Industry Q&A: Lunar Capital

Q: You've described the firm's focus as being ‘inland and inward'. Can you explain what that means?

A: Inland is Central and Western China. Inward is the domestic consumption story, so businesses that are driven by urbanization or by increasing consumer demand we see rising from this urbanization. That has led us to predominantly three sectors: agriculture, food and materials - things that we think are the building blocks of infrastructure. These are quite traditional industries, but industries that are very well-positioned for growth.

Q: Have you been actively investing over the past 18 months?

A: We made two investments in 2008, three in 2009 and one at the beginning of this year. Late 2008 through early 2010 I think was a sweet spot in terms of getting deals done because no one else was doing anything. From a liquidity/flow standpoint, most of the capital from our current fund was put to work at a very opportune time. It's something that I feel pretty good about.

Q: Deals have clearly ramped up since the beginning of the year for many, do you have thoughts on the flurry of China activity?

A: People are starting to talk a little more about second and third-tier cities... blah blah blah... but mostly when I've heard it, it's been a justification for real estate investments in cities that people haven't heard of. When I actually look at the real, bona fide private equity activity, people are really trying to go in and get dirt under their fingernails.

We're chasing investments that I would say are a bit off-the-radar. You know the old adage, ‘If it's more than 30 miles from a Grand Hyatt, some people just don't want to go there.' We try to go with the opposite - we don't want anything less than 30 miles from a Grand Hyatt.

Q: With that in mind, what types of businesses have you invested in?

A: In terms of the geographic location, in the regions like Central and Western China, [entrepreneurs] aren't as jaded. They know they need the help. If the typical investment bank comes to you with a deal, you're probably not going to do it because people aren't looking for your help. I often find that in Shanghai and Beijing and the coastal regions, people are now supremely confident of their abilities, whereas in the more central and western regions they're more humble about their abilities. We structure investments around needing and wanting and having those people [founders or entrepreneurs] involved.

From a fundamentals perspective, we've focused on businesses with characteristics which I believe are quite good for this stage of macroeconomic growth. Within food, we own a meat processing business, and we also own one of the largest juice processing businesses in China. In materials, we own one of the largest cement businesses in Western China and also a mineral processing business. Within agriculture, we own a lot of trees. If you're entering into an inflationary environment, owning a lot of trees is generally inflation-protected.

Q: Is forestry not quite a protected industry in China?

A: The forestry investment was very much driven by a liberalizing of regulations on the sector. Forest land is essentially very hard to own - it was difficult to get long commercial leases prior to a few years ago. In 2006-2007 the government began to reform that. Until a year or two ago, banks could not lend against forestry assets. So recently there's been a lot of positive regulation, which is one of the things that really attracted us to the sector.

Q: There has been quite a lot of debate over the amount of operational experience a firm needs to have to be successful in China. Where do you stand on the issue?

A: If you look at how it's structured in our firm, of the 25 people in our firm there are 10 on the investment team and 10 on the operations team. We give pretty equal weighting to the investment side and the operations side.

I believe that sweat equity is so valuable, because so few other people are willing to put the time into [operations]. When I walk into the office to good news, it's the result of sweat equity - I can honestly say it's someone on the management team who made that happen. Conversely, if there's a problem, at least I know that we know about it and we can go about solving it.

 

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• Lunar Capital Management
• Derek Sulger