China outbound: More haste, less speed

Only one Chinese private equity firm has ever succeeded in raising purely US- or Europe-focused funds; it is quite possible that only one has tried. CITIC Capital Partners launched its first international vehicle in 2003, looking to invest in middle-market US companies keen to expand into China. A final close of $497 million came two years later.

CITIC has since raised two further US-focused funds, and with a dedicated team and base in New York, it has completed approximately 15 deals in the country.

Until recently, CITIC was a minority player in these transactions, taking responsibility for the China piece of a US business majority-owned by a US private equity firm. That changed with the acquisition of dental products manufacturer DDS Lab in July 2014; this time CITIC was the lead investor with Florida-based Blue Sea Capital coming in as the junior partner.

There are various reasons for this shift in the balance of power. China is of increasing importance to mid-market US companies with products and technologies of interest to local buyers, and a need to penetrate higher-growth markets. With this in mind, intermediaries are seeking out Chinese PE firms and the firms themselves are becoming more comfortable with the dynamics of a US acquisition.

It is against this backdrop that one in five LPs participating in the latest installment of Coller Capital's global private equity barometer survey expect a major Chinese GP to launch a Europe or US-focused fund within the next three years (presumably excluding CITIC). This is far from a majority but remarkable nonetheless.

"What a lot of LPs would hope is that major Chinese GPs will launch developed market-focused funds," says Peter Kim, an investment principal at Coller. "This just proves how ambitious and confident Chinese GPs have become and how there is much more interaction between developed market deals with links to Asian transactions. We have seen a number of Chinese GPs acquiring US and European assets."

Talk vs. action

CITIC's control deal, however, is not a panacea. For all the talk about Chinese private equity firms doing buyouts in the West, action is limited. Plenty of deals sizzle with possibility in the early stages but then fizzle out before consummation, in part because a competitive process requires a faster turnaround than many groups can manage and sellers are wary of Chinese buyers' ability to complete deals.

Still, 2014 saw Hony Capital buy the primarily UK-focused Pizza Express chain for GBP900 million ($1.54 billion). FountainVest Partners also acquired a controlling interest in Key Safety Systems, a US-based auto components manufacturer, while Sailing Capital teamed up with Sanpower Group to buy US retailer Brookstone out of bankruptcy.

The potential synergies are as strong as ever. They work up and down the industrial spectrum - deals targeting Chinese consumer markets as well as manufacturers looking for advanced technologies - and in both directions.

Kenyatta K. Matheny, senior investment officer at the Teachers' Retirement System of the State of Illinois, told the AVCJ Forum in November that he sees global PE firms buying assets from Chinese counterparts in order to scale them overseas and China-based firms approached by overseas investors that need help building a footprint for a business in China.

Monte Brem, CEO of StepStone Group, added: "I have seen cross-border activity in both directions. It has not been an area of much success historically but the conditions are starting to line up for situations where there are going to be successful deals - finally."

A different panel at the same event also provided insight into why Chinese GPs are loath to act as hastily as the reports of their appetite for overseas deals might suggest.

Prior to the Pizza Express deal, Hony's most notable cross-border transaction was supporting Chinese construction equipment manufacturer Zoomlion in its acquisition of Italy's Compagnia Italiana Forme Acciaio (CIFA) in 2008. Zoomlion took a 60% interest for $215 million, with Hony - an investor in the Chinese firm since 2006 - Goldman Sachs and Mandarin Capital Partners acquiring the remainder.

Partnering with a Chinese strategic investor was logical and ultimately essential. Within weeks of the deal closing the global financial crisis began to bite and CIFA slipped into the red.

"If we were a pure financial investor we would have lost our shirt on that," said Bing Yuan, a managing director at Hony. "But we partnered with a Chinese strategic that was also a portfolio company so we had influence. The original plan was to integrate the two companies in three years; we did it in three months. Instead of trying to sell Zoomlion's products overseas, we sold CIFA's products in China."

In short, the stimulus package introduced by the Chinese government in 2009 - which included substantial infrastructure investment, driving demand for construction equipment - and Zoomlion's domestic distribution channels saved the investment. In 2012, the Chinese strategic bought out the PE investors for $236 million, ensuring them a return of more than 1.5x.

This is not the only case in which Hony has partnered with existing portfolio companies. It is important to balance the strategic needs of the corporate with the financial imperatives of the private equity firm, but this easy when the parties have an established working relationship.

Others follow a similar line. NDE Capital, which focuses on China and Southeast Asia, specifically targets partners that could be viable trade sale buyers. With this in mind, the firm has teamed up with food conglomerate Cargill on a deal in China but it is also now working with domestic insurers that want to pick up assets overseas.

"They would like to be able to match whatever offers we get, whether it is a trade sale or an IPO, in 5-7 years. We select partners on that basis," said John Lin, managing director at NDE. "We accept that strategics have different priorities to us. We try to manage it from the perspective of our LPs' interest and figure out how to put in place the plans for liquidity."

Pizza Express represents a different kind of private deal in that the onus is on developing an overseas business within China and Hony went into it solo, but there could still be an element of partnership.

China may be the future for Pizza Express and Hony's bullish expansion strategy - it is planning to add 77 restaurants by the end of year five and thinks it could reach 200 - allowed it to outbid rivals for the deal. However, the UK market represents the company's present. While Pizza Express has 68 outlets overseas, including 12 in Hong Kong, nine in Shanghai and one in Beijing, the remaining 450 or so are in the UK. Hony doesn't have the manpower or expertise on the ground to provide post-investment guidance.

"How do we manage that business while trying to grow the China business?" asked Yuan. "We don't have the full answer yet. We are exploring multiple answers, including partnering with UK or Europe-based sponsors and trying to hire industry veterans to sit on the board."

Minority report

Fosun Group, a Chinese conglomerate turned investment holding company that manages third-party funds as well as making strategic investments, can boast a presence in London, New York, Silicon Valley and Portugal. It is increasingly hiring personnel who are non-Chinese and can bring international experience. Nevertheless, the firm's preferred approach is to acquire minority interests in overseas targets and serve as the strategic partner for China.

"We know what our limitations are and what we are good at - and Fosun as a group is good at doing things in Asia," said James Cen Bonsor, director at Fosun Capital Group. "Many of the investments we've made, whether its Club Med, Folli Folli or Secret Recipe, we tend to take 10-30%. Management has to want to work with us and expand in China. We are not going to try and run a business in Spain or France."

Club Méditerranée (Club Med) morphed into a $1.1 billion takeover battle that pitted Fosun, Ardian, JD Capital and assorted co-investors against Italian businessman Andrea Bonomi's Investindustrial, but it started out as a minority deal. Fosun bought an initial 7.1% stake in the company in 2010.

At the time Club Med had one facility in China and Fosun helped get another two up and running. Three more are in the pipeline, while Chinese visitors to Club Med resorts globally have trebled since the investment. According to Bonsor, Club Med's management was wary about having a large Chinese shareholder but after two years it was convinced. It was in this context - and in partnership with management - that the takeover bid was launched.

Secret Recipe, a successful restaurant chain in Southeast Asia, has gone from 30 outlets in China when Fosun invested in December 2013 to 80, with another 100 likely to be added over the next two years. This acceleration is possible in part because Fosun is able to secure large-scale real estate rentals across multiple shopping centers, whereas Secret Recipe on its own would have to go outlet-by-outlet. But even this would not be possible without an engaged and incentivized management team.

"We tend to focus first on making sure interests are aligned," echoed NDE's Lin. "Most of our portfolio companies are run by local teams and we have very clear pre- and post-acquisition plans. We inform them in advance who we want to retain. The management incentive plans are put in place for the people we want to keep and they are locked up for 3-5 years."

Both Fosun and Hony now see more deals brought directly to them by companies in addition to the steady stream of assets marketed by sell-side advisors. But the traditional challenges that come with these transactions - language barriers, dealing with people, appreciating cultural sensitivities and grasping local regulatory nuances - are still present.

There was more than one Chinese bidder for Pizza Express and Hony's Yuan expects this dynamic to become increasingly common in certain kinds of offshore transactions. Not all bidders are equal, though.

"It takes more than your knowledge of the Chinese market. It takes your knowledge and expertise in doing cross-border deals, the relationships you build with sellers and management teams, and your resources in China. The market potential is always there but I don't think everyone can deliver it," Yuan said. "Most Chinese companies are not sophisticated when doing deals overseas or making deals work. You will see more failures than successes. We have learned a lot of lessons."

Core competencies

An indication of how far off Hony is from envisaging a US or European fund can be absorbed from the fact that the firm has yet to establish dedicated foreign teams. Rather, it is assembling a general international team comprising mainland Chinese who have been educated and worked overseas.

A question for all Chinese private equity firms as they consider investing in their cross-border infrastructure is whether the effort is justified. Many GPs want to do offshore deals but it remains to be seen how many of them can accommodate this strategy, and the resources it requires, alongside a domestic investment program. It is possible to be pulled in too many directions.

When discussing the contributing factors to Chinese PE firms' appetite for cross-border deals, Coller's Lim notes that Asian institutional investors are holding a lot of capital that they want to deploy outside the region. In certain markets - and it is perhaps more visible outside of China - LPs are backing local GPs for the sole purpose of having them acquire US and European assets.

The implication is that managers might be driven more by the will of the LP than an awareness of how far their capabilities and resources can stretch. This dilemma is not China's alone. Any private equity firm that develops new geographic or strategic silos, whether in developed or developing markets, must ensure that expansion doesn't come at the expense of excellence in the core area.

Guy Hands, chairman and CIO of Terra Firma, observed on another panel: "What we keep doing is we go out and one investor says I want to see this and another says I want to see that, and we try to be all things to be all people and what we end up with is a complete mismatch."

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• Topics
• Buyouts
• North America
• Greater China
• China
• USA
• buyout
• Fountainvest Partners
• CITIC Capital
• Hony Capital
• Fosun Group
• sailing capital