Private Equity in China

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Our recent post, New Sources of Capital in China, and the follow-up letter that we sent on China’s Evolving Story attracted quite a bit of attention and many questions from our readers. For example, a reporter from a major financial publication had some questions on private equity. We thought we’d pass along my responses.

Reporter: In your note on how Chinese enterprises now have money, can you elaborate on whether this means many will begin to get into PE investing?

Jack: Chinese enterprises are already investing in private equity — through PE funds as well as by taking ownership stakes directly. Domestic PE funds have told us that some of their key investors are companies, and we have worked on deals where we have seen corporate investors. On an auto components deal that we were working on in China, for example, we saw strong interest from companies to take an ownership stake. It’s also well known that Chinese companies have frequently used excess cash to invest in real estate and to buy shares in China’s A share market. Going forward, though, I believe that Chinese companies will prefer to find acquisitions, either inside or outside China, that can help grow their business in China, expand their markets, or bring technology.

Reporter: Do you think Chinese PE players are sophisticated enough and if not, where are they lacking?

Jack: Chinese and international PE firms go about the process of forming their investment opinions in different ways. Chinese PE players are not as rigorous in their investment analysis and tend to rely more on their gut instincts and local knowledge of the country when investing in China. For better or for worse, a Chinese PE firm will not spend the time and money that an international PE firm will spend on due diligence, but will instead rely on its own network of contacts to form opinions. The fact that Chinese PE firms do not spend as much time on due diligence enables them to act much faster than their international counterparts, making them extremely competitive when it comes to making deals in China.

When the China investment officer from an international firm sends a deal back home, the senior investment officers, who are most likely not as familiar with the country, will spend a great deal of time discussing whether growth is slowing in China, whether there’s a property bubble, or whether the yuan will continue to appreciate. On the other hand, the investment committee at a Chinese PE firm doesn’t have to spend any time discussing such issues and will go right to the particulars of the investment opportunity. On a China deal that we were working on, Chinese investors were able to complete due diligence and close within a month, whereas the international firm said they would require at least three months and one million dollars in fees for lawyers, consultants and accountants to complete the same deal.

Reporter: Do you see China’s PE sector becoming one of the biggest in the world someday, rivaling the U.S.?

Jack: China has an exciting story in private equity, but comparisons with the U.S. are problematic at this point. The U.S. is a $14.7 trillion economy, while China’s economy is less than half its size at $5.9 trillion. For all their shortcomings, the U.S. capital markets are highly developed, while the development of capital markets in China are still at a very early stage. Finally, because the U.S. dollar remains the world’s reserve currency, capital from all over the world flows in and out of the U.S freely.

There is no doubt that China’s PE sector will continue to grow, both in terms of size and influence, but it will take a long time for it to rival that in the United States. The relative sizes of the two economies, combined with their comparative stages of development and structural differences, will enable the U.S. to maintain its preeminence in the PE sector for a long time to come.

Reporter: What is JFP Holdings doing in PE — have you set up funds and how big are they at this moment? Who are you partnering with? Have you made any investments? Which sectors are you most interested in and which have the biggest growth potential?

Jack: What we see at JFP Holdings is that there is too much money in China chasing too few deals. Every major international PE firm has allocated large amounts of capital to the country, and Chinese sources of capital are growing day by day. On top of that, deal sizes are considerably smaller in China than they are in the U.S. and Europe. As fast as China is growing, and as large as the country’s economy has become, this imbalance shows no sign of reversing.

In this context, we believe that there is an excellent opportunity for a firm like JFP Holdings that can create and develop new investment opportunities and match them up with investors. Because of my experience on Wall Street and China, and the team of experienced Chinese professionals that we have assembled, we act as a lightning rod for Western and Chinese companies alike. Companies from all parts of the worlds, in all industries and in all shapes and sizes are coming to us for help of one kind or another. Many of these companies require capital. Though I would not rule out creating a fund some day, our current range of activities will keep us busy for a long time.

In terms of sectors, we are seeing many opportunities in clean tech, health care and services. These areas are right down the middle in terms of where China is heading and are very active.

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