Q&A: PAG's Weijian Shan

Q: How much of a concern is the weak exits market for China-focused investors?

A: For investments that are structured to require A-share market exits, obviously you should be very concerned. The A-share market has never been a reliable market for exits, but for renminbi investors it might be the only option. Overseas investors, even on the growth side, don't necessarily have to structure deals that way. You can hold all the assets in an offshore vehicle so you aren't subject to domestic restrictions when it comes to exit.

Q: What about the availability of other exit routes?

A: There are always many options. It depends on whether or not you are knowledgeable enough to structure your deal in such a way that you can take advantage of them. Some investors probably don't focus enough on different exit options. But if you want to do a strategic sale you have to buy control of the company. Two thirds of our deals are buyouts or control transactions.

Q: Do you expect to see more buyouts in China?

A: I have no idea. For those who are focused on buyouts, opportunities have always arisen from different circumstances. In pre-IPO investment the target doesn't really care who you are; you're just a short-term investor who flips out after the IPO. In buyouts it's very different. China is a low-trust society compared to the US and in low-trust societies who you are becomes very important - your brand name, reputation, track record and operational capabilities, and what you bring to the table other than capital. Whoever owns a company, they usually care how it will fare after they have sold it. Often they may not sell 100%, just a majority stake. As such, in the US you have auctions but in China you do not because not every buyer is the same. If you have done this before then you will get a bigger share of the buyout opportunities. If you are new and inexperienced then you don't see them.

Q: How do you work with a founder who givea up control but retains a minority stake?

A: If a founder wants to sell 100% you have some concern as to whether or not there are skeletons in the closet. Typically you don't want him to get out immediately. You negotiate a deal so that he will stay for a period time until you are comfortable. We did a deal where the founder wanted to sell 100% but we bought 80% with a call option to buy the remaining 20%. With another of our companies we also bought 80% and we don't have an option to buy the rest because the seller thinks there is more upside.

Q: Isn't there a risk that the founder won't be able to behave as a passive minority shareholder?

A: In one of those cases where we bought 80%, it was somewhat difficult because the entrepreneur kept interfering, which placed a burden on the employees. They don't want to disregard his orders but on the other hand they know he is no longer the controlling shareholder. We ended up exercising our call option. In another situation we bought 80% and sales improved 30% per store in the first year. The founder was very happy and completely passive. He is building another business and would like us to work with him.

Q: Has there been a change in the nature of operational involvement?

A: I don't think there has been any change in the importance of operational capabilities because if you are a growth capital investor taking minority positions you don't necessarily need a strong operations team, but if you are a buyout firm then you've always needed a strong ops team. We are always trying to find the best people who can work with the management.

Q: So how has investment strategy changed compared to five years ago?

A: Five years ago it was hard to find opportunities requiring more than $100 million per deal. Today we don't invest less than $100 million per deal. Companies are larger in scale because today, unlike five years ago when economic development was quite uneven and largely concentrated in coastal regions, if a business model is successful you can quickly replicate it. However, it is very important to invest in businesses that are somewhat unique, not just one of the many. The problem in China is overcapacity. You may be profitable today but if you don't have any sustainable compelling advantage in terms of brand name or technology or market share or even regulatory barriers, you're profitability will not be sustainable.

Q: How far does this overcapacity stretch?

A: I would argue that China today is not one economy but two. There is the bad economy, comprising most of the heavy industrial and capital goods manufacturing sectors, where there is overcapacity. Then there is an economy where companies' ultimate customers are consumers and there is generally not so much overcapacity. However, the market can evolve quickly. Look at electronics retailing and the experiences of Gome and Suning: they face competition from online players that don't need to make a profit. If there is nothing unique, no entry barrier to protect, then any business could be subject to over-competition.

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• Topics
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• Greater China
• Buyouts
• PAG
• Weijian Shan
• buyout
• China