PRIVATE EQUITY IN CHINAA COMPARAISON OF TWO CASES.

Done by:

El rhallam ayoub

Cherkaoui zineb

Mouline mouhamed salim

Boutahra ismail

El adlouni myriem

Plan

I. Development of Private Equity in China

II. Case Study I: Newbridge Capital and Shenzhen Development Bank

III. Case Study II: The Carlyle Group and Xugong Group Construction Machinery

IV. Lessons Learned from Case Studies

V. The Future of China's Private Equity Market

Introductory phase Mid-1980s to Mid-1990s

• Before 1980, the concept of private equity was unfamiliar in China until it government decided to boost the development of science and technology by creating the first venture capital fund was established in 1985.

• This first venture was named China New Technology Capital Funds.

Introductory phase Mid-1980s to Mid-1990s

• This funds were created by the local government to develop the regional and the national economy putting in focus the technology-based venture as the key to this devlopment-

It took until the early 90s for the venture capital to take foothold in China, this was followed by the creation of the stock exchange concept in 91/92, this procedure led to centralizing and consolidating the capital market.

Developement phaseMid-1990s to Early-2000s

• At this phase, after the approval of the state council china’s private equity has grown to a stage where a nationwide regulation was necessary.

• This regulation consisted on approving the co-fund between domestic and foreign investors to develop projects in the chinese soil.

Developement phaseMid-1990s to Early-2000s

• Few regulations followed until 98, when the U.S. dot-com boom contributed considerably on the venture capital rise due to the growth of china’s internet industry « Internet Boom 97-98 »

• By the end of the 90s the internet bubble popped causing many venture capital firms suffered losses.

Accelerated Growth phase Mid-2000s to 2010

• By 2001, the need of significant changes in the financial system pushed China to access the world Trade organisation.

• In 2006, a revision of the law and securities law was needed, this revision laid the ground for a developement of multi level securities market, giving investors more protection.

Accelerated Growth phase Mid-2000s to 2010

• Still, by this time, the foreign investors could only buy shares in cash, and were required to notify the government before gaining control of a chinese firm.

• August 2008, a very significant regulation, the anti-monopoly, took effect.

• This regulation raised question of how efficient this regulation and it’s succesors are, and also pointed the inconvenience for the foreign investors.

Accelerated Growth phase Mid-2000s to 2010

• On the other hand, domestic private equity, was not submitted to severe regulations, which allowed it’s steady growth.

• With this significant growth, the investors continue to believe in the opportunities china’s equity market has to offer.

SUCCESSFUL FOREIGN PRIVATE EQUITY INVESTMENTS IN CHINA

Case Study : Newbridge-Capital and shenzhen Development Bank

Shenzhen Development Bank

• It was recognized as regional public commercial bank in 1987, and is based in Guangdong

• It was the first bank to reveal its IPO and got listed on the Shenzhen Stock Exchange in April 1991

• (SDB) is an icon of China’s developing capital market thanks to its transformation from a failing bank sinking in bad loans to a well-managed and profitable institution.

Shenzhen Development Bank • After earning a national banking authorization, SDB

extended to 225 new offices throughout China by 2002• 27.6% were detained by Shenzhen government controlled

entities and 72.4% of SDB’s stocks outstanding were held by the public.

• SDB’s nonperforming loans (NPL) to gross loans ratio was 11.6%, which was 4.3% greater than the average of other joint stock banks at the time.

• SDB's large domestic network in China’s affluent regions attracted Newbridge Capital.

Newbridge Capital

• Created in 1994 by Texas Pacific Group’s (TPG) Blum Capital Partners’ Richard Blum and David Bonderman, Newbridge Capital was considered to be among the first U.S.-based private equity companies concentrating on investment located in Asia.

• Newbridge gradually entered China’s market through marginal stake investments in some customary industries such as beverage and food in the mid-1990s.

• A 51% stake in Korea First Bank for $417 million was bought by Newbridge in 1999, consequently it became the first overseas proprietor of a South Korean bank.

Newbridge Capital

• Weijian Shan, a skilled and experienced Chinese negotiator who is the managing director for Asian operations stood behind the success story of KFB.

• Shan led the first foreign acquisition of a stake in SDB beginning in 2002 despite his reluctance to work on deals with Chinese firms because of the lack of respect for private property rights that would create formidable obstacles for foreign investors.

• Private equity was still an unfamiliar concept in China when preliminary negotiations between SDB and Newbridge took place

Newbridge Capital

• The Shenzhen government worried that SDB’s declining performance would negatively affect the local economy.

• This made it easier for Shan to persuade the municipal government that Newbridge’s notable management and operational expertise would help SDB get out of its period of fragility.

• Backed by the government, Shan and his team started a due diligence process in May 2002 to determine a comprehensive turnaround strategy for the bank

Newbridge Capital

• The binding contract gave Newbridge a 17.89% stake of non-tradable shares in SDB, allowing Newbridge to gain sizable control with a small stake by securing the right to appoint 8 out of 15 board members.

• This was a win-win position. SDB would be able to take advantage from foreign expertise to get back in shape, and Newbridge would be able to hold a majority stake in SDB with management control at a profitable price

SDB’s renouncement

• SDB abruptly dissolved the transitional management committee set up by Newbridge earlier in September, which led Newbridge to immediately take legal action.

• There was great tension between the transitional management team and the existing board members because the Shenzhen officials on the board were more concerned about their own job security than SDB’s possible boost in performance with Newbridge’s assistance.

• Newbridge’s loss of backing and support due to the changes in the securities agency, the Central Bank and the State Council

The solution

• After SDB’s announcement to dismiss the management contract, Newbridge launched a suit against Chinatrust Commercial Bank in a Texas court, condemning Chinatrust of “obvious unjustified intrusion” with Newbridge’s “contractual rights,

• Newbridge went on and launched arbitration proceedings with the International Chamber of Commerce (ICC) in October, demanding financial compensation from the four major shareholders of SDB for the alleged breach of agreement.

• The dispute came to an end on april 2004. In a declaration delivered through the Shenzhen Stock Exchange, SDB stated that Newbridge, and the shareholders had agreed to remove all adjudication petitions and cross-petitions without offering a clear reason

The success

• Newbridge lastly prospered in formally buying a controlling or monitoring stake in SDB and became the first foreign investor to get the control of a Chinese bank

• The panel also accepted the selection of several managers and directors from Newbridge, making foreigners compose half of the 15-member board.

• TPG, which incorporated Newbridge in 2006, was able to reinforce the bank’s offices network, nurture a credit culture, and enhance its overall balance sheet

• Over approximately the five years under TPG’s control, SDB’s net profit raised from $25.8 million in 2004 to $736.9 million in 2009, its CAR went up from 2.3% to 8.88 and its NPL ratio dropped down from 11.41% to 0.68%.

• TPG’s success in improving SDB’s financial situation enabled the company to exit its investment with an extremely profitable stake auction ( 4 times)

FAILED FOREIGN PRIVATE EQUITY INVESTMENTS IN CHINACase study : The Carlyle Group and Xugong Construction Machinery

The Carlyle Group and Xugong Group Construction Machinery

I. The target firmXuzhou Construction Machinery Group (XCMG) is one of China’s largest manufacturers of construction machinery and is based in the Jiangsu province.

After its foundation in 1989, XCMG has grown to become China’s second biggest construction equipment maker and has gradually expanded its business worldwide by selling machines at a lower price than its foreign competitors.

The Carlyle Group and Xugong Group Construction Machinery

owned by the government of Xuzhou, XCMG aspires to become an internationally competitive firm ranking among the world’s top three in the industry.

Xugong Group Construction Machinery which supplies more than half of the domestic market for hydraulic cranes and road-paving equipment, is one of XCMG's subsidiary companies.

The Carlyle Group and Xugong Group Construction MachineryDue to growing competition in the construction machinery sector, the Xuzhou city government concluded that Xugong needed capital injections and restructuring in order to globally expand its national brand.

In 2004, Xugong began a rigorous auction process that consisted of two rounds and six international bidders among which Carlyle Group surfaced as the front-runner for the control of Xugong.

The Carlyle Group and Xugong Group Construction Machinery

II. The private equity firmThe Carlyle Group, a Washington, D.C.-based global asset management company specializing in private equity.

It has dominated foreign private equity investments in China since the early 2000s.

The Carlyle’s strategy in Asia In 1998 , it has established Carlyle Asia Partners, an Asia-focused buyout fund amounting to $750 million, signaled its full-fledged effort to invest vigorously in Asian firms, particularly in the financial, consumer, and manufacturing services.

In 2004, Carlyle revealed its ambitious plans to invest as much as $1 billion in a wide variety of industries in China.

One of its aspired investment projects was the purchase of an 80% stake in Xugong Group for $300 to $400 million.

The Carlyle’s strategy in Asia

Carlyle rose as the highest bidder after a long auction process

It declared in October 2005 that it had signed a definitive agreement with Xugong Group to buy a 85% stake for $375 million, leaving 15% in the hands of XCMG.

Both the Xuzhou government and Carlyle Group viewed this as a beneficial transaction.

The Carlyle’s strategy in AsiaCarlyle was unable to overcome the last hurdle of obtaining approval from the central government’s regulatory authorities.

In March of 2006, China’s Ministry of Commerce rejected Carlyle’s planned purchase of an 85% stake in Xugong Group for US$375 million, signed in October 2005 due to economic patriotism issues.

LESSONS LEARNED FROM CASE STUDIES

The Chinese government has progressively developed the regulatory environment for foreign private equity investment to build a more sophisticated market economy in the face of economic internationalization

Lessons learned from case studies

• In the State Council’s recently published, the government included industries like biology, environmental protection, new energy, and high-end equipment manufacturing. But the government did not allow foreign private equity investments in these firms.

Lessons learned from case studies

•The role of Guanxi cannot be overlooked when doing business transactions in China, and the case studies show that foreign private equity investment is not an exception

Shan

• Shan has looking up to change China’s business culture. China’s total debt-to-equity swaps and bank recapitalization dealing with NPLs exceeded the total pre-tax profits in China’s industrial sector since 1999, Shan attributed the source of China’s rapid.

Shan

• Shan was able to lead Newbridge to a successful agreement. Looking at Shan, establishing guanxi in China does not necessarily mean condoning to illegal business behavior in China and flattering government officials if one has built a credible reputation with deep industry knowledge. That is not to say that Carlyle and Coke lacked a wide guanxi network unlike Newbridge and Blackstone

Xugong

• In Xugong’s case, the nationalist sentiment was instigated by the CEO of Sony Corporation, Xugong’s main competitor.

Nationalism

• Nationalism in China is often linked to anti-Western sentiment, which was initially encouraged by government in the 1990s. During a similar time period, cyber nationalism began to emerge with the rise of the Internet in China. cyber nationalism can play a significant role in China’s policy making process.

The future of china’s private equity market

• May not be as bright as it seems due to the challenges and restrictions imposed to the foreign investors.

• As for now, the selection is quiet difficult and this is due to the exceedingly high valuation standards, small details are also part of the checklist like the investors family background, if he has a mistress or if he has a gambling addiction.

The future of china’s private equity market

• As known, the chinese culture influents every aspect of the social interaction but, in this case, the economic interactions as well, in fact, the lack of sophistication in judicial system leads to an incomprehension for the foreign investors regarding this approach.

Conclusion

• As a conclusion, there is no formula for a succesful private equity investment because of the persistance of the political, social and economic barriers.

• We may say that the foreign private equity investement are trapped in chinas domestic equity deals, wich with the present circumstances lead to a certain sharp plounge