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Private Equity in China: Challenges and Opportunities

Private Equity in China: Challenges and Opportunities

Kwek Ping Yong

ISBN: 978-0-470-82654-6

Jan 2012

256 pages



Learn valuable lessons from the newly successful private equity players in China and explore the challenges and opportunities offered in Chinese markets

The first book to deal with private equity finance in China, Private Equity in China: Challenges and Opportunities provides much-needed guidance on an investment concept that has so far proved elusive in Asia. Focusing on the opportunities that the Chinese finance market offers to private equity firms, the book shows how these firms can strategically position themselves in order to maximize success in this new marketplace.

Private Equity in China includes in-depth case studies illustrating both successful and failed ventures by private equity firms operating in China, outlining the challenges faced by private equity firms in setting up new funds. It contains a collection of valuable experience and insights about acquiring companies and turning them around essential for any firm currently operating in, or considering entering, the Chinese market.

  • Discusses the challenges faced by private equity firms in China including setting up the initial fund, fund raising, deal sourcing, deal execution, and monitoring and exit strategies
  • Provides key insights drawn from keen observations and knowledge of the more mature private equity market in Western countries, analyzing the way forward for the Chinese private equity industry
  • Discusses the role of renminbi-denominated funds in the development of the private equity industry in China

Breaking new ground in exploring and explaining the private equity market in China, the book offers incredible new insight into how equity companies can thrive in the Chinese marketplace.

Preface xiii

Acknowledgments xvii

CHAPTER 1 Private Equity: An Introduction 1

Overview 1

Stages of Development of a Company 2

Differences between Private Equity and Venture Capital 5

Differences between Private Equity Investments and Corporate Mergers and Acquisitions 6

Inventis Private Equity Model 8

Structure of a Private Equity Fund 11

General Partners 11

Limited Partners 12

Investment Committee/Advisors 12

Professionals 12

Private Equity Investment Process 13

Planning, Fund-Raising, and Deal Sourcing 14

Due Diligence 16

Deal Structuring 18

Portfolio Management 21

Exit Strategies 24

CHAPTER 2 Overview of the Political, Macroeconomic, and Financial Landscape in China 33

Overview 33

Regulatory Environment 35

Chinese Government Agencies and Their Relevance to Private Equity 37

China’s Macroeconomic Conditions and Trends 45

Macroeconomic Condition 1: Inflation 48

Macroeconomic Condition 2: Widening Income Disparity 49

Macroeconomic Condition 3: Accelerated Aging Population Structure 50

Macroeconomic Trend 1: Increasing Urbanization 51

Macroeconomic Trend 2: Westward Shift in Industrialization and Development 53

Macroeconomic Trend 3: Strong Growth in Domestic Consumption 54

Macroeconomic Trend 4: Shift Toward Value-Added Industries 56

China’s Financial Markets 57

Key Phases of Developments in China’s Capital Markets 58

China’s Equity Markets 62

Foreign Listings on Chinese Exchanges 65

China’s Credit Market 67

Trust Financing 72

China’s Futures Markets: Commodity Exchanges and Derivatives Exchanges 73

Summary 75

CHAPTER 3 Private Equity in China 77

Overview 77

Key Market Trends and Developments 79

Private Minority Placement Quadrant 81

Private Majority Placement Quadrant 82

PIPE Minority Deals Quadrant 83

Private Equity Funds in China 97

Foreign-Owned Private Equity Funds (FOPE) 97

Chinese-Owned Private Equity Funds (COPE) 99

State-Owned Industrial Private Equity Funds (SOPE) 100

Hybrid Foreign/Chinese USD and RMB Private Equity Fund (HOPE) 101

Private Equity Investment Structures in China 102

Red Chip Structure or Round-Trip Investment 102

Onshore Structures 108

Leveraged Buyouts 112

Valuation Adjustment Mechanism 114

VAM in China’s Private Equity Industry 114

Financial Measures 116

Non-Financial Redemption Measures and Stock Offerings 117

Stock Offering: Expiration of VAM Agreement 119

Challenges of VAM 121

Exit Strategies for Private Equity Investment in China 121

Initial Public Offerings 122

Initial Public Offerings in Domestic Markets 125

Initial Public Offerings in Overseas Markets 129

Trade Sales 130

Secondary Sales 130

Leveraged Recapitalization/Distribution of Dividend 131

Benefits of Private Equity for China 132

The Case for Demutualization of Chinese Stock Exchanges through Private Equity Investments 136

CHAPTER 4 Renminbi Private Equity Fund 137

Overview 137

Setting Up and Fund-Raising in China 138

Investing in China 142

Exit Options for the RMB Fund 143

The Renminbi Private Equity Fund 144

Types of RMB Funds 145

Domestic Limited Partners 149

Private Equity Regulations and Incentives 159

RMB Funds’ Edge in Investing in China 160

Challenges and Opportunities for FOPE-RMB Funds 161

The Future of Domestic Limited Partners 162

Qualifi ed Foreign Limited Partnership Pilot Program 163

Management of Hybrid Funds 166

Onshore Legal Structures of RMB Funds 171

Restrictions for Foreign-Invested Partnerships (FIPs) 175

Treatment of FOPE-RMB Funds: Domestic or Foreign? 176

Exit Options for RMB Funds 177

Domestic Listings on Chinese Stock Exchanges 178

Private Equity Secondary Markets in China 179

China’s Domestic Limited Partners 180

Impacts of RMB Convertibility on RMB Private Equity Funds 181

RMB Private Equity Outbound Investments 182

CHAPTER 5 Investment Opportunities for Private Equity in China 187

Overview 187

Foreign Acquisition and National Security Review 189

China’s Five-Year Plan for National Economic and Social Development 191

China’s Seven Emerging Strategic Industries 195

Energy Saving and Environmental Protection 199

Renewable Energy 205

Alternative Energy Vehicles 210

Next Generation Information Technology 213

High-End Equipment Manufacturing 215

Biotechnology 217

New Materials 221

Investment Opportunities in China’s Energy Sector 224

Key Energy Security Concerns 224

Strategies to Tackle China’s Energy Challenges 227

Trends in the Oil and Gas Sector in China 230

Relationship between the Energy Firms and the Government 233

CHAPTER 6 Challenges and the Future of Private Equity in China 235

Overview 235

Fund-Raising 236

Deal Sourcing 238

Good Deals Are Getting Scarce, Valuations Becoming Too High 239

FOPE Funds Are Competing with COPE Funds in Deal Sourcing 239

Moving West 240

Consolidation Opportunities 240

Seeking Uniqueness from Other Funding Sources 241

Due Diligence 242

Reliability of Financial Statements 243

Intellectual Property Rights 245

Deal Structuring 247

Portfolio Management 250

Change from Boss Culture to Management Culture 251

Communication and Timely Information 251

Resistance to Change 252

Fighting for Control 253

Exit 255

Valuation Obstacles 256

China’s Private Equity Secondary Sales Market Is in the Nascent Stage 257

Foreign Exchange Controls and RMB Convertibility 258

Avoiding the Restriction or Seeking Local Government’s Aid 258

Gradual Loosening of Capital Inflows, Especially for Private Equity 259

Capital Outflows Are Strict, But Less Stringent than Inflows 259

The RMB Fund Advantage—Artificial and Temporary? 260

Media Reports and Public Perception 262

Guanxi Management 264

One Party to Gain Positive Career Prospects, the Other to Gain Justice Support 265

Private Equity Firms Do Not Invest in Green Fields, So No Need to Build Complicated Relationships 266

The Company Shareholders and Management Team Already Have Guanxi for Running the Business 266

Private Equity Firms Can Engage an External Consulting or Public Relations Firm 266

FOPE-RMB Funds 268

COPE-USD Funds 269

Leveraged Buyouts 270

Private Equity Professionals in China 271

Trend 1: From Foreign to Domestic Private Equity 273

Trend 2: From Investment Banks to Private Equity 274

Trend 3: From Traditional Industries to Private Equity 275

Trend 4: From Entrepreneurs to GPs and LPs 275

Conclusion 276

APPENDIX A Government Structure of the People’s Republic of China 281

APPENDIX B Key Points in a Private Placement Memorandum 287

APPENDIX C Geography of China 289

APPENDIX D Selected Private Equity Funds in Greater China 293

About the Author 299

Index 301