Private Equity in China Comes of Age

It's still early days, but the private equity mania sweeping the world's major economies is starting to gain traction in China

by Frederik Balfour and Xiang Ji

The private equity mega-wave that is transforming global finance and business continues apace. Firms such as the Blackstone Group (BX), Carlyle, Goldman Sachs (GS), Kohlberg Kravis Roberts, the Texas Pacific Group, and others spent $737.4 billion in 2006 globally purchasing companies privately or buying stakes in outfits with plans to go public—more than double the level the year before, according to market researcher Dealogic. And there was $630 billion worth of deals done in the first half of 2007.

Yet until recently the dealmaking frenzy has pretty much passed China by. The Chinese government, wary of foreign dealmakers, last September clamped down on allowing Chinese companies to transfer their assets to offshore holding companies, a move regarded as a major blow for foreign private equity firms interested in eventually listing mainland companies overseas and recouping their investment.

The outlook for private equity deals in China, however, is starting to brighten, thanks to the white-hot performance of China's domestic stock exchanges and continuing, robust, economic growth. Share prices at the bourses in Shanghai and Shenzhen are up 58% and 117%, respectively, in 2007, though both markets are highly volatile. And that is generating insatiable appetite for new listings and providing an exit strategy for private equity outfits with a stomach for risk. "I think there is a lot of opportunity for private equity in China," says Chauncey Shey, chief executive officer of Softbank China Venture Capital.

Tied to Local Authorities

To be sure, the volume of deals is still very low and so far this year is up only to 24, from 22 for the same period last year, according to Thomson Financial. The value of private equity transactions from Jan. 1 to July 17 actually dropped 84%, to $678 million, compared with $4.2 billion for the same period last year. However these figures are distorted by the $3.8 billion pre-initial public offering investment in Industrial & Commercial Bank of China (ICBAF.PK) by a consortium including Goldman Sachs, Allianz (ALIZF.PK), and American Express (AXP).

Until now, domestic Chinese private equity firms have been tied to single companies or local authorities and jurisdictions. The best known is Hony Capital, the private equity arm of Legend Holdings, the parent company of Lenovo (LNVGF.PK). It has $720 million under management, and investors include Goldman Sachs and Temasek, the investment arm of the Singapore government.

The majority of the roughly 200 private equity firms in China are yuan-denominated funds, typically involved with earlier-stage investments, and are focused on the regions where they are based, giving them an inside edge over truly independent private equity firms. "Many people hope to raise capital from state-owned entities because if your fund has capital from state-owned entities, then your fund has the government's backing and therefore has the government's support," says Walter Huang, who plans to set up a Tianjin-based fund.