Fund focus: Old heads, new firm

David Liu (pictured) was in his early 20s when he started participating in China investments. It was the mid-1990s and the country’s private equity pioneers were providing growth capital to entrepreneurs who wanted to scale up their businesses. The Morgan Stanley Private Equity Asia (MSPEA) team, of which Liu was a member, saw a string of these early bets turn into lucrative Hong Kong IPOs: China Mengniu Dairy, Ping An Insurance, and Belle International.

More than two decades on, Liu is still active and still working alongside Julian Wolhardt. They were young recruits at MSPEA – Liu hired Wolhardt in 1997 – moved to KKR in 2006 as heads of the China PE business, and together launched DCP Capital in 2017. It is a partnership that has endured even as the investment landscape has undergone substantial evolution.

“People used to invest in companies in China to ride the pre-IPO growth wave. You pick the right target, help it to grow and go public – that’s how you made money in the old days,” says Liu. “As the Chinese economy matures and a lot of sectors see growth slow down, there are not as many of those buy low, sell high pre-IPO deals. As seasoned PE investors, you need to have deeper industry knowledge, analytical discipline, and operational capabilities to drive real value creation and achieve sustainable returns throughout cycles.”

DCP is designed to take advantage of these new opportunities. A team of 23 investment professionals is led by four partners: Liu and Wolhardt, who serve as executive chairman and CEO, respectively; Wayne Wang, formerly a director and China operations office at KKR; and Hwan Yoon Chung, who previously worked alongside Liu and Wolhardt at MSPEA.

The key themes are domestic consumption upgrades and industry consolidation, with consumer, industrial technology, healthcare, food and agriculture, business services, financial services, and technology, media and telecom (TMT) all on the agenda. So is control. DCP expects to see more assets become available as the children of aging founders pass on the opportunity to lead the family business and as entrepreneurs come to terms with the tougher operating environment. With rapid growth no longer guaranteed, they need help delivering efficiencies that impact the bottom line.

Institutional backing

DCP recently closed its debut fund at $2.5 billion, comprising a US dollar-denominated tranche of just over $2 billion plus a renminbi sidecar of $500 million. LPs are said to include Abu Dhabi Investment Authority, Asia Alternatives, Bank of China, Caisse de depot et placement du Quebec (CDPQ), China Investment Corporation, GIC Private, Mousse Partners, Mubadala Investment, New York State Common Retirement Fund, Temasek Holdings, and University of California Regents.

According to AVCJ Research’s records, it is the joint largest first-time China fund raised by an independent GP, sitting alongside Hopu Investments’ debut vehicle, which also closed at $2.5 billion in 2007. DCP may also prove to be the last private equity spin-out by a senior executive or group of senior executives of that generation in China.

“It has been a smooth fundraise and that is largely due to the support of institutional LPs who worked with us over the past 26 years at KKR and Morgan Stanley Private Equity. Even though we are a first-time fund, people know how long we have been around as a team together. At the same time, we benefit from a strong combination of the skills and professional culture of a leading global PE firm and the nimbleness and savvy of a local GP,” says Liu. 

DCP looks to write equity checks of $100 million and above. So far, it has deployed about 30% of the Fund I corpus across six deals, representing a mixture of control and minority investments. They include circuit board manufacturer MFS Technology, energy industry supplier Sunpower, medical devices manufacturer Venus Medtech, financial leasing business Far East Horizon, and meat processor COFCO Meat.

The latter two deals are the result of longstanding relationships. KKR invested in Far East Horizon in 2008, took the company public in 2011, and then exited a couple of years ago with an approximately 3x return. Liu remained on the board and when an opportunity arose to invest again, DCP took it. It was a similar situation with COFCO Meat – KKR invested in 2014, an IPO happened two years later, and Wolhardt is on the board – but the connection stretches back even further.

Cows and pigs

MSPEA backed Mengniu in 2002 and Wolhardt joined the board four years later, around the time of his move to KKR. In 2008, with the dairy industry reeling from a tainted milk formula scandal, KKR invested in China Modern Dairy, which had been established by executives from Mengniu. The subsequent exit came primarily through a sale to Mengniu. KKR then worked with Modern Dairy on Asia Dairy, a greenfield farming enterprise. Modern Dairy later bought the business in its entirety.

COFCO became the largest shareholder in Mengniu in 2013 and gained some insights into KKR’s work in the dairy industry. This led to an investment in COFCO Meat, a subsidiary of COFCO that runs hog farms and meat processing plants. KKR was the biggest contributor among the four private equity firms involved.

“In addition to looking at deals that are available on the market, we very much focus on generating proprietary deal flow by working with management teams and companies that we've worked with in the past,” says Liu. While Far East Horizon and COFCO Meat are both listed, DCP leveraged its relationships and understanding of the businesses to secure privately negotiated investments. Joint operational initiatives and extensive post-investment involvement are part of the cooperation.

At the same time, entering through the public markets in 2018 when valuations were depressed has delivered short-term gains. Far East Horizon and COFCO Meat have gained approximately 14% and 183%, respectively, over the last 12 months. Numerous Chinese GPs kept their powder dry in 2018 due to concerns about valuations and the market outlook. DCP claims to prioritize studying industry trends and company fundamentals over short-term macro considerations. It didn’t hold back.

“The best deals are always done when the macro picture is uncertain, public markets are depressed, and people don’t see the light at the end of the tunnel,” says Liu. “This also means we don’t chase hot deals. We might miss out on some deals, but we always want to be disciplined and value-oriented. This is key to delivering long term, sustainable returns throughout cycles.”

• Tweet  
• Facebook  
• LinkedIn  
• Google plus  
• Save this article  
• Send to  

• Topics
• Greater China
• Fundraising
• Buyout
• Growth
• GPs
• LPs
• China
• DCP Capital Partners
• KKR