Q&A: CDH Investments' Shangzhi Wu

Q: CDH's early funds saw quick exits delivered very high IRRs. Have LPs been spoilt in terms of China funds?

A: I wouldn't use the word spoilt. I think expectations definitely have to be adjusted. Before 2007, we were restructuring companies into red-chip offshore holding structures and it was quite tedious but all the work was done before the investment. As soon as the money went in you could almost immediately start processing the offshore listing. Then regulations were introduced and the creation of new red-chip structures became more difficult. In the meantime, the A-share market became the main route for IPOs and there are regulations defining how long it takes to restructure a company into a joint-stock company. If you are foreign-invested it takes even longer. There is the queue for IPOs and then the lock-up could be 1-3 years. This transition has made the pace of exits much slower, so IRRs come down.

Q: What has the exit situation been like in the last year?

A: Last September at our annual LP meeting we said we would return $1 billion in cash and we are now about halfway. We had sell-downs of Sunac and China Modern Dairy, we exited Nanjing Aotecar, and we have sold some Belle International and quite a bit of Qihoo 360. We continue to liquidate our positions so we should meet our target.

Q: Your fund sizes have increased with each vintage. Is this driven by a) rising valuations, b) having a bigger team, or c) the availability of larger deals?

A: It's all three. First, companies are larger. Look at Focus Media - we bought a 10% stake in that company for $6 million in 2004; now you probably wouldn't get 10% for $200 million. Second, we have more people. In Fund I and II, five of us were leading deals. Now we have 12-13 guys doing that. Third, our average deal size is about $100 million. If you do eight deals, that's $800 million, and over a four-year commitment period, it's $3-3.5 billion. If you combine the dollar and renminbi funds, we are comfortable with fund size.

Q: How as the team grown in terms of operations and how does this reflect the changes in the kinds of deals available?

A: We started off with six original partners 10 years ago and now we have 45. I am strong believer in productivity - I don't think having a large army within the shop is necessarily a good way of doing business. We have an operating team of seven people. The original idea to setting up an operating team was to prepare ourselves for buyout situations. In the next three years, most of the deals will be for minority positions, but there potentially will be an increasing percentage of control deals. However, if you raise a China fund just for control deals, the strategy is too risky. I think you need to blend large growth deals with control deals.

Q: Do you expect to become more sector specialized?

A: When we started off we had a high concentration of consumer brands, but the theme was really ratcheting. We were restructuring and doing offshore listings, creating liquidity in an illiquid market. Later, state-owned enterprise restructuring was encouraged, but now state assets are like a sacred cow you can't touch. Then there were times when pre-IPO deals were relatively easy because the private sector was growing fast and the exit market was friendly. And then Muddy Waters threw muddy water on the China concept, so you have take-privates. We have skill sets of all the major themes. The core of what we do is getting the best managed companies in the most attractive sectors - and the ways of getting them vary.

Q: What made you want to enter the renminbi space?

A: The main reason we got into the renminbi space was because the exit route through red-chip structures was more difficult and the CSRC encouraged us to use the A-share market. Then the National Council for Social Security Fund (NSSF) decided to get into the asset class and CDH and Hony Capital were the first two they picked up. At the beginning, the renminbi opportunity was just a small complement to what we were already doing, but with the NSSF coming in it became an important consideration. We raised RMB5 billion ($814 million) for the first fund and the NSSF was almost 40% of that. In the second fund, we raised RMB8 billion and they came in with RMB3 billion.

Q: CDH covers private equity, venture capital, real estate, listed equities and high-yield mezzanine. Was diversification always part of the plan?

A: Diversification wasn't really consciously planned - it was more LPs pushing for clarity on the asset class. For our first fund, some people put us in the VC portfolio because we did deals like Focus Media and others put us in the buyout portfolio because we did a control deal. When we were raising Fund II, people asked us about our strategy, and that led to the spin-out of the VC business. Then one of our LPs got a Qualified Foreign Institutional Investor (QFII) quota and used our office to interview fund managers. They weren't comfortable with the people they were seeing so we offered to put together a platform, with the LP anchoring us. That was the beginning of the hedge fund. Now diversification is important for long-term stability.

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