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July 2008 Issue
In Brief

Exit Dynamics on China Portfolio have changed sharply in the 18 months to June that will affect performance record Feature
SPACs Could Be Friends or Foes to private equity as they gain recognition Analysis
Investors from China and ME are asserting their position in private equity Institutional Investors
Largest Secondary Deal by FoFs underscores the merits of being private Institutional Corner -Investments
Investors Log Buyout Deals in Oz albeit in different strategy from the past General Section – Investments
Deal Momentum in Japan continues with a secondary opportunity General Section – Investments
Joint Venture Funds is in Vogue as foreign and local investors leverage on each other’s expertise Greater China – Funds
Online Portals is the Game for investors that are committing to wide ranging deal sizes Greater China – Investments
Exchange of HK Witnesses tepid investors’ responses to debuts of private equity-backed China companies, a reversal from the past Greater China – Divestment
Indian Specialised Funds Mushroom as the country’s private equity market deepens India Corner– Funds
BPO Has Lost Its Position as an investment target for investors as evidenced by the latest trend India Corner– Investments
Vietnam’s Inflation and Stock Market warrant concern, but committed investors hold differing views Perspectives
Content

Analysis

Institutional Corner
News
Institutional Corner
Investments

General Section
News
Investments

Greater China
News
Funds
The Partnerships
Investments
Divestments

India Corner
News
Funds
Investments

Perspectives
Star Dimmed

People on the Move
Subscriber Weekly Summary
Summary
Stock Watch
Index & Exchange Rates

A Tale of Two Markets

A few years ago, a listing on either the New York Stock Exchange (‘NYSE’) or NASDAQ was a goal post that an aspiring enterprise in China would strive for. With the US dollar continuing to depreciate against China’s yuan, and the stock market of the world’s largest economy plagued by volatilities, the first half of 2008 recorded the lowest number of initial public offerings (‘IPOs’) of Chinese companies on these two bourses since 2004. During these six months, only two companies from China chose to be quoted on a US listing platform. The number paled in comparison to the 58 that went public on China’s A-share market. Significantly, there are telling signs that these two US bourses, NYSE and NASDAQ, which have been home to some of the most illustrious listing performances of China plays, have lost their position as the desired public addresses for unquoted Chinese companies. In a sharp reversal from the past trend, the number of private equity-backed China companies that were listed on these two exchanges has plunged to one in the first half of the year. With the imminent launch of a second board of the Shenzhen Stock Exchange that is modelled on NASDAQ, a new chapter has arrived in which China’s A-share market will govern the listing profile of private equity-backed companies at home, and, thus the ultimate exit performance.

The Chosen Exchanges

In the three years ending December 2006, both the NYSE and NASDAQ were clearly the favoured listing destinations for Chinese companies backed by private equity investors. In these 36 months, 89 such companies were listed on either of these two bourses, while investors clocked an aggregate of US$2.33 billion in realised capital.

The dynamics began to change in 2007 when Beijing promulgated a new set of regulations for mergers and acquisitions. The rule came into force on 8th September 2006 (‘September 8 Regulations’). It would require, for the first time, approval from the central government for all investments made by an offshore company in domestic assets, in addition to the mandatory nod from China Securities Regulatory Commission. Since the implementation of this new regulation, no private equity investors are known to have received this seal of approval from the applicable authorities.

Despite the September 8 Regulations and subprime loan debacle that began to engulf the US financial industry in the second half of 2007, both NYSE and NASDAQ have been able to maintain their allure. In the 12 months ending December 2007, 26 private equity-backed Chinese companies were listed on these two exchanges, with investors recording over US$724.6 million in returned capital, although it was a substantial decline compared to the US$2.05 billion recorded for the preceding year.

By the first half of 2008, the toll of the US financial woes and China’s September 8 Regulations came to light. In these six months, ATA, Inc. was the sole private equity-backed Chinese company that went public on NASDAQ. With its investor, SAIF Partners, not disposing of its holdings, no capital realisation at IPO in the US had been recorded for this period.

In China, the dynamics have been sharply different. Since 2007, the listings of private equity-backed companies on the A-share market have been gathering momentum. In that year, 28 domestic companies with private equity investors as shareholders went public on either the Shenzhen or Shanghai Stock Exchange. At the same time, a new milestone has been achieved by China’s A-share market. It was the first time that private equity investors have been able to record cash return of their invested capital. Hony Capital and Shenzhen Fortune Venture Capital Co., Ltd. were the only two investors known to have successfully disposed of a portion of their respective holdings to return an aggregate US$73.1 million to their coffers ...

Greater China - Funds

The Partnerships

Joint venture funds mushroom as domestic and foreign investors leverage on each other’s expertise

Beijing’s recent radical move to fuel the growth of its domestic private equity industry was an awakening to foreign investors. It has not only led to a cascade of yuan-denominated funds being established, but has also erected formidable barricades to non-domestic investors. In the absence of any clear parameters on how foreign parties could establish a yuan-denominated fund, foreign investors have decided that a joint venture fund with domestic partners is one of the best avenues to access China assets. To domestic enterprises, a joint venture fund with a foreign partner organisation would be a window of opportunity for them to better understand the markets outside of China.

Among the recent joint venture funds being launched, the brainchild formed by Beijing-based Berun Group and Australian Private Capital Investment Group is by far the most ambitious. Green Private Equity Fund has a target fund size of US$2.0 billion. It is not only the largest fund ever launched for China with a “green” theme, but a substantial portion of the capital raised will be directed to rebuilding the quake-stricken areas in Sichuan province.

Berun is a local financial group formed in 2004 that manages a total assets of over 5 billion yuan (US$714.3 million). The group focuses on investment in the high-tech sector. Back in June 2007, it set up the West Region Angel Investment Fund with a target fund size of 130 million yuan. Little, however, is known about the Australian Private Capital Investment Group.

Although this is the first time that the two have joined hands in order to manage the Green Private Equity Fund, investors have been responding warmly to the fund. According to Mr. Wang Xiaodong, chief executive officer of Berun Group, the final closing of this fund is not far from sight.

Another recent joint venture being launched is Shenzhen Oriental Venture Capital Management Co. Ltd, a yuan-denominated fund with an initial fund size of 900 million yuan (US$130 million). The sponsoring organizations are the Hong Kong-based Sun Hung Kai Financial Group and Shenzhen Oriental Fortune Capital Co., Ltd, with each to hold a 49% interest in this joint venture fund. It will invest in sectors like information technology, biological medicine, new energy, consumption and services. Sun Hung Kai Financial is one of the oldest financial institutions in Hong Kong and was among the first to establish a China fund in the early 90’s. Shenzhen Oriental Fortune Capital, is a venture capital firm with US$171.4 million under management.

However, it is the impending US$71.8 million joint venture fund between Japan’s SBI Holdings and a host of domestic organisations that sheds light on the complexity of a joint venture fund and the clever structure employed by the participating parties.

This US$71.8 million fund initiated by SBI Holdings enlists a consortium of domestic investors, including China CITIC Bank Corp. Ltd., Resource Capital China Ltd. and China Merchants Securities Co. Ltd. (‘consortium’). The fund in fact comprises two portions, one a US$50.1 million fund that is entirely subscribed by SBI Holdings, while the remaining equivalent to US$21.7 million will be denominated in the domestic currency. SBI Holdings together with the consortium will establish a fund management firm to manage these two funds that are denominated in two separate currencies .

One of the earliest to sponsor a China venture capital fund was the Beijing Enterprises Group Ltd. (‘Beijing Enterprise’) when it launched the US$70 million Beijing Technology Development Fund in 1999. A decade since it first launched its own venture capital fund, Beijing Enterprise has decided to partner with the Hong Kong-based Kerry Group Ltd. to launch a US$150 million private equity fund, according to Caijing, a leading domestic financial publication. This joint venture fund, to be known as Bluewhale, will focus on clean energy and infrastructure.

The first half of 2008 witnessed vibrant activity in the launch of joint venture funds. In late May, the US-based investment firm Sycamore Ventures teamed up with China Association of Resources Comprehensive Utilization (‘CARCU’) to launch the US$1 billion China GreenStar Resource Utilization Investment Fund. It will be managed by Sycamore GreenStar Management Company, a Hong Kong-based subsidiary of Sycamore Ventures. Beijing is displaying its full support for such a joint venture fund through CARCU, a government agency, and has earmarked US$100 million for this fund. China GreenStar Resource Utilization Investment Fund will mainly invest in companies focused on energy saving and environmental production.

Perspectives

Star Dimmed

Vietnam’s economy faces defining tests

In less than 18 months, the prestige that was accorded to Vietnam’s nascent stock market in 2006 as the best performer was reversed. With the VN Index having lost more than 62% during the first half of this year, Vietnam’s stock market now bears the un-enviable label as the worst performer. At the same time, repeating 2007’s economic growth of 8.5% looks unattainable, as the country is enveloped in soaring inflation. In May, Vietnam’s inflation escalated to 25%, an alarming surge compared to 15.7% for February. By the end of June, Vietnam’s dong was trading at 16,901.5 against one US dollar, a 5.4% drop within these six months. Morgan Stanley has forecast that the dong will devalue by 38% within the next 12 months.

Although Vietnam’s private equity industry is still very small, nevertheless the percentage growth of its fund pool was only behind China and India. Between 2005 and 2006, growth of the Vietnamese private equity fund pool was the highest in Asia, recording an impressive 741.8% growth compared to 55.2% and 21.6% for China and India respectively. Significantly, Vietnam played a central role in re-igniting investors’ interest in the Southeast Asian economies after the 1997-1998 Asian Financial Crisis. The country, blossoming with growing private enterprises, as well as having a reservoir of state-owned enterprises that are expected to be privatised, has established itself as the hub for growth and expansion capital in this economic region.

While Vietnam’s inflation warrants concern, institutional investors and fund managers who shared their views with Asia Private Equity Review all unanimously agree that the media might have overplayed the issue. Recently dubbed as the next tiger economy in Southeast Asia, is Vietnam’s economy going through a “boom and bust cycle”? Mr Rick Mayo-Smith, co-Chairman of IndoChina Capital questioned the validity of such pessimism. “How much of a bust is 7.5% growth?” He was referring to the impressive growth that Vietnam has been able to attain during the past few years. Mr Mayo-Smith maintained that the current correction in Vietnam is “healthy”, albeit severe. It is a statement that represents the common view of all other investors.

Weeding Out the Speculators

Mr Craig Martin, Head of Private Equity and Investment Director at Prudential Vietnam Fund Management Company (‘Pru Vietnam’) likens the current situation in Vietnam as a heart beating at a growth rate of 8% to 9% per annum, but the arteries have not yet been “cleaned out” to accommodate the rapid expansion process. He is referring to the infrastructure in Vietnam, which is in dire need of being upgraded in order to keep pace with the country’s economic growth.

While Mr Mayo-Smith does not doubt that the unabated inflow of foreign direct investment (‘FDI’) capital is playing a role in shoring up Vietnam’s consumer price index, the main catalysts are now the ever rising food and fuel prices. Mr Martin is quick to add that FDI is being directed to long-term fixed assets and is, in fact, helping the Vietnamese economy as a “stabiliser” in the face of a trade deficit at 20% of the country’s gross domestic product. For the first five months of 2008, Vietnam recorded US$15.4 billion in foreign investment, twice the amount over the same period in 2007.

However, both Messrs Mayo-Smith and Martin concurred that the correction that has enveloped Vietnam is another opportunity to weed out speculative investors, separating them from those committed to the country. Mr Martin pointed out that some overly aggressive investors had raced to purchase companies that are listed on the over-the-counter (‘OTC’) market, which is now locked in illiquidity. It is an awakening to those who made their hasty investment decisions. Mr Mayo-Smith was unreserved in confirming that committed investors are taking a “wait and see” position in order to correctly ascertain the market dynamics.

Stock Market Correction

For Mr Chris Freund, Managing Director of Mekong Capital, who witnessed the painful correction that Vietnam had to endure a decade ago, he is unperturbed. In fact, Mekong Capital’s Vietnam Azalea Fund Limited, which seeks opportunities in those state-owned enterprises being privatised by the government, is well positioned as “already equitised [firms] need to raise equity capital due to a shortage of credit.” The downward adjustment of price/earning ratios of publicly-listed companies has also led to a growing plethora of opportunities in the secondary market. “There are many more opportunities for secondary transactions now as investors and companies that rushed into the market a year ago are now liquidating many positions at big losses. There is a lot of pressure on Vietnamese equitised companies to divest securities investments that they made last year in hope of quick and easy profits,” Mr Freud commented. Mr Martin disclosed that, while the bear market conditions did delay the initial pubic offering schedules of two of Pru Vietnam’s portfolio companies, this is not disrupting Pru Vietnam’s overall exit plan. “With strategic investors eager to seek assets in Vietnam, our portfolio companies have been the targets of trade buyers”, he noted.

Comments

Although Mr Ayumi Konishi, Vietnam Country Director for Asian Development Bank, agrees that the current correction in Vietnam is a positive process in its path of growth, he nonetheless holds the view that, to some extent, it is also a reflection of “investors’ lack of confidence in the long-term stability of the Vietnam economy”. There are clear indications that institutional investors have reduced their exposure to Vietnam. In the first six months of the year, foreign investors have cut their stock purchases by 50%, to US$334.2 million. At this juncture, fund investors appeared to be more willing to make allocations to real estate funds than to private equity funds, based on market movements.

Cushioned by the last few years’ impressive growth, today, Vietnam is much better equipped to weather the current economic storm than before. Mr Mayo-Smith pointed out that “Vietnam now has a stock market, whereas there was none back in 1997”. His suggestion that Vietnam is now a much stronger country than 10 years ago has also won echoes of support from Messrs Freund, Martin and Dragon Capital. They represent Vietnam’s pioneering and most committed group of private equity investors. All lauded the government’s initiatives to address the inflation issue, although the government did not react until late May, nearly four months after the International Monetary Fund warned Vietnam that its fast-growing economy was overheating

With Cambodia just beginning to arouse private equity investors’ interest, would the current economic situation in Vietnam have a contagious effect and erase investors’ interest to that country? Mr Mayo-Smith likes to dismiss Cambodia at this juncture, but Mr Martin, who had earlier resided in Cambodia, felt that the home to Ankor Wat is quite a different economy altogether. He further elaborated that investors’ interest in that country for the foreseeable future will largely confined to real estate.

Since becoming a member of the World Trade Organisation, Vietnam is facing its first significant challenge. It is perhaps a momentary dimming of this star economy in the Mekong region that it is learning to reverse in order to shine again.