AVCJ Awards: PE Professionals of the Year: KKR's David Liu & Julian Wolhardt

Q: How significant has the slowdown been in driving deal flow?

DAVID LIU: We have consistently been an active, value-oriented and operationally focused investor in China. When the capital markets are at a very low point - as they were last year for Chinese companies - we see this as an opportunity. The China slowdown has implications for how people invest and manage their portfolios. For an investor like KKR this environment presents an opportunity to further differentiate ourselves. The key is identifying interesting sectors and interesting companies run by good management teams, and working hard with them to grow the businesses.

Q: Are you more likely to be active in sectors that are clearly in difficulty, such as real estate?

DL: We prefer to invest in sectors with growth potential despite economic slowdown. Nevertheless, there are also interesting opportunities in certain sectors facing headwinds. The real estate sector is certainly experiencing tough times. There is oversupply in many areas, and speculative properties are no longer delivering the price increases people used to see. It's never easy to predict the outcome for an entire industry but it is very important when investing in China to also focus on company specifics and avoid overly generalizing. We have made some good real estate investments by partnering with best-in-class local operators at attractive locations and prices. You have to be very disciplined - smart investors get ahead of the curve by identifying attractive industries with sustainable growth even in an economic downturn.

Q: So, on a broader level, what sectors do you find interesting?

DL: Our sector preference has evolved over time. Go back 15-20 years and we were investing in companies like China Mengniu Dairy, Ping An Insurance and Belle International, but our focus has progressively shifted as the Chinese economy develops and matures. When we backed Mengniu Dairy, Chinese consumers were very focused on whether there was enough milk to drink. Today as consumers get wealthier and more sophisticated, they focus on milk quality and are willing to pay a premium for premium-quality milk. This applies to chicken, pork and a number of businesses we are investing in across the healthcare, environment and food sectors. Twenty years ago consumers focused on basic living necessities; now they are focusing on quality of life, such as the type of water they drink and which cities have good air quality. Even though GDP growth has slowed down over the last two years, the sectors that have been impacted the most are traditional manufacturing, export-oriented companies and traditional retail. If you look at environment, healthcare, food safety and TMT, growth is quite robust.

Q: At $530 million and $400 million, the investments in home appliance maker Qingdao Haier and Fujian Sunner Poultry are among the largest KKR has done in China. Are check sizes in general increasing?

DL: I think it's fair to say deal sizes in general are increasing in China - that has been the case for the last 10 years. There aren't many deals in China in the multi-hundred-million-dollar range; I would say the super majority of investments are below $100 million. We always try to invest in market-leading businesses with long-term growth potential and operational upside. I do think that with the current downturn some leading companies are more open-minded about working with partners that can add real value to their growth. When the market was just going higher and higher, people could grow their businesses more easily. These companies have become bigger in size and so by definition it is harder for them to continue rapid growth. A downturn makes it even harder.

JULIAN WOLHARDT: Larger companies are also getting more sophisticated. Historically, all they thought about was capital, but now they are thinking beyond that. Their sophistication plays well into the context of us providing operational value-add. Companies are increasingly thinking about how to make the pie bigger and this helps us deploy more capital through partnerships with local companies.

Q: So how do you pitch an investment to a company like Haier?

DL: If you look at Haier, they have a lot of money on the balance sheet so they want more than just capital. They want a partner with the global resources and local expertise to help them grow. It is about being a long-term, value-added partner to them. With Haier, we appreciated why it is a good, undervalued company and also identified areas in which it can further improve and grow. This is tied to Haier's long-term growth strategy - where they want to grow, what are the M&A opportunities, how to better manage capital market activities and global expansion - and how our resources and knowledge could complement their existing capabilities. The deal took a year or more to complete but that is what we do.

Q: The Asia Dairy investment this year comes on the back of a successful partnership with China Modern Dairy. At what point did the Asia Dairy opportunity present itself?

JW: When we invest in one business we typically focus on growing that business; we typically do not back another company in the exact same sector. Asia Dairy is unique in that sense. We had been exiting our position in Modern Dairy and we found an interesting opportunity to create the most cutting-edge dairy farm in China. We approached Modern Dairy about doing it in partnership with them. It was really driven by us having been in the dairy industry for so many years and therefore knowing where to find the best managers, what kind of equipment to use, and how to help build best-in-class farms. Just as importantly, we have established a very good working relationship with Modern Dairy's management team over the years, so they were happy to partner with us again in Asian Dairy.

Q: On this basis, were the subsequent moves into pork with COFCO Meat and chicken with Fujian Sunner logical?

JW: Yes, the genesis of all this is food safety theme we have been actively pursuing in China. As consumers get more sophisticated, they demand high-quality food products for their family, from milk, to chicken, to pork, and so on. We will see growth in this area in years to come, and this is only the beginning. We started with success in dairy, and it was natural to move on to chicken and pork. Chicken is a particularly difficult business and I am not sure we would invest in any chicken company in China other than Sunner. Sunner is truly the exception because it is the only chicken producer in the country that is fully integrated. This is critical to ensuring food safety as they will need to control the entire supply chain to achieve such goal.

Q: Was it a similar process for the COFCO Meat deal?

JW: That deal was derived from our long-term partnership with Mengniu, which is backed by COFCO. We created a joint venture with Mengniu to invest in Modern Dairy in 2007 and ended up selling our shares to Mengniu. Based on what COFCO had seen us do with Mengniu and Modern Dairy, as a value-added investor COFCO gave us a shot on the pork deal. We try to work with the same teams over and over to build on our trust-based relationships because when there is trust, operational improvements are easier to implement. In most cases, as a minority shareholder if you do not have that trust, it is very difficult to persuade management to adopt changes that you think are right.

DL: The reason we are able to generate good proprietary deal flow and create a competitive advantage in food safety is because we have a team with deep industry knowledge. That is going to be more important going forward when investing in China. The days of riding the easy growth wave and relying on multiple expansions to generate returns are gone. You have to know a business incredibly well and be able to add value to the entrepreneur and management team. We go in and talk about feed costs and breeding technology rather than price-to-equity multiples. Having that kind of expertise across multiple industries is important and taking an industrialist approach to investing is critical to generating sustainable proprietary deal flow and attractive returns in China going forward.

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