” Hoo says. Of
course, it is still unclear how an investor
might get such Rmb converted to bring
out of the country. Right now, it is a caseby-case situation.
Even if the economic currency risks
have subsided, the political risks remain:
KGR Capital’s White says, “One of the
issues the KGR China fund is tracking
is the discussion between U.S. and
Chinese officials over the value of
China’s currency.” KGR sees the Chinese
as taking a more moderate stance than
the U.S. official line and believes that a
more measured pace of appreciation of
the Rmb is desirable from the Chinese
perspective (and that the rhetoric from
the U.S. side is directed at the U.S.
domestic audience).
Another set of shifting risks involves
China’s A-share market, which has
C H I NA
been simultaneously competing with,
and providing an exit platform for,
acquirers and investors in China. Public
demand for equity not only gives Chinese
companies more choices when it comes
to raising capital, it is exerting strong
upward pressure on prices.
The rise in prices has not only made
it more challenging to strike a deal, in
some cases it has invalidated a deal after
the agreement is signed. Because of
the comparatively lengthy government
approval process for foreign investment,
Hoo explains, “From the time an
agreement is signed until the various
government departments finish their
review process, the share price of the
target may have quadrupled or even
quintupled.” China’s securities regulator
recently withheld approval of another
Goldman investment, this one in Fuyao
Glass, on the grounds that Goldman’s
offer price, by the time the government
finished its review, was no longer market.
At the same time, the performance of
the stock market encourages domestic
M&A—and creates exit opportunities
for investors, an example of which
was the merger of leading electronics
company Gome with China Paradise. The
November faltering of the domestic stock
market, after rising several hundred
percent over two years, exposes another
stock-market-related risk. Analysts,
however, expect the market to remain
high in the medium term.
All this points to another way that China
is playing a global role. International
investors frequently complain that laws
and regulations in developing countries
are not meeting “international norms.”
Hoo observes, “What we’ve seen in
China is that international investors
have adjusted their risk profiles and
educated their investment committees
back home.” For example, two years
ago, private equity buyers would invest
primarily in offshore entities. Since
last year, the government has made it
difficult to restructure ownership of
Chinese companies offshore, and now
private equity investors are learning
to invest directly in Chinese entities
under Chinese law. Hoo says, “We went
to educate clients—some bit the bullet,
others held back.” Those that held back
are behind the curve a year later. “Now
they have all realized they have to learn.
An international norm is a collective
decision, and China is a participant in
shaping that decision.”
The government’s ongoing—
prominent—role
For instance, the government recently
revised the “catalogue” that categorizes
foreign investment in certain industries
as “encouraged,” “restricted,” or
“prohibited.” Other new rules by
the Chinese central government
discourage “flips” of short-term preIPO investments and encourage longer
term investments, foreign investment
in industries like alternative energy, or
in under-invested parts of the country.
The government is attempting to direct
investment in general toward highervalue-added industries.
Matias Miao of InterChina Consulting
comments in a recent research note,
“As the experiences of Japan and South
Korea suggest, this will be no easy
task. It will require significant changes
among foreign investors, Chinese
companies and the government. But
China’s transformation into a world
export power suggests that the will and
potential for such change are there.” n
Even as the government has allowed new
financial institutions and instruments to
A New Opportunity
KGR Capital’s China Fund of Funds
China’s rapid financial modernization has made it possible
for Hong Kong-based KGR Capital to launch a China fund of
funds—something that many global investors may never have
imagined possible as recently as five years ago, when KGR
Capital was founded.
In 2002, three investment banking colleagues from investment
bank Jardine Fleming—John Knox, Nick George and
Christopher Rampton—set up a firm to focus on companies
with investments in Asia. Today, KGR has $350 million under
management and offices in Hong Kong and London. “The firm’s
performance has exceeded our expectations,” says Director
Mark White, who joined the firm in 2005.
KGR was at the right place at the right time. China has been
engaged in rapid capital market liberalization over the past
several years. The number of hedge fund managers focusing
on Greater China—Hong Kong, Taiwan and the mainland—or
on Greater China-based companies listed in New York or
London, has grown tremendously.
KGR maintains strict definitions for the 10-15 China-focused
funds it selects for its portfolio. The fund is new, so it has
EYES ON WORLD MARKETS
emerge, it has tried to centralize approval
authority over foreign investments and
acquisitions. Investors and companies
can no longer rely on local government
relationships to get deals approved.
to develop a track record and prove the robustness of its
methodology, and the company is continually reevaluating the
funds in its portfolio. “Our competitive advantage is our close
monitoring of the situation,” says White. “This is vital in such a
rapidly evolving area. We must stay close.” In addition to fund
performance, the company also notes changes in personnel or
any other relevant operational issues in evaluating whether to
keep a fund in the portfolio.
Reflecting the continuing evolution of China’s financial
sector, China hedge funds currently do not follow the full
range of typical hedge fund strategies—for instance, there is
only a very limited fixed-income market in China. The result
is a preponderance of equity-related funds. The biggest
question KGR gets asked, White says, is whether these are
hedge funds or long-only funds that go up and down with the
market? He points to the fund’s encouraging backtest, which
“clearly shows a decrease in volatility,” and says that hedging
within the funds in which KGR invests is significant. At the
same time, White says, “the value of the fund’s concept will
be proven when it weathers a difficult period.” In fact, the
recent two months have been choppier—both the Hong Kong
and mainland Chinese stock exchange rose and then dropped
dramatically.
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C H I NA China
A More Level Playing
Field Means More Growth
Ahead for M&A in
By Catherine Gelb
W
hat a difference a year
makes for mergers and
acquisitions in China.
Just one year ago,
regulatory uncertainty appeared likely to
dampen foreign investors’ enthusiasm for
China, but 2007 has turned out to be a
much more active year than expected for
M&A and private equity—private equity
fundraising in particular continues at a
steady pace.
According to Mergermarket.com, in
2006, there were 799 M&A deals in
China, for a total of $94.6 billion. By
the end of October 2007, there were
528 deals, worth $63.7 billion. In 2006,
according to Asia Private Equity Review,
private equity fundraising for China
reached $4.6 billion; through the first
half of 2007, fundraising had already
reached $4.3 billion. While it’s likely
that M&A activity may be lower in
2007 than 2006 in terms both of value
and volume, important regulatory
groundwork was laid in 2007 to justify
confidence in a resumption of the longterm upward trend in 2008. Leveling the playing field
This time last year, China had also just
passed the deadline for the phase-in of
the country’s last major World Trade
Organization commitments. China’s
WTO entry was, in effect, a five-year
transition period during which China
issued rules to level the playing field
for foreign and domestic commercial
enterprises. This level playing field
means that foreign investment in
new sectors has been facilitated and
encouraged, says Deloitte’s Lawrence
Chia, managing partner of M&A
EYES ON WORLD MARKETS
Transaction Services, China. “Coupled
with that,” he says, “new laws have
been adopted in the last year which
have reduced regulatory constraints to
some extent.” China has also clarified
uncertainties about the rules for
conducting transactions using offshore
vehicles. Meanwhile, the number of
available targets is increasing in China,
Chia says; and with an economy growing
annually at 9 to 10 percent, resisting the
slowdown many had predicted, it is no
surprise that the compounded annual
growth rate for announced M&A deals
has been at 20 percent.
Chia’s colleague Alan Alpert, senior
partner of M&A Transaction Services
at Deloitte Tax LLP, observes as well
that the momentum engendered at
least in part by the government’s
regulatory moves has been significant.
“There is clearly an appetite for deals
in China,” Alpert says, pointing to the
record amount of new private equity
funding raised for China so far this year.
Additionally, the growth of the private
equity industry in China is an important
development for the country’s overall
development at macro levels and should
lead to better transparency and efficiency
in financial markets, Alpert notes.
New regulatory landscape
China’s new corporate income tax law,
which takes effect January 1, 2008, is just
one of the several recent laws that have
clarified the investment environment
for M&A. The effort to “unify and
harmonize” corporate taxes to a single 25
percent rate is another consequence of
WTO entry, Chia says.
China has had in place different tax rates
for foreign and domestic companies,
Chia explains. Foreign investors have
also been entitled to numerous tax
breaks and holidays depending on their
location in China or their industry or
activity. The WTO calls for the same
“national treatment” to be granted to
foreign and domestic firms. The new tax
law is intended to achieve this goal.
“This is a positive development,” says
Chia. “We expect that there will be more
activity—mergers of foreign and Chinese
enterprises, and Chinese enterprises
merging with Chinese enterprises.”
Furthermore, he says, “as a result of the
tax reform, the M&A tax rules should
achieve uniformity between domestic
companies and those that are foreign
owned—companies formed under
Chinese law and resident for Chinese
tax purposes—which previously was not
the case.” The State Administration of
Taxation is expected to release additional
tax guidance on mergers, acquisitions
and reorganizations in China as a result
of the corporate tax reform.
Another important development has
been the passage of the new Partnership
Law. The law sets out rules for
limitations of liability, which should
boost the private equity industry, Chia
observes. The law also encourages the
use of renminbi-denominated investment
funds and eliminates double taxation of
partners and partnerships.
At the same time, some laws have
imposed restrictions on certain types
of deals, or investments in Chinese
companies, by foreign participants in
certain industries. For example, the new
anti-monopoly law, which takes effect
August 1, 2008, gives the government the
power to prevent acquisitions of Chinese
entities that will result in dominance in a
single market.
This is standard competition policy
applicable to domestic and foreign
buyers alike—potentially more
discriminatory to foreign investors
is the provision in the law that states
that acquisitions by foreign buyers may
be subject to national security review,
although a definition and other specifics
are yet to come.
Also, in late 2006, China’s government
released a rule giving the Ministry of
Commerce power to review inbound
cross-border deals that occur in strategic
industries that affect “national economic
security” or involve the acquisition of
well-known Chinese brands. However, to
the extent that these rules are clarified
and made consistent by forthcoming
implementation guidance, they should
not be a great impediment to future
transactions.
A marketplace immune to global
fluctuations
These legal and regulatory developments
have had more of an impact on China’s
M&A marketplace than has the recent
global credit crunch. Deloitte’s Chia says
that this has a lot to do with the kinds of
deals that are done in China: many are
equity deals, in which the investors have
minority stakes (a minority investment
does not require leverage to pay off
shareholders because there is no change
of control).
Chia also comments that because of
the booming Chinese economy, and
strength of the Rmb, “there is liquidity
in the marketplace right now.” In
fact, Chia says that this liquidity “is
opening up opportunities for Chinese
investors” to search for deals outside of
the country. The Chinese government
has been encouraging the large Chinese
companies to do exactly that: acquire
businesses overseas which can enhance
their position.
Even as Chinese investors are
increasingly looking abroad, Asia is
looking like a more attractive destination
to investors in comparison to the West,
which is still experiencing the effects of
the recent financial turmoil in the credit
markets. Alpert comments, “The impact
of the U.S. and EU credit markets on the
availability to finance deals, has caused
a slowdown in private equity deals in
those markets. So global private equity
investors are going to Asia since deals in
Asia are not as leveraged or not leveraged
at all. Therefore, the impact on China of
the U.S. credit crunch may be positive. It
could generate more deals.”
What to expect in 2008
Overall, Chia believes that investors
should expect 20 percent growth in
investment activity for the next several
years. “Given the liquidity in the market,
the new funds coming in, and the
changes in regulations,” he says, “there
is no reason to expect a slowing of the
current pace.” He also expects deal
size, already on the rise, to continue to
increase.
Of course, the challenges of seeing a
transaction through in China still exist. It
is still difficult to gain access to accurate
“The impact on China of the
U.S. credit crunch may be
positive.”
data, for example, and the length of time
it takes to close a deal is still longer than
in the U.S. or other developed markets,
but the improvement in regulatory
clarity has made a difference, Alpert says.
Chia highlights other observations about
the M&A environment heading into
2008. First, he says, “On the corporate
side, foreign investors are less likely
to form joint ventures. They tend to
establish wholly foreign-owned ventures.
This is because these companies have
become more comfortable in China due
to the favorable regulatory environment.”
Alpert adds that the private equity field
is becoming more competitive, and
notes that “this may be a good sign,
because it suggests that the government
is recognizing the value of private equity
by making a more level playing field
for private equity investing.” He says
the Chinese government’s ambitions
to spur innovation within domestic
Chinese companies will probably help
keep private equity welcome in China.
If they are serious about having Chinese
companies make up 50 of the Global
Fortune 500, he says, the expertise of
private equity can be helpful to make
these companies become globally
competitive.
Finally, Chia and Alpert agree that
Chinese interest in overseas acquisitions
will continue in 2008 and beyond. Chia
identifies financial services, energy and
resources as the main focus for Chinese
outbound investment. Chia notes that as
the frequency of outbound acquisitions
increases, China will need to continue
to liberalize its own M&A regulations to
remain competitive.
With China’s WTO implementation
efforts nearly completed, there is
an impetus for Chinese companies
to be globally competitive. This is
why Chinese companies are making
investments abroad, acquiring
technology and resources, management
expertise and new products, and why
they will continue to do so for the
foreseeable future. n
Secondly, China is currently enjoying a
global account surplus, so, Chia notes,
“it has become easier to get money out
of China, and paradoxically harder to
bring it in. This has meant that foreign
investors are thinking differently about
how to structure deals.”
A third set of observations concern
private equity investments. “Private
equity investors are now asking, ‘What’s
the right way to do this deal?’ They
can choose to joint venture or form a
strategic alliance—they no longer assume
that they will go it alone,” Chia says.
C H I NA
Advising Chinese
Middle-Market
Companies
HuaMei Capital Co. (HMCC), a financial
services advisory firm based in Chicago
with three offices in China, began
operations earlier this year. It is a unique
50-50 U.S.-China joint venture. The
company’s founders, former U.S. Senator
Adlai Stevenson III and Leo Melamed,
Chairman Emeritus of the Chicago
Mercantile Exchange, discussed HMCC’s
goals in a recent conversation.
Q: What is HuaMei Capital’s approach
to China transactions?
Stevenson: HuaMei represents China’s
first investment in the U.S. financial
services sector. It straddles the culture
gap. It is half owned by China Merchant
Securities (CMS), a full-service
Chinese investment bank. CMS has
71 branches in 28 cities throughout
China and 1,700 employees, providing
HuaMei with an unequalled footprint in
China for origination and execution of
transactions.
Melamed: We personally vetted the
idea of a middle-market intermediary
with many senior government officials
in China and members of the financial
community. In all cases we received a
high degree of encouragement with the
clear understanding that the middlemarket in China is in need of the kind of
services HuaMei can provide.
based on contracts and distrust. China
produces engineers; we produce lawyers.
Leo and I are both lawyers. We have to
step out of our roles as lawyers when we
are negotiating deals in China, and then
step back in when we negotiate in the
United States.
Melamed: In China, business is based
on relationships, and these take years to
establish. Fortunately the two of us have
extensive, longstanding relationships we
have developed over many years.We have
a certain amount of built-in credibility.
When we deal with a Chinese client,
there is a trust factor that makes it easier
for them to talk to us and explain what
they are looking for.
Q: What kinds of deals are you seeing
most frequently?
Melamed: We’re seeing a whole range of
deals—from technology, to healthcare, to
10 E Y E S O N W O R L D M A R K E T S
agriculture, to toll roads, to every other
sector of business—there is no limit to
what we see in China. Recent statistics
show that the number of middle-market
M&A transactions in Asia has climbed
tenfold since 2003. There are thousands
of companies without the wherewithal to
find help, whether they need financing or
a distribution partner outside of China,
or some other strategic need. The same
is true in the United States. If a company
is below the radar screen, how do they
go about finding a Chinese counterpart?
This is where we can help.
Stevenson: Chinese companies have
come to us seeking assistance for foreign
acquisitions as well as for inbound
investment. Initially, we had more than
50 Chinese companies approach us that
were seeking strategic and financial
investment from foreign sources. We
are seeing tremendous potential for deal
origination.
Q: What do Chinese companies look
for in a target?
Melamed: In strategic deals, Chinese
companies are seeking a partner to help
with distribution for their products. They
need a partner to showcase their wares
to the world. They are looking for strong
brands—with marketing capabilities, and
of course name recognition.
Q: In what ways does HuaMei’s
identity as a joint U.S.-Chinese
company benefit its clients?
Stevenson: The Chinese system is based
on ethics and trust, while our system is
Leo Melamed
Adlai Stevenson III
Stevenson: As we call on middle-market
companies throughout China, we find they
all want to expand, but they are not sure
what to do. Part of our business is to help
them develop strategies and alternatives.
Q: What are the opportunities for
U.S. sellers and transaction partners
in terms of Chinese outbound
investment?
Stevenson: We are beginning to
experience Chinese companies seeking
to diversify outside of their borders. We
expect Chinese outbound activity to
grow rapidly.
Melamed: In terms of outbound
investment, we have seen the highprofile investments like in the Blackstone
Group—this is the kind of deal that
attracts notoriety, but there is an
enormous amount of Chinese investment
into the United States and other
countries that doesn’t get front page
attention.
Q: What are some of the factors
fueling this outbound investment
activity?
Stevenson: China’s huge foreign
exchange reserves are one reason;
another is the desire for strategic
investments. Chinese firms are
diversifying their holdings and taking
advantage of the weak dollar to make
financial and strategic investments.
Melamed: From what I have read, in
the third quarter of this year alone,
China’s outbound investment increased
186 percent—38 contracts worth $907
million. Since January 2003 in China
alone, there have been 337 M&A deals
worth $39 billion—this is but the tip of
the iceberg. It’s exactly what Adlai says:
there are many, many opportunities.
Q: What recent activities exemplify
HuaMei’s approach?
Stevenson: We’re advising one Chinese
company that seeks a foreign equity
investor. In taking on that assignment we
also took on an additional assignment to
help the company arrange financing for
the purchase of the company’s products
by its customers in China. We also found
a potential joint venture opportunity
for the same client. One client … three
potential deals.
Q: Do you anticipate any nationalist
backlash against Chinese M&A
activity in the United States?
Stevenson: The answer is no. State and
local governments are eager to attract
Chinese investment. The City of Chicago
has opened an office in Shanghai. Mayor
Richard M. Daley is a frequent visitor to
China. Our public schools are teaching
Chinese. I suspect that in time, more
members of Congress will also see China
as an opportunity and recognize that
the U.S. is now dependent upon China
to finance its deficits. Most of HuaMei’s
transactions are middle-market and not
contentious.
Melamed: For anyone who thinks about
it, business between our two nations is a
good thing for the American public and,
good for China. We both need trade and
investment to grow our economies. We
need each other. n
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C H I NA 11
Prax Capital
The Future of Private Equity in China
By Catherine Gelb
I
ndependent firm Prax Capital,
based in Shanghai with an
experienced foreign and Chinese
staff, knows what it takes to
be a successful private equity firm in
China. The firm was founded in 2003
and now has about 20 professionals
with a mixture of Western and Chinese
expertise. The founders each have more
than a decade of experience in China in
industrial enterprises. Prax has a fully
invested growth capital fund of around
$20 million from 2004, a $150 million
growth capital fund set up in 2006
that is 30 percent invested, and a 50
percent-invested real estate fund of $100
million (with a target of $150 million)
that is open to investors. In the growth
capital funds, the firm typically makes
investments of about $10 to $30 million
over 3 to 7 years in companies with
sales of $10 to $125 million. The firm
looks for management quality, proven
technologies and scalability. In real
estate, the fund looks to capitalize on the
growth of the residential markets in tierone and tier-two Chinese cities.
opportunities by offering higher prices
as a weapon. The competition can get
ugly because the business isn’t worth
that much.” The firm insists on quality
investments. Yao says this is one reason
Prax prefers to create deals by building
relationships, over several years if
necessary, rather than relying solely on
advisers or colleagues in the industry.
What makes Prax Capital different from
other private equity funds operating in
China, says China managing partner
Jeff Yao, is the founding partners’ strong
manufacturing backgrounds. “When
we look at a potential investment, it is
not purely from a financial angle. We
understand factories. … We speak their
language, and know what they need.
Trust is easier to build. When we see
the factory—we do not take the standard
half-hour tour. We spend tremendous
time investigating any problems and
seeking out areas where we can help
improve the company’s operations.”
“We demonstrate our ability
to add value.”
Such an approach is crucial in China’s
increasingly competitive private equity
environment because, says Yao, “So
many new private equity firms fight for
12 E Y E S O N W O R L D M A R K E T S
One of Prax Capital’s strategies is to offer
help without requiring a return, Yao
explains. “We demonstrate our ability
to add value. For one company, we sent
our people to France four times over two
years, because we realized they needed
a lab for their product.” The fund did
so without informing the company’s
management team. The grateful
management team subsequently agreed
to Prax’s investment offer.
Another competitive advantage is
Prax Capital’s efficiency in evaluating
a potential investment. Yao also says
the company provides flexible terms.
“Many local Chinese companies don’t
use international standards. They don’t
understand the reasons behind many of
the terms—such as requiring veto power
over certain decisions.”
Prax Capital’s first investment in
Tianneng Batteries is a good example
of how the fund operates, Yao says.
Tianneng, the leading producer of leadacid batteries for electric bicycles, was
listed on the Hong Kong Stock Exchange
earlier this year. It was an attractive
investment for the fund for several
reasons. First, Tianneng was the top
producer in an industry with potential
for significant growth in markets across
China. Also, its financial reports were
good and showed net margins in the
double digits.
Prax Capital helped the battery maker
in several important areas. First, the
firm put Tianneng in touch with
an environmental consulting firm
that helped raise the manufacturer’s
environmental compliance to
international standards. Prax also helped
improve the relationship between the
company and the village in which it
operated. Though management came
from the local village, Tianneng’s success
sparked resentment. On the firm’s advice,
Tianneng set up a fund together with the
local government to help aid the village’s
welfare and education systems.
Pax was also integrally involved in
Tianneng’s IPO, and even partnered with
Tianneng on its road show in Europe. All
of this went far beyond what would be
expected for what is now a little over a 4
percent stake. Also, says Yao, Tianneng’s
management still calls for help. This is
true of many, if not most, of the firm’s
investments.
Prax Capital’s real estate fund operates
slightly differently because of the
different nature of the industry. For
example, its investment in the Peng
Ching development in central China took
advantage of a favorable offshore legal
structure that simplified legal and tax
requirements. The firm was able to offer
financing to ensure the deal could be
completed ahead of schedule.
The Chinese government has placed a
priority on developing technologically
sophisticated, competitive Chinese
companies. Prax Capital is working
toward the same goal—and is willing to
go the extra mile to achieve its goals.
For this reason, the firm’s approach is
likely to prove profitable for some time
to come. n
Product Quality
in China
A Simple Solution
M
attel’s mea culpa and
prostration before
consumers and politicians
caused—dare I say—a
Chinese fire drill within the boardrooms
of many U.S. companies. Quality
and sourcing managers, along with
corporate counsel, were called into these
boardrooms to define and defend their
procedures to protect companies from
quality lapses, such as the use of lead
paint on children’s toys.
Unfortunately for some and fortunately
for others, the crux of the issue is rather
mundane. There is no smoking gun or
sinister villain at work, but really just
two simple problems: first, a lack of
resources for managing and monitoring
our supply of consumer and industrial
goods; and second, a focus on ever lower
prices, particularly in commoditized
markets. In short, too few people are
monitoring too many suppliers in a
now-lengthy and often complex supply
chain. For dealmakers this represents an
opportunity and a challenge.
First, the bad news. Many sellers of
commercial and industrial products
have a limited understanding of the
actual content of many of the products
that they sell. Product engineers may
have generated technical specifications
that drive the vendor selection and
production processes—but not always.
Often, buyers come to Asia with a
product that they want to copy or
modify, without a drawing or detailed
specifications of the product. Moreover,
even when buyers are armed with
detailed specifications, the overriding
need to reach certain price points drives
buyers and sellers to compromise on
quality. In many hyper-competitive
markets such as more generic consumer
goods—toys—the need to meet price
points is dire. The incentives and market
MADE IN CHINA
By Francis Bassolino
dynamics drive bad behavior, and quality
can suffer.
The good news is that overall, the
majority of goods produced in China
meet global requirements, and the
procedures and costs for monitoring
product quality are well known and
effective, if implemented and sustained.
Those companies that want and need to
ensure content and quality specifications
will need to hire (or re-hire) qualified
support teams that can document,
implement and monitor rigorous quality
control procedures. These additional
steps will increase costs but this
incremental cost to achieve the desired
level of quality is measurable. The
question is not, “Can China make quality
products?” Rather, it is, “Is the price high
enough to support the production of
quality products and do we have systems
in place to make sure that our vendors
meet commitments?”
The recent media attention on product
recalls could put a damper on demand
for many products that our children
would have played with during this
year’s holiday season. By and large,
however, the economic rationale for
manufacturing in China is so strong—and
the actual level of risk moderately
low—that next year at this time, children
and parents will be playing with quality
products from China.
To be sure, companies with higherprofile products that experienced
recent quality problems will need to
increase scrutiny and monitoring in the
short term, but the long-term impact
on sourcing in China will be negligible.
Indeed, for lower profile products
such as components that consumers
don’t see, it is business as usual, albeit
with a greater focus on management
of the supply chain. There will be little
interruption in the supply chains for
inputs over the long term, and China will
continue to be a major sourcing hub.
The press and our politicians continue to
criticize “China quality,” but consumers
continue to buy “Made in China” and
there has not been any marked decrease
in trade between China and the United
States. Deal flows—M&A activity
and foreign direct investment—have
continued apace; there has been no
reduction in traffic, number of, nor size
of transactions.
The main result of the recent events
appears to be a heightened awareness
and willingness to probe deeper into
the supply chain and define the content
of products produced in China. More
deal teams will now conduct due
diligence that documents sub-contractor
processes, defines commodity sources,
and outlines potential risks in the supply
chain. This level of detail will now be
required to satisfy investor demands.
The bottom line is this: quality is a
function of cost and management. If we
are willing to pay for quality products
and if we have adequate management
oversight, we will likely find safe, highquality products in China. If we push
too hard for impossible pricing and we
stop monitoring what the suppliers
do, we will receive low-quality goods.
Manufacturers in China can produce
quality product. The question is, are
we willing to pay a reasonable price for
reasonable quality?
Based in Shanghai, Francis Bassolino
is the managing director for the China
operations of Alaris Consulting, an
advisory firm that helps companies solve
issues related to operations and strategy.
For more information, visit
www.alarisconsulting.com. n
C H I NA 13
Real Estate for a
Growing China
I
reland-based Treasury Holdings,
one of the country’s leading
property developers, set up
China Real Estate Opportunities
Ltd. (CREO) in 2005 with the goal of
“becoming a substantial component
of China’s real estate market,” says
managing director Richard David. Only
two years later, CREO, which is listed
on the AIM market in London, has a
£500 million (over $1 billion) portfolio
of rental and development properties
located primarily on China’s booming
east coast, in Beijing, Shanghai and
smaller Qingdao in Shandong Province.
In contrast to some other foreign real
estate investors, particularly Western
companies, which focus mainly
on financial benefits of real estate
investment in China, “CREO is a genuine
real estate company,” David says. The
company is committed to operating in
China for the long term. He adds that
Treasury Holdings, CREO’s founder, has
always been a strong advocate of holding
properties for long-term value.
In China, CREO adds value by renovating
existing properties and bringing
Western-style management to both
existing properties and those that the
company develops itself. As an indicator
of CREO’s commitment to China,
Richard Barrett, one of the founders of
Treasury Holdings, relocated there when
CREO set up a permanent office in 2004.
Holding for long-term value
Media reports over the past year have
detailed the many attempts by the
Chinese government to try to slow
runaway growth and investment in real
estate. David says, “the government
is concerned about speculation, given
the recent increase in pressure on the
14 E Y E S O N W O R L D M A R K E T S
By Catherine Gelb
renminbi,” China’s currency. The focus of
this real estate speculation, particularly
by foreign investors, has been towards
high-end residential property. Domestic
Chinese investors have also accumulated
local land banks of properties that are
not developed.
have retail sales been growing at about
20 percent per year for the last few years,
but Richard David says that more than a
thousand foreign retail brands entered
the Chinese market in 2006—more than
entered China in the previous 12 years
combined.
CREO’s long-term approach to its
holdings is not what the government
is targeting with its recent restrictions,
but the government’s new rulemaking is
sometimes a case of “crushing a peanut
with a sledgehammer,” David says.
“Over the past six to 12 months, there
has been little in the way of regulation
that has been new,” he says. “But as
in any immature market, companies
confront change at every turn; situations
change because of the constant growth.
So of course policies and regulations
present challenges.” CREO has had to
adjust business strategies as government
regulations shift.
Logistics and distribution have been
opened up to foreign participation as
well. One of CREO’s Beijing property
developments is a logistics facility next to
the Beijing airport.
The company’s on-the-ground staff
of 50 in three offices, in addition to
Barrett, is indispensable in helping
the company adjust to this changing
regulatory environment. Through
hands-on building and maintaining of
local relationships, the company has
the flexibility to respond to frequent
changes, David explains.
Building for China’s growth
CREO’s goal of seeking strongly
performing properties has focused the
company on developments that support
some of the most rapidly growing parts
of China’s economy. In the last three
years, China has opened up key parts
of its economy to foreign operators
as it complies with its World Trade
Organization commitments. One of these
newly opened sectors is retail. Not only
David points to CREO’s City Centre
project in one of Shanghai’s regional
hubs as representative of the company’s
goals in China. It is an existing property
with a retail shopping center and two
office towers. The company is also
developing an adjoining site that will
add significantly to the center’s retail
space and add a third office building.
When it is completed, it will be one of
the largest shopping centers in Shanghai.
The location of City Centre is one of the
site’s key advantages. It is located in an
area with high disposable income, and in
a part of the city that is slated to become
a logistics hub for distribution of goods
and services to the north, west and south
of the city.
The site provides the company with
“an opportunity to enhance asset
growth by increasing gross floor area,
through refurbishment, and by bringing
Western-style management. These
are fundamental goals across our
portfolio,” David explains. They are
also goals that are broadly consistent
with the government’s priorities for
the development of China’s real estate
market, and should serve the company
well as it branches out to other cities
throughout China. n
The Great Call
of China
Donald W. Tang, vice chairman of Bear Stearns, shares his
thoughts on China’s economic and financial development
and the prospects for Bear Stearns and other financial
services firms in China.
Worldwide private capital deal volume has
reached over $700 billion
Roughly $350 billion is focused
in emerging markets
With over 150 private equity funds investing
in developing nations
Q: What are the prospects for China’s emerging
globally oriented companies to play important roles in
international transactions?
Tang: I think we are going to see the emergence of more Chinese
companies with the scale and sophistication to be global leaders in
their industries and an increasing number of them participating in
international transactions. Agreements such as Bear Stearns’ recent
strategic alliance with CITIC Securities are just the beginning of the
cooperation between leading Chinese and U.S. companies.
Q: What recent achievements in the development of
China’s economic and financial sectors position the
country’s companies for further
success internationally?
Tang: China’s economy and financial
sector are progressing on many fronts.
The domestic capital markets have
exceeded expectations in terms of overall
sophistication as well as the valuations
that many companies are receiving. The
regulatory and share reform that have
prompted this have opened up vast
Donald Tang
reserves of capital for use by local firms.
This will accelerate their development into internationally competitive
enterprises.
Also, China’s leadership has seriously embraced a fuller model of
economic development stressing sustainability and innovation, rather
than just pursuit of GDP growth. This is very encouraging and should
help foster successful companies bringing value to their respective
industries.
At the same time, we’re seeing a serious commitment to enforcing higher
standards for quality and corporate governance. While this is going to
be a long-term process, the experience of the past two decades really
demonstrates China’s ability to affect an enormous amount of positive
change in a very short timeframe.
Q: What opportunities do you foresee in the coming
months and years for Bear Stearns and other foreign
financial firms in China’s rapidly modernizing capital
market?
Tang: We feel that our recently announced strategic alliance with
CITIC gives us an ideal platform for working in China. Bringing together
Bear Stearns’ leading capital markets expertise with the resources and
business network of a domestic leader like CITIC, is, we feel, a positive
way to develop the new financial products and services to meet the
evolving needs of the Chinese market. After all, China’s markets have
shown again and again, across many industries, that a Western-model
usually will not work. Only the companies that can deliver top products
and services combined with a deep understanding of the Chinese
consumer will succeed.
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C H I NA 15
China’s New Government
and
Individual Investors
C
hina’s government,
corporations, and even
individuals are flush with
cash and are looking outside
of the country for opportunities. The
government recently set up a sovereign
wealth fund, China Investment
Corporation (CIC), and is encouraging
its large, state-owned companies to make
strategic acquisitions in a wider range
of industries than ever before. Chinese
domestic individual investors are also
gradually being allowed to invest in
securities markets overseas.
A new sovereign fund
Of the many developments that deserve
dealmakers’ attention, says Mark Roppel,
managing partner of the Beijing office
of Cadwalader, Wickersham & Taft LLP
and partner in the firm’s corporate M&A
department, CIC could be the most
significant.
“CIC has the potential to change the
landscape for private equity,” Roppel
says. “It could become by far the largest
leveraged buyout fund in the world.”
China announced its plans to set up a
sovereign wealth fund at the end of 2006.
The country registered $1.4 trillion in
foreign exchange reserves in September,
the result in part of its record trade
surplus, which reached $27 billion in
October. (Foreign exchange reserves
also reportedly have flowed in to take
advantage of China’s dramatic stock
market increase, which rose more than
100 percent this year, before dropping
nearly 20 percent in November.) Most
of these reserves are being held in
U.S. Treasury securities, euros and
other conservative investments. The
government is hoping that CIC will help
16 E Y E S O N W O R L D M A R K E T S
By Catherine Gelb
it diversify away from U.S. government
securities, says Roppel. The falling dollar
means China’s holdings are losing value.
Press reports indicated that wrangling
among government ministries,
particularly the Ministry of Finance and
People’s Bank of China, delayed CIC’s
formation. It was formally established in
late September as a government-owned
entity, with $200 billion. This makes it
larger than Singapore’s Temasek fund,
Roppel points out, though about onethird of its funds were reportedly spent
to acquire China Huijin Investment
Co., the government entity that helped
recapitalize China’s four large stateowned banks several years ago and now
owns shares in the banks.
Nevertheless, CIC represents a bold
move into uncharted territory for China.
In the past, Roppel explains, China’s
overseas investments were largely in the
resource sector. They were high-profile
acquisitions in mining, oil and gas made
by Chinese state-controlled companies;
most of China’s investments overseas
have been in Africa, South America and
Central Asia. “These were generally
strategic investments to secure control
over resources,” Roppel says.
China seeking returns
What makes China Investment
Corporation different from China’s
past overseas forays, Roppel observes,
is that “CIC is purely an investment
vehicle, with the goal of making
money.” Its initial investments have
also been in a new area for China’s
overseas investments—financial services
institutions.
In May, months before CIC’s formal
launch, it made a high-profile, $3
billion investment for 9.3 percent of
the Blackstone Group, just prior to
Blackstone’s IPO. Then, in August,
CIC’s now-subsidiary, Central Huijin,
helped fund the purchase by China
Development Bank of a 3 percent stake in
Barclays Bank of the U.K.
Mark Roppel
The financial services sector appears to
be newly attractive territory for China’s
strategic investors as well: CITIC
Securities recently exchanged $1 billion
investment stakes and entered into a
joint venture with Bear Stearns. And
in late October, China’s Industrial and
Commercial Bank (ICBC) bought a 20
percent stake in South Africa’s Standard
Bank for $5.6 billion. There were even
press reports that ICBC and Bank of
China had approached Temasek about
purchasing Temasek’s 17 percent stake in
the U.K.’s Standard Chartered plc.
Political implications
All of these recent investments raise an
interesting question. “The investments
are all for minority stakes. But what will
the reaction be in the United States if
CIC—or any other Chinese investor—
takes a large stake in a major bank?”
Roppel asks.
Chinese companies traditionally have
made few controlling acquisitions in the
United States because there are relatively
few resource companies for sale here, but
another reason for the absence of large
acquisitions by China in the U.S. may be
China’s awareness of possible political
opposition to large-scale investments.
An example the Chinese often cite is
the failure of China National Offshore
Oil Co. to win its bid for Unocal Corp. in
2005. “The pushback from the United
States appears to have discouraged China
from seeking control acquisitions in U.S.
companies,” Roppel says.
It is also driving Chinese leaders to
pledge openness and transparency
in CIC’s operations. Vice Minister
of Finance Li Yong even promised
in early November that CIC would
avoid investments in foreign airlines,
telecommunications or oil firms. China is
not alone in treading cautiously: Middle
Eastern sovereign funds and government
investors are making similar assertions.
Roppel says, “The Chinese are puzzled—
all of their major banks received large
pre-IPO investments by U.S. financial
institutions, and many of these U.S.
institutions saw several-hundredpercent returns.” They can’t understand
why their financial institutions should
face opposition to similar investments
in the U.S.
So far, of course, Chinese financial
investments haven’t. The problem is
the investments’ performance. Roppel
points out that Blackstone’s share
price is down significantly from its IPO
price, and the Barclays’ investment is
down as well. This has sparked severe
criticism in China of the wisdom of CIC’s
investments.
Which way will CIC go?
Given that CIC’s mandate is
apparently solely to make positive
returns on its investments, another
question arises, says Roppel: “Which
way will CIC go? Will it invest mainly
in other firms, or will it decide to
compete with private equity houses? It
will be interesting to see.”
CIC has been hosting a parade of private
equity funds and bankers who would
be eager to help CIC source its own
deals. “It is somewhat analogous to the
situation in the United States twenty
years ago, when pension funds started
more aggressively making their own
investments.” More recently in Canada,
he cites the record-setting leveraged
buyout of Bell Canada by the Ontario
Teachers Pension Plan and Providence
Equity Partners for nearly $50 billion.
In the short term, Roppel predicts, there
will be no control investments anytime
soon. In the meantime, he says, analysts
will be watching to see whether CIC
“CIC has the potential to
change the landscape for
private equity.”
sticks with financial sector investments
or branches out into industrials or other
types of investment. It may well be doing
so: in late November, CIC announced it
would take a $100 million stake in China
Railway’s IPO.
The new Chinese individual investor
Even as the government and the
country’s largest companies make ever
bigger bets abroad, Chinese investors
are starting to take advantage of the
Qualified Domestic Institutional Investor
(QDII) scheme to diversify their own
holdings. China’s national savings rate is
somewhere around 50 percent, and real
interest rates on household deposits have
been negative for some time. The result
is that money has poured into China’s
stock markets, “which can’t absorb all of
the funds,” says Roppel. Unfortunately,
the choices for retail investors in China
are limited for the most part to these two
options.
execute. One reason for this enthusiasm
may have been that the government
allowed fund originator China Southern
Fund Management to raise funds to
invest 100 percent in overseas equities,
where previous funds had been restricted
to overseas investments largely in fixed
income products. China Southern was
also allowed to accept investments in
amounts as low as Rmb1000 (about
$130).
The original allocation to China
Southern was $2 billion, but it was
massively oversubscribed, Roppel says,
to the tune of $6 billion. As a result,
the government increased the quota
allocation to $4 billion and gave the
green light to another three funds to
raise $4 billion each.
Unfortunately, the recent decline in
foreign equities markets has meant that
these QDII funds are trading below their
original investment prices. As a result,
Roppel says, interest in the funds has
cooled off—for now. “Assuming markets
pick up, there still could be a large influx
of Chinese retail investment,” he says.
In short, Chinese investors of all stripes
seem poised to make their investment
power felt in markets around the
world. All they need now is for those
markets to stabilize enough to offer
attractive returns. n
When Cadwalader attorneys worked
on the pilot QDII deal last year with
Hua’an Fund Management and Lehman
Brothers, there was less interest among
Chinese domestic investors for these
kinds of QDII funds. The domestic stock
market was booming, the renminbi,
China’s currency, was rising, and
the returns on the QDII funds were
relatively modest.
Less than a year later, Roppel says, “there
was a huge appetite for investment” in
a QDII fund that Cadwalader helped
C H I NA 17
Are Rmb-Denominated
Private Equity Funds
in China Here To Stay?
O
n August 8, 2006, a tremor
struck China—but not in
the form of an earthquake.
China’s government
announced a new regulation with
potentially far-reaching effects
on entrepreneurs and the private
equity community. On that date, the
government declared that a locally
registered company would henceforward
need approval from the Ministry of
Commerce for stock acquisitions by
special purpose vehicles (SPVs)—
offshore holding companies—and said
that such approval would expire after a
year if the company did not complete an
IPO. Companies owned by SPVs would
also require approval from the China
Securities Regulatory Commission to go
public on a foreign stock exchange.
The new rules—intended to keep China’s
most successful companies from listing
on foreign stock exchanges—are not only
forcing investors to look at exits through
listings in China, but private equity
partnerships are also evaluating whether
to raise funds denominated in Rmb.
This usually means reaching out to local
limited partners, because of currency
restrictions and unclear guidelines for
overseas LPs under new rules.
Finding Chinese LPs can be difficult,
despite the explosion in China’s wealth
and currency reserves over the past
decade. Andy Tang, managing director
of DFJ DragonFund China, explains that
“The notion of limited partnership is still
18 E Y E S O N W O R L D M A R K E T S
By Bolei Zhan and Philip Anderson
relatively new and the legal framework
for it is still not as clear as, say, in the
United States.” He says, however, it is
only a matter of time.
China veterans such as Tang point to
local governments, industry-focused
funds, and high net worth individuals
as future LPs. Some city governments
already have their own investment funds,
such as Tianjin’s Bohai fund, capitalized
at an estimated 20 billion Rmb.
Governments may have requirements
that funds invest locally; other funds,
“Having an Rmb fund gives
an investor a distinctive
competitive edge.”
like that of the Suzhou Industrial Park,
may require investments in certain
industries. Also, “a short-term mindset
makes it harder to convince people to
park their money with us,” says York
Chen, president of iD TechVentures.
Inexperienced investors may also be
wary of private equity funds, since fraud
has been a persistent problem in China.
Rmb-denominated private investment
funds are not new; the novelty is Rmb
funds raised by private equity firms
based outside China. “This is a natural
progression of a vibrant domestic
private equity market,” comments
Chris Rowland, managing partner for
3i China. “Anything that will support
the development of the market in China
is definitely good. It is certainly not a
surprise, and neither is it a threat to
3i; we welcome the emergence of Rmb
funds.”
Rmb funds offer several potential
strategic advantages. Says Michael
Zhu, vice president of Gobi Partners,
“Having an Rmb fund gives an investor
a distinctive competitive edge. The time
advantage achieved with an Rmb fund is
critical when fighting to secure the good
deals.”
Furthermore, the appreciation of the
Rmb has made it more attractive relative
to the U.S. dollar, and administration
costs are lower when every transaction
can be conducted in Chinese. The
“guanxi factor” can also make a
difference. “Some of these funds have the
city government’s money in them, which
means portfolio companies stand to
profit from local policies and tax benefits,
not to mention the other advantages that
a relationship with the city government
can bring about,” says Tang.
In addition, having an Rmb-denominated
fund can offer venture investors more
choices. “Traditional industry firms may
not achieve the same high growth rate as
technology firms, but they can guarantee
a more stable return over a longer
period of time,” argues Edward Leung,
managing partner of iD TechVentures.
“These companies have a greater need
for renminbi, compared to U.S. dollars.”
However, along with these advantages,
Rmb funds face a number of risks. “We
haven’t seen a successful venture capital
cycle from the investment stage to an
exit on the local market so far,” says iD
TechVentures’ Chen. “There are only
two boards where you can go public at
this moment, located in Shanghai and
Shenzhen,” notes his partner Leung.
“They have a long waiting line and
the waiting companies also have to go
through an approval process, though
the new board being planned will help
to increase options for exit.” Zhu notes
that the immature limited partnership
mechanism may mean that the relevant
government authorities may be unsure
of how to apply the new rules when
disputes arise. Adds DFJ Dragonfund’s
Tang, “The investment entities must be
structured carefully to avoid or reduce
double taxation.”
The important aspect is how foreign LPs
can participate in the fund,” Chen said,
explaining that the 2003 law offers hints
on how to go about raising an Rmb fund.
Whether an Rmb fund makes sense will
vary from company to company. For
example, 3i’s Rowland contends that
as both a general and limited partner
in China, “We are in a unique position.
As an existing investor in China, we
can recycle Rmb as we exit from our
investments,” he says. “In that sense, we
can build up our own Rmb capital and
not have to do any fund-raising. That lets
us avoid regulatory uncertainties.”
“Portfolio companies stand
to profit from local policies
and tax benefits.”
In addition, Rmb funds are still relatively
small for firms that specialize in growth
capital or buyouts. Says Rowland, “Since
3i makes investments that may average
$40 or $50 million, we are definitely
looking at much larger fund raising
than what’s out there so far in the
China market. We are reviewing and
monitoring developments.”
Meanwhile, iD TechVentures is raising
its first Rmb fund, which York Chen
expects to close soon. The firm’s
relatively long experience in China
makes it comfortable being a pioneer
of Rmb fundraising by a non-Chinese
general partner.
The firm began by carefully analyzing
the entire legal framework for such
funds. “Legal opinions about how a Rmb
fund can be structured may vary among
the different law firms,” Chen warns. “It
is important to review what’s do-able
and what’s not. The partnership law was
just put in place on June 1, 2007, and a lot
of things are still unclear, especially with
regard to the implementation details.
The next step for iD TechVentures was
to evaluate potential limited partners
for the fund. Chen, Leung and their
associates spoke with limited partners
who already had experience in China and
to large enterprises that are starting their
own investment arms.
Says Chen, “The overseas LP community
practice is very mature—there’s a definite
process and procedure in place—but for
the local Chinese LP, this is a learning
process. The relationship between the
LP and GP is still not as clear-cut as what
you would have in the overseas market.
Local LPs also want to participate in
GP operation, so it is not a 100 percent
handoff. Many are short-term driven,
so one must be very prepared for such
requests. You have to be ready to discuss
some unconventional practices, such as
a seat in the investment committee, only
investing in a certain area, or LPs holding
equity stakes in the GP company. I had
to learn to anticipate potential changes,
obstacles,” he said, and had to prepare to
compromise.
Determining how to recoup financial
returns raised unexpected issues. Says
Chen, “For a company with foreigninvested capital, there is a need to
understand how one does an exit once
the Rmb fund has been raised. If you
have foreign LPs, it is not a pure Rmb
fund—you still need approval when
the fund goes about investing in local
companies, though the approval only
needs to be done in the municipal or
provincial level.” He adds, “You also have
to think about how foreign LPs get their
money out.” Cross-border exchange
requires government approval and
there is a 10 percent withholding tax for
foreign LPs, he says.
approvals can take between 3 to 6
months.
For this reason, building relationships
with potential Chinese limited partners
should start long before a firm starts
raising an Rmb fund, not only to ensure
the alignment of interests, but also
to build up negotiation skills before
embarking on the government approval
process.
Andy Kung, general partner of CTC
Capital, predicts that more and more
general partners will hire “a hybrid
team that has experience in dealing with
renminbi and U.S. dollar funds.”
In the future, private equity firms may
raise separate funds targeted at China in
Rmb and in U.S. dollars, to gain flexibility
in responding to future changes and
investment choices. However, conflicts
of interest might pose problems for this
approach. “How can you justify to an
overseas LP that you are using the funds
from the Rmb fund to invest in this deal
versus its fund?” asks Kung.
Rowland of 3i points out that despite
considerable uncertainty, Rmb funds
are here to stay. In addition to the lack
of a full investment-to-exit case, “We
also don’t know yet whether there will
be other sources of exit. Instead of
going public, what about trade sales?
Would the companies welcome strategic
buyers? How vibrant would that be?”
he asks. Because of these unknowns,
he estimates, “It will be about a period
of three years before we will see a
proliferation of Rmb funds, but this is
definitely a natural progression and will
not fade away.” n
Philip Anderson is the director of
INSEAD’s Rudolf and Valeria Maag
International Center for Entrepreneurship,
where Bolei Zhan is the director for China.
The primary lesson Chen would pass on
to others investigating this path is, “Be
flexible with the time frame, and it is
better to be conservative.” The Ministry
of Commerce and other government
C H I NA 19
CHINA’S ANTI-MONOPOLY LAW PASSES GO
By Sara Catley
C
hina adopted its first
comprehensive AntiMonopoly Law (AML) on
August 30, 2007. The AML,
which has been over a decade in the
making, will come into effect from
August 1, 2008. “The adoption of the
AML is an important milestone for China
in its journey as a market in transition,”
says Michael Han of Freshfields
Bruckhaus Deringer.
The AML also marks an important
milestone for foreign investors in
China. “The two key merger control
jurisdictions for large transactions have
traditionally been regarded as the U.S.
and EU; we can now expect China will
soon join them,” says Jane Newman of
Simmons & Simmons.
Martyn Huckerby of Clifford Chance
LLP agrees: “The AML represents
a wholesale reform of the Chinese
antitrust regime and is likely to have a
more significant impact on transactions
relating to China than any other recent
Chinese law.”
Against that background, this article
summarizes the key provisions of the
AML and considers its implications for
foreign investors.
The Key Provisions
The AML covers three classic antitrust
areas:
* Monopoly agreements
* Abuse of dominance
* Merger control
“Most provisions derive from European
or German antecedents and are generally
in line with international norms,” says
Freshfields’ Han. However, it is clear
that the U.S. approach to competition
analysis has been considered in some
areas, such as vertical price agreements
and efficiencies. “In addition, some of
the provisions have arguably distinctive
‘Chinese characteristics’ and it will be
interesting to see how these manifest
themselves in the implementation and
enforcement of the law,” adds Han.
20 E Y E S O N W O R L D M A R K E T S
Perhaps most noteworthy of these
Chinese characteristics is contained
in article 1 of the AML, which sets out
its purpose: “... promoting the healthy
development of the socialist market
economy”. In addition, the AML contains
novel provisions to prevent government
bodies misusing their powers to restrict
competition.
Monopoly agreements
The provisions dealing with monopoly
agreements are broadly similar to
those under article 81 of the EC
Treaty and Section 1 of the Sherman
Act. Agreements, decisions or other
concerted conducts that eliminate or
restrict competition are prohibited
unless a relevant exemption applies.
Undertakings are prohibited from
entering into “horizontal” monopoly
agreements (that is, agreements with
their competitors) relating, among other
things, to price-fixing, limiting output
or sales volumes and allocating sales or
purchasing markets.
Undertakings are also prohibited from
entering into “vertical” monopoly
agreements (that is, agreements with
those above or below them in the
supply chain) that fix resale prices or
limit minimum resale prices. Monopoly
agreements that fix maximum resale
prices are not expressly prohibited.
However, in practice they may still
be caught as the AML Enforcement
Authority will have the power to prohibit
other horizontal and vertical monopoly
agreements.
There are exemptions for various
monopoly agreements that do not
materially restrict competition in the
relevant market and allow consumers to
share in the benefits, including:
* Researching or developing improved
technology
* Improving product quality or efficiency
* Environmental protection
In addition, monopoly agreements that
safeguard legitimate interests in foreign
trade and foreign economic cooperation
(that is, export cartels) are also exempt,
regardless of their effect on competition.
The State Council also has the power to
stipulate further exemptions.
The AML Enforcement Authority can
confiscate gains and impose substantial
fines of between 1 percent and 10
percent of turnover for breach of these
provisions. There is some scope for
leniency where undertakings come
forward to report monopoly agreements
on their own initiative and it will be
interesting to see how this develops.
Abuse of dominance
The AML prohibits undertakings from
abusing dominant market positions
that enable them to control the terms of
supply or affect the ability of competitors
to enter the market. Much like article
81 of the EC Treaty, the AML includes a
nonexhaustive list of abuses including
unfair pricing and unjustified refusals to
deal and exclusivity requirements.
Determining whether a particular
behavior constitutes abuse will require
the new Chinese antitrust authorities to
exercise judgment in determining what
constitutes “unfair” or “unjustified,” and
it will take time for a clear practice to
emerge.
What constitutes dominance depends
on a number of factors, including market
share, competition in the market and
barriers to entry. However, there are
rebuttable presumptions of dominance
where one undertaking controls half of
the market, and of collective dominance,
subject to a safe harbor for undertakings
that control less than one-tenth of the
market, where two undertakings together
control two-thirds of the market or three
undertakings together control threequarters of the market.
As with monopoly agreements, the
AML Enforcement Authority has the
power to confiscate gains from abuse of
dominance and to impose substantial
fines of between 1 percent and 10
percent of turnover for breach.
Merger control
The AML Enforcement Authority can
prohibit or impose restrictive conditions
on “concentrations” (such as mergers
and acquisitions) that have the effect of
eliminating or restricting competition.
Undertakings are required to notify
and obtain advance clearance from
the AML Enforcement Authority
for concentrations that meet certain
thresholds. These are to be specified in
implementing regulations before the
AML becomes effective.
Review by the AML Enforcement
Authority can take up to 180 days, during
which the concentration cannot be
implemented.
The AML Enforcement Authority has the
power to require undertakings to unwind
concentrations that are implemented in
breach of the AML and may also impose
fines of up to Rmb500,000 (around
$70,000) for breach.
National security review
Where the concentration involves
foreign investors (for example, where
it involves the acquisition of a domestic
undertaking by foreign investors), there
is provision for a separate national
security review. “There has been media
speculation about whether the Chinese
government will use this power to
prevent foreign takeovers of Chinese
companies on national security grounds,”
says Clifford Chance’s Huckerby.
“This seems unlikely, as there are
substantially similar provisions under
the existing regime. In addition, Chinese
government officials have said that it is
possible that such review may in practice
be confined to key industries considered
as requiring state control, such as
defense, energy, telecommunications,
coal and transport,” Huckerby adds.
There can be no guarantees however:
“There will be a lot of pressure on the
new regulators to use the AML to protect
domestic companies from competition
and limit foreign investment. That
pressure exists in the U.S. and Europe
as well, but the competition authorities
there generally resist it successfully,”
says MJ Moltenbrey of Freshfields.
“It may be harder for the Chinese
authorities to do so, because they will
have multiple policy and regulatory
roles,” she concludes.
Administrative monopolies
The AML protects certain monopoly
activities of enterprises in statecontrolled industries that involve
the national economy and national
security. However, it also contains
provisions that prevent administrative
authorities and similar bodies abusing
their administrative power in ways that
damage competition (for example, by
restricting access to local markets).
The AML does not give direct rights of
redress to undertakings in relation to
abuse, but the chief officer and other
persons directly responsible for the
breach will be subject to disciplinary
sanctions.
“It is only as the implementing
rules are issued, and the new system
comes into operation, that the
remaining areas of uncertainty will
be resolved,” concludes Simmons &
Simmons’ Newman.
Sara Catley is an analyst with Practical
Law Co., the U.K.’s pre-eminent provider
of legal know-how, transactional analysis
and market intelligence for business
lawyers. For more information, visit
www.practicallaw.com.
China’s Current Antitrust Regime
A number of anti-competitive behaviors,
including false advertising and price
manipulation, are already prohibited under
existing rules in China.
Implications for Foreign Investors
However, the existing rules are piecemeal,
and found in a number of different sources
including the Anti-Unfair Competition Law,
the Price Law and the Foreign Trade Law.
“As China is viewed as one of the most
important emerging markets, no foreign
multinational company can afford to risk
the potential adverse consequences to
their business arising from a failure to
comply with the AML,” says Moltenbrey.
In addition, a number of different bodies
have overlapping jurisdiction in relation to
monopolies. In practice, this means that
the legal sanctions for certain practices
are unclear and there can be confusion in
relation to the enforcement process.
Foreign companies with significant
market share in China will need to
review their operations in light of
the AML. Conduct that could be
characterized as contrary to the AML
should be carefully examined and clear
records of any justification for such
conduct should be kept.
It is not entirely clear what will happen to
these enforcement bodies under the new
regime.
As a practical matter, once the AML
comes into force, the new merger control
timetable will mean that undertakings
will need to involve counsel at an early
stage in proceedings to avoid delay. The
new regime may also have an effect on
deal structuring.
China’s
The AML leaves a number of important
areas, such as notification thresholds for
merger control, to secondary legislation.
In addition, there is uncertainty as to
how the regime will work in practice in a
number of areas.
For example, the AML prohibits
monopolistic conduct not just inside
but also outside China where it has
a restrictive effect on competition
in China. It is unclear how wide an
interpretation will be put on these
provisions in practice.
For an overview of the current regime, see the
chapter on China by MJ Moltenbrey and Michael
Han of Freshfields Bruckhaus Deringer in the
PLC Cross-border Competition Handbook at
www.practicallaw.com/9-206-5033.
New Antitrust
Regulators
The Anti-Monopoly Law (AML) requires the
State Council to establish two new regulatory
bodies:
* The Anti-Monopoly Commission:
responsible for organizing, coordinating
and guiding anti-monopoly work. Its duties
are to include formulating policy, organizing
investigations, formulating and promulgating
guidelines and coordinating enforcement
work.
* The AML Enforcement Authority:
responsible for enforcing the AML. It is to
have extensive information and investigation
powers, including powers of search and
seizure, together with the power to enter
into agreements with undertakings in the
course of investigation about measures to
eliminate the effects of monopolistic conduct.
In addition, it will have the power to delegate
its responsibilities if necessary to local
government authorities in China.
C H I NA
21
Private Equity and M&A Activity in China
The figures on this page show the unstoppable growth of Chinarelated M&A and private equity transactions over the past three
years. Overall capital raised grew almost five times between
2004 and year-end 2006, according to Asian Venture Capital
Journal; just in the first half of 2007, funds raised for China
increased from $14.7 billion to almost $20 billion. Overall M&A
volume grew 44 percent between 2002 and 2006, and total
volume of $55 billion in 2006 is on track to be exceeded in 2007.
Private Equity Market Overview
$7,269*
$19,880*
Capital Under Management
20000
*Only 1st half data is available
6000
New Funds Raised
* Q1-Q3
$14,680
15000
$5,233
5000
10000
4000
$8,660
$7,330
3000
5000
$2,320
2000
0
1000
2004
$884
5000
0
2004
2005
2006
Investments Made
10000
Number of Deals
Disclosed Deals
*Q1-Q2
219
174
8000
407
328
2007
*Q1-Q3
2007
$4,011
3000
$10,102
$9,435
2006
Trade Sale/M&A Exits
4000
12000
2005
$2,718*
$2,523
$8,206*
2000
322
242
6000
1000
$595
4000
0
$2,395
2000
0
40000
35000
2004
157
118
2004
2005
PE/Venturebacked IPOs
2006
2007
*Q1-Q3
$33,876*
50000
30000
2006
2007
M&A Market Overview
60000
$38,484
2005
M&A Volume
$55,443
Number of Deals
Disclosed Deals
*Q1-Q3
1,295
948
$45,083
25000
40000
$54,372*
$38,515
20000
30000
15000
$10,098
10000
20000
$6,560
5000
0
2004
2005
2006
Source: AVCJ Database, Nov 2007
2007
10000
0
2004
22 E Y E S O N W O R L D M A R K E T S
2005
2006
2007
Creating Value For Clients Since 1981
ChinaVest is a merchant bank
founded in the early 1980’s by
American investment bankers
ƒHeadquartered in Shanghai
with offices in Beijing, Hong
Kong, San Francisco, and
New York
ƒOn-the-ground team in
China; Chinese and
Western staff
ƒDeep and broad network
within Chinese business
community and government
ƒCompleted M&A deals with
domestic companies and
Fortune 500 international
corporations
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C H I NA 23
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24 E Y E S O N W O R L D M A R K E T S