AVCJ Awards 2018: Operational Value Add: Qingdao Haier

In 1985, when Ruimin Zhang took to the factory floor with a sledgehammer and smashed up faulty refrigerators as a demonstration of his zero-tolerance policy on defective products, few expected Qingdao Refrigerator Factory to expand beyond its home province, let alone overseas. 

But Zhang, the founder and CEO, proved the doubters wrong. By the early 2000s, the company had rebranded as Qingdao Haier and established itself as one of three dominant players in China’s white goods industry, competing head-to-head with Gree Electric and Midea Group. The product portfolio encompassed all major home appliances categories, but Haier was the outright market leader in refrigerators, freezers, and washing machines. 

However, over the ensuing decade, sales of white goods began to slow as government subsidies dried up. Competition among manufacturers intensified as they sought to offset stagnation by gaining market share. Cutting costs at home and accessing new growth opportunities overseas became priorities for Haier – and Zhang recognized he needed outside help to achieve these goals.

The company’s domestic operation could benefit from third-party operational expertise, while language and cultural barriers meant that entering international markets on an independent basis was unfeasible. More importantly, assuming Haier succeeded in making an acquisition, it would need assistance in integrating the Chinese and international management teams – an area in which numerous other domestic players had been found wanting. This was where KKR came into the picture. 

“It was more like a mutual effort as both we and Haier were looking for appropriate partners. KKR started to have a conversation with Haier’s management team as early as 2012, and our impression was the company always had a vision of becoming a global leader in the white goods space,” says Cathy Cai, a director at KKR. “It was not like Haier was in desperate need of more cash, rather it wanted an investor like us with teams and networks globally that could help it achieve this goal.” 

KKR duly invested $603.5 million in Haier for a 10% stake in June 2014. Four years on, the arrangement has worked out well for both parties. KKR still held a 2.64% interest as of September, having made three partial exits through block trades over the preceding 10 months. Its return on the investment was more than 2x, based on data to June 2018.

Haier, meanwhile, has seen its revenue grow from RMB88.8 billion ($12.8 billion) in 2014 to RMB159.25 billion in 2017, with EBITDA jumping from RMB7.59 billion to RMB11.5 billion over the same period. Financial and operational initiatives rolled out in collaboration with KKR have contributed to this performance. Haier is now also a recognized international player.

M&A agenda

The Chinese company was clear in its objectives from the very first meeting with KKR – an executive wrote on a blackboard that one-third of revenue should come from overseas. “At the time, the percentage of business from overseas business was still pretty small in revenue terms.  We looked at the one-third target and thought, ‘That’s a high aspiration,’” Cai recalls.

To make this happen, Haier needed to go shopping. The company wasn’t a novice in international M&A. Three years earlier, it had acquired Panasonic Corporation’s Sanyo Electric washing machine and refrigerator units in Japan and Southeast Asia for $130 million. Twelve months after that, Haier assumed control of New Zealand’s biggest white goods maker, Fisher & Paykel Appliances Holdings, in a deal worth $766 million.

While these purchases had delivered deeper penetration in the Japanese and New Zealand markets, the company had yet to establish a broad-based position in the US white goods industry, which was worth more than $43 billion in 2016. Haier and KKR decided that they needed to pursue a brand-name player with a comprehensive product portfolio in both the high and low price brackets. 

The answer was 113-year-old GE Appliances, America’s second-largest home appliances maker. It held an approximately 14% market share at the time, compared to 1.1% for Haier. KKR worked closely with the company on due diligence, negotiation, and deal financing. Eventually, in January 2016, Haier announced that it would buy GE Appliances for $5.6 billion – then the single-largest overseas acquisition by a Chinese company. The agreement included the right to use the GE brand until 2056.

“We helped foster the deal, but as it was signed, we all knew the journey had only just begun because there was an assortment of cultural conflicts that needed to be addressed,” said Cai. “For instance, at the first or second meeting, we spent a lot of time talking to Haier about the different approaches it could take to unions in the US. These organizations are quite different from unions in China.”

Senior members from KKR were heavily involved in the integration process, as were executives from KKR Capstone, the firm’s affiliated operations unit, which works alongside the deal and portfolio management teams on a consultancy basis. 

“Working with Haier and GE Appliances, we identified 300 improvement initiatives,” says Cai. “People from many different areas of KKR participated. For example, one guy sitting in the human resources department in New York helped review insurance programs for Haier employees in China.” Involvement went right to the very top. At one point, KKR co-founder Henry Kravis walked into one of the meetings between Haier and GE Appliances and helped correct the interpretation of some terms translated from Chinese to English, Cai recalls. 

Thanks to the contribution of GE Appliances, Haier beat the goal written on the blackboard. In 2017, 42% of revenue was generated by overseas markets. Meanwhile, GE Appliances achieved sales of $6.9 billion in 2017, the best in 10 years. 

Initiatives introduced by Haier proved helpful. These included the Chinese company’s signature “Ren Dan He Yi” operating model, which treats each employee and unit as a start-up and rewards them for responding quickly to meet consumers’ needs. GE Appliances is now divided into seven units – based on product groups ranging from cookers to water heaters – and each one has license to act autonomously in certain situations.

Haier’s overall share of the global white goods market, including the GE Appliances contribution, rose from 10.2% in 2014 to 10.6% in 2017. The company established a meaningful presence in markets such as the EU, East Asia and South Asia, and Australia, as well as the US.

Cost conundrums 

As for Haier’s domestic operation, this required just as much attention as overseas expansion. Around the time of the KKR investment, margins within China were being squeezed ever more tightly as Haier became  it became locked into a price war with Gree and Midea in the air conditioner vertical. Sales were sluggish due to an unhelpfully cool summer in 2014, and so the manufacturers slashed prices, hoping that a decline in the cost of key raw materials such as copper would minimize bottom line impact. In all, prices of air conditioners fell by around 20% that year.

“Haier was facing a crucial period that would determine whether it lost market share to rivals in China for good,” explains Cai. After careful assessment and discussions with Haier’s management, KKR concluded there was potential for further cost reductions on the production side. 

Notably, it advocated a fundamental change in mindset on product design. Haier engineers had until then designed goods that could last for a lifetime, regardless of the fact that a consumer’s needs would evolve. This pushed up the budget for developing new products. “For groups like Chinese millennials, who might have just purchased their first apartment, they don’t need a fancy machine that can be used forever. They want something with basic functions that offers better value for money,” says Cai. 

KKR and Haier launched a series of workshops intended to re-map the entire product line for air conditioners. By focusing on functionality and near-term affordability, the company eliminated billions of renminbi in costs over the course of 2016.

This was not the only budget-based initiative supported by the private equity firm. A wider-ranging two-year cost-cutting program introduced ideas such as an algorithmic commodity hedging platform intended to manage the impact of the rising raw materials prices. This paid off once copper prices rebounded following the trough of 2015. KKR was also instrumental in the development of standardized bidding processes that assisted Haier in its negotiations with suppliers. 

“What we did primarily was help the company identify real drivers for things,” Cai adds. “If you were an insider working for the same company for more than 20 years, it might be difficult for you to focus in on small changes that can have a substantial impact on operations. But this is what we at KKR would like to achieve.”   

Pictured: David Katz (left) of KKR with Oliver Stratton of Alvarez & Marsal

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• Topics
• Greater China
• PIPEs
• Consumer
• China
• KKR
• Growth capital