China's Private Equity Boom

(page 2 of 2)

As one 25-year-old Shanghai woman told us, "I like eating at Kungfu because I know I'm going to get healthy, steamed food quickly every time."

Emerging Stronger from the Tainted Food Scare

Chinese companies that need capital and international expertise to take their companies global also make attractive investments for private equity firms. One example is China Minzhong, a producer of processed vegetables. To help in its global expansion, China Minzhong took funding from Olympus Capital Holdings Asia and a consortium of other investors. New York-based Olympus, which has allocated $1.2 billion in middle-market private equity investments in Asia since 1997, saw that Minzhong had lower costs than competitors in the developed world yet had implemented quality-control standards to ensure the safety demanded by Western consumers.

Bulwarked by additional capital and expertise, Minzhong has more than doubled profits in the past two years and now exports to 22 countries. Following China's tainted food scare last year, Minzhong has emerged stronger. It has consolidated market share as smaller, less well-capitalized players cannot compete in ensuring food safety.

During the Chinese stock market's bull run in 2006 and 2007, many companies demanded higher valuations. If they did not get them from private equity firms, companies decided to raise money in the public markets instead, where initial-public-offering prices regularly doubled on the first day of trading. The drop of China's market—down more than 50% since November—has changed the situation. Many entrepreneurs who could previously demand huge valuations for their companies in the public markets now are turning to private equity investors for reasonable valuations.

Changes in China's banking system also bode well for private equity. Although relatively unscathed by the subprime debacle, Chinese banks can no longer loan as much money because the government has moved to combat rising inflation by increasing the bank reserve ratio to 17.5% from 16% earlier this year. What money banks do lend tends to go to state-run enterprises first or to large private companies, leaving even very profitable private smaller companies unable to get funding from traditional sources. They are turning more to private equity to get the capital they need to grow.

The sinking stock market and the ongoing credit squeeze create a great opportunity for private equity firms to provide capital and get more reasonable valuations from fast-growing companies than has been possible in the last few years.

Shaun Rein is the Founder and Managing Director of the China Market Research Group, a market intelligence firm that helps companies make smarter decisions in China. He can be reached at shaunrein@researchcmr.com. .