Monday, November 12, 2007

China & Its Private Equity Strategy

Inflow - Foreign PE firms sealed 129 deals in China last year, with a total investment of US$12.9 billion. In the first quarter of this year, the investment soared to US$7.56 billion, a year-on-year jump of 329%. The Chinese government has been actively trying to "control" foreign PE firms from being overly-aggressive in their buyouts. US buyout firm Carlyle Group's high-profile bid to take 85 percent of China's biggest construction equipment maker Xugong Group Construction Machinery in 2005 was a trouble spot for Beijing. Carlyle has since scaled down its original 85% bid to 45%, but the deal is still pending approval.

China issued Provisions on Acquisition of Domestic Enterprises by Foreign Investors last year in a bid to regulate foreign M&A activities in the country. In August, the Anti-Monopoly Law was enacted and will take effect next August. The new rules require any major foreign M&A deal to be examined and supervised for national economic and industrial security reasons by relevant government bodies. But the tightening regulatory environment will not deter or scale back foreign M&A activities. The interest among foreign investors is still overwhelming despite their concerns about regulatory uncertainties.

The number of M&A deals involving foreign capital decreased slightly to 296 in the first half of this year, down from 316 in the first half of 2006. The slump was mainly due to the bull stock market, which has pushed up share prices and transaction costs, and the uncertainty about regulatory approval procedures. The situation is likely to continue in the second half of this year until valuation expectations subside, and financial investors are likely to remain focused on minority positions in larger transactions until they sense a change in the regulatory landscape.

Outflow - This is more tricky for China as they have been rebuffed and chased away like a pack of wild dogs by some countries' protectionist policies on certain big deals - remember CNOOC; the failure to buy Unocal and Maytag!

Owing to nature of these big Chinese companies, they are defacto arms and legs of Beijing anyway - even when they do not have "state enterprise" printed on their front door. Hence diversifying away from USD and reinvesting the forex reserves smartly, can be done via various vehicles.

On October 25, ICBC announced a bid for 20% of South Africa's Standard Bank for US$5.6bn. This ties in very well with Beijing pronounced strategy to secure better ties with the African nations. Beijing is now more willing to accommodate minority stakes in order not to attract negative press. It is considered as a better long term strategy to accumulate strategic stakes without ruffling feathers. Another example, recently China Development Bank bought 3.1% of Barclays. Citic's recent purchase of a convertible note (convertible into a 6% stake) into Bear Stearns is another example. Bear Stearns will get 2% Citic in return.

However, sometimes you will have to get your hands dirty because you just have to get involved. BHP's audacious bid for Rio Tinto cannot be allowed to happen just like that, in the eyes of Beijing. Word has it that China Development Bank has been buying Rio Tinto shares by the bucketloads even as I write. That's because a BHP-Rio Tinto company amounts to a near monopoly in many areas of commodities supply chain. However, a bid by China development Bank for Rio Tinto looks unlikely in light of last week's comments by China's Vice Minister of Finance, Li Yong, who effectively barred CIC from taking control of "strategic" global assets. He said one-third of fund capital had been earmarked to buy banking assets that the state already owned and another third would recapitalise the Agricultural Bank of China and China Development Bank. Only about $US67bn would be left to invest in global financial markets, he said. Li said the fund would invest gradually and cautiously and it would steer clear of industries such as airlines, telecommunications and oil. Well, Rio Tinto does not fall under those categories, so still game on.

To just look at the US$200bn under the newly established China Investment Corp (CIC) would be a blinkered move as that will not fully reflect the firepower and arsenal within Beijing's grasp and overall strategy. CIC's swift purchase of a minority stake in Blackstone (one of the world's leading private equity house) is more than just an investment. it serves two main purposes. One, CIC will get shown a lot more important deals under the purview of Blackstone - hence CIC will get access to invests together on significant deals should CIC so chooses. Two, by dancing with Blackstone, CIC will not be seen as the main aggressor when acquiring stakes of important and sizable companies around the world, even in sensitive sectors CIC will be able to hide under the professional guise of Blackstone.

Word has it that CIC will take up similar minority stakes in some other big private equity firms as well for the same purposes. Apparently 3 big PE firms have been approached, including KKR, Texas Pacific and Carlyle. I would expect a deal with Carlyle to be tabled soon as that group understands the political landscape better, and would better appreciate the synergies beyond just capital involvement. Beijing just doesn't want more backlash on the movement of China's capital juggernaut.

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