Innovative intermediaries: China's boutique advisors

"Evercore is no longer a boutique. We passed away from that category three, four years ago," asserted Roger Altman, former deputy US Treasury secretary and co-chairman of Evercore Partners. "There are some folks who follow this industry that still classify us in that group. And if you look at it that way, we literally did five times more M&A business this year than the second-most active [boutique] firm."

Altman made this remark in February as Evercore announced that 2011 revenues had eclipsed $500 million for the first time in the US-based corporate advisory firm's 16-year history. Business was boosted by lucrative mandates to work on the $58.9 billion restructuring of AIG's preferred stock and Kinder Morgan's $37.6 billion takeover of El Paso Corp. With other boutiques - Lazard, Blackstone, Rothschild, Greenhill, and so on - also climbing up the ladder, the whisper on Wall Street is that the bulge-bracket banks are losing their preeminence.

China, by comparison, remains in the Dark Ages. The country's boutique corporate finance houses are barely a decade old. While rising stars have caught onto the potential of smaller or more specialized deals beyond the reach of traditional investment banks, most of the rest are still flitting around the market, landing on transactions wherever they might emerge.

"Chinese corporate finance is 30 years behind the US," says Hong Chen, CEO of the Hina Group, one of the country's leading local PE and M&A corporate finance boutiques. "There are more than 100 boutiques, but we only see a limited number of quality ones."

Changing landscape

In China's short history of corporate finance, it has been common practice for top-tier investment banks to advise on sizeable offshore deals, while onshore transactions are handled by local giants such as CITIC Securities and China International Capital Corporation (CICC). The latter tend to focus on large IPOs and transactions related to state-owned enterprises.

Among the boutiques that do exist, average headcount is 5-10 people, a far cry from the hundreds of investment professionals that Evercore and Lazar have on the payroll to handle clients as large as AIG. The emphasis is firmly on guanxi, or personal networks, with CEOs and local financial sponsors. Rather than provide high-quality advisory, certain small boutiques simply charge their clients introductory fees for bringing the right guy into the meeting room.

"There are thousands of them running around trying to connect all kinds of things. PE firms don't like to admit that they are getting deals through brokers, but it's true," one pan-Asian GP tells AVCJ. "They don't like LPs to know because the response will be: ‘I don't pay you to use a broker; I could just do that myself.'"

The value of introductions has been plain in the past few years as China enjoyed a boom in pre-IPO deals.

Private equity firms keen to capture the huge short-term returns obtained by guiding a company to the public markets required nothing more from intermediaries than meeting with a few relevant CEOs. According to anecdotal evidence, some GPs even paid a premium for access to IPOs regardless of the lack of professional advisory services.

"During the pre-IPO boom, some people did not partner with corporate finance advisors that were too rigid in procedures because they wanted to complete transactions within a short timeframe," says Jim Tsao, a partner at Unitas Capital. "In some cases, local GPs didn't even bother with due diligence if they were sure they could get the companies listed."

With exit multiples on local exchanges a shadow of what they once were, private equity firms that invested in companies at relatively high valuations are being given pause for thought. China dominates the Asian IPO market and in the fourth quarter of 2010 there were 127 PE-backed listings in the region, raising a collective $44.2 billion. In the first three months of 2012, $7.5 billion was generated through just 30 offerings, a more than two-year low. Advisors whose business is heavily dependent on listings have suffered as a result.

In addition, the China Securities Regulatory Commission (CSRC) has tightened rules in a move to encourage better quality listings. Most recently, it introduced revised guidelines on new share issuance: The selling party is now required to disclose a tranche of more detailed information if it prices its IPO at a price-to-earnings (P/E) ratio 25% higher than the average for its listed peers.

"Capital markets in China have been evolving over the years," says Kevin Xie, a partner at local corporate finance boutique China Renaissance. "The CSRC's new pricing mechanism and the cooling down of IPO appetite clearly indicate that private equity players and other investors need to carefully analyze companies in order to understand if they are investable."

As the pre-IPO story fades, more GPs are now looking for secondary and M&A transactions as alternative exit routes for their portfolio companies. For some, the pressure is mounting. In 2007, a record-high of 619 private equity and venture capital transactions were completed in China. Five years on, with the funds now maturing, these investments must be exited. They are fortunate that a growing number of strategic investors - local conglomerates that want to boost market share of foreign players looking for China exposure - are on the M&A trail.

For corporate finance advisors, it is another source of deal flow. "After so many years of nurturing the market, we are seeing a lot of deals coming on the table concerning M&As," says Hina's Chen. "There have been fewer opportunities to go public and PE funds need exits after investing heavily five years ago, so a new trend is emerging."

Smaller transactions

While opportunities are expected to emerge alongside a maturing private equity and M&A market, top-tier global investment banks and local financial institutions have only advised a small portion of transactions in China, usually large IPO and cross-border transactions worth hundreds of million dollars. If a bulge-bracket bank is spending its time with the likes of KKR and the Carlyle Group and TPG Capital, smaller players tend to slip below the radar.

"There isn't a rule of thumb for transaction sizes for Morgan Stanley or other larger investment banks - we frequently work on smaller transactions when the circumstances make sense for us and our client," Stephen Seelbach, managing director and co-Head of Morgan Stanley's regional financial sponsors division, tells AVCJ. "That said, many of our larger PE clients focus on transactions where they write a minimum equity check of $100 million."

Deals of this size are the exception rather than the rule in China. According to AVCJ Research, the average PE transaction size was $72 million, up from $20-50 million between 2004 and 2010. For the year to mid-June, the figure has ballooned to $129 million, partly a result of rising valuations but largely driven by a few mega-deals. In April, for example, Temasek Holdings paid Goldman Sachs $2.3 billion for a minority stake in Industrial and Commercial Bank of China (ICBC). A month earlier, the National Council for Social Security Fund (NSSF) and China Investment Corp. (CIC) participate in a $2.5 billion private placement by China Bank of Communications.

This means there is a large portion of the market uncovered by the bulge-bracket banks, creating an opportunity for local corporate finance houses. China Renaissance has an average transaction size of $30-50 million, while The Hina Group generally advises deals in the region of $50 million.

"Similar to global investment banks, China Renaissance charges on a success fee basis but we are more flexible on the ticket size," says Kevin Xie from China Renaissance. "If we think the business of a company is interesting, we can do as little as $5 million or as big as $200-300 million."

There are other reasons, unconnected to deal size, for going with a boutique player. In certain circumstances, PE firms are wary about sharing their proprietary ideas with the major investment banks when there is no guarantee that they will work together. They might also have concerns that some deals, typically mid-range transactions that don't generate huge fees, will be delegated to junior advisors. There is much to be said for relying on relationships with trusted local players.

"For Unitas' pure China deals, around 80% of them are done through these Chinese corporate finance boutiques and individual teams," says Tsao. "In many cases, company owners don't want to be too open and transparent, and it is always local boutiques with whom they have relationships, that bring potential transactions on the table."

Another attraction of boutique providers is the fee. A global bulge-bracket bank brings with it considerable deal infrastructure, such as access to larger capital markets, equity research and global experience, and it charges for the privilege. However, Chinese firms that don't necessarily have a global perspective are more likely to respond to a package offered by a local boutique that is 60% cheaper.

When foreign private equity firms are involved, the priorities are different. Aware that LPs want to see deals executed quickly and cleanly, GPs often insist on paying a premium for quality and many local advisors don't make the grade. Several industry participants note that smaller Chinese boutiques don't have the skill sets to work on complicated transactions such as IPOs or cross-border M&A.

Add up the total revenues of all local advisory boutiques and they still representation a tiny fraction of the fees generated by major financial institutions in China.

"We would like to see more big banks providing corporate finance advisory services because all funds in China are aiming at doing bigger and more complicated deals," says one China-focused GP. "In terms of value-add, Chinese boutiques are too young to help and the big players can't do everything. That's why you see the emergence of smaller banks."

The $650 million sale of Beijing Leader & Harvest Electric Technologies by Affinity Equity Partners and Unitas to Schneider Electric was a case in point. When the two private equity players wanted to exit the company last year, they opted for a dual-track sale process which targeted an IPO in Hong Kong as well as a buyout bid. Only large investment banks were considered for the advisory mandates because no local player was deemed sophisticated to handle the transaction.

"If a transaction is easy, local firms can tackle with it because that doesn't require complicated expertise, but once the deal involves international sales process, local advisers always lag behind and hard to get the deal done," says Unitas' Tsao.

Getting specialized

The competitive advantage for local boutiques comes in leveraging their local expertise and focusing on certain kinds of deals or in specific sectors. Hina, for example, only advises on M&A transactions where it feels its on-the-ground knowledge and connections come to the fore. The company's partners have been working with Chinese entrepreneurs for a decade, developing relationships on a professional and social level. As such, when a PE firm wants to sell a company, Hina might be able to close the transaction quickly.

"We don't do IPOs and we don't want to handle complicated pricing matters with mutual funds," says Hina's Chen. "Rather, we focus on relationships and dynamics in China. When people are looking for M&A opportunities, we can quickly search 40 companies and then screen the ones they like."

China Renaissance, meanwhile, is a sector specialist. It focuses on tech, media and telecom, education, healthcare and consumer, and has developed sophisticated research processes for each one. In addition, it engages in daily dialogues with companies and financial sponsors to share thoughts on execution plans, valuation and risks.

China Renaissance's Xie adds that it is important for local advisors to support clients through both good and bad times. The company often targets start-ups and early-stage enterprises in order to develop long-term ties. This paid off with mobile networking services provider PICA. China Renaissance helped the company raise a $10 million funding in 2008, followed it for two years and then secured an advisory role when PICA was acquired by Chinasoft for approximately $100 million.

The company sometimes provides research and assistance to clients even if they aren't involved in a transaction, a service the big banks don't have the time to emulate. However, this only gets you so far, Xie cautions. "Relationships are definitely important but there is always a limit to that. Looking forward, clients will become more sophisticated and Chinese CEOs and PE funds start to understand the nature of investment banking. If it's just about relationship building, we couldn't ask the fee we are charging."

The overseas angle

Obliged to differentiate their services from the mainstream, cross-border deals represent a particular challenge for Chinese boutiques, given that they don't have an overseas presence. Partnering with international investment banks appears to be the preferred option.

In 2009, when NASDAQ-listed AsiaInfo and Chinese-based Linkage Technologies, both providers of software solutions and IT services to the domestic telecom industry, decided to merge, Bank of America Merrill Lynch (BoAML) and the Hina Group advised AsiaInfo, while Barclays worked with Linkage. "We sourced the deal and thought it's important for us to bring in a partner with global experiences," says Chen from the Hina Group. "We split the fee 50-50 with BoAML - they did most of the valuation analysis and we did the relationship and negotiation work."

China Renaissance opted for a similar strategy when advising US-based Thayer Hotel Investors V-A LP, a private equity fund sponsored by Thayer Lodging Group, on its joint acquisition of Interstate Hotels & Resorts with Shanghai-based Jin Jiang International Hotels. BoAML and UBS also had a piece of the mandate but China Renaissance's specific role was to help Thayer bridge the financial, legal and cultural gap when communicating with Jin Jiang.

"For Chinese investors securing foreign assets, there is a need to hire Morgan Stanley or Credit Suisse but then you still need to have some Chinese advisers to navigate the process," says Xie.

These partnerships are expected to proliferate. The reality that no single corporate financial advisor or group of advisors can corner the entire China market acts as a natural differentiator. As it stands, global investment banks target the larger-scale deals while their counterparts at the boutique end leverage their local knowledge and particular areas of expertise to capture the small- to mid-size space. In some cases, their skills complement one another.

How long this balance endures depends on the depth to which global players are willing or able to penetrate China and whether the boutique operators are capable of scaling up their business and becoming more sophisticated at the same time. The prospect of China emulating the US model and giving birth to Evercore clones is not beyond the realm of the possibility, but it won't happen just yet.

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• Topics
• Advisory
• Greater China
• China
• Financial Services
• Evercore Partners
• Morgan Stanley
• Unitas Capital
• professional services