The Global Economic Impact of Private Equity Report 2008 - World ...

going private; there have been virtually no emergingmarkets transactions of this type. In the few cases wherebuyouts have occurred in China, the seller has invariablybeen the State (i.e., privatization), and in most cases thenew controlling shareholder has been a local rather thanforeign private equity entity.• Leverage: Buyouts in the US and Europe tend to be highlyleveraged, often involving 60%‐80% of debt financing.In China, as in most emerging markets, private equitydeals involve relatively little or no debt. This may changeover time as credit markets deepen and legal frameworksadjust to permit more leveraged transactions, but notin the near‐term.• Transaction size: Buyouts in the US and Europe frequentlyrun into the hundreds of millions, or even billions of dollars.Very few companies of comparable size exist in emergingmarket countries, and most private equity transactions arefar smaller. 2• Politics and foreign ownership: The spectre of foreigninvestors gaining control of large, high visibility enterpriseshas begun to trigger a political backlash in China, just asit has in other emerging market countries as well as in theUS and many other Western countries. These politicalsensitivities are likely to remain prominent features of theprivate equity landscape for the foreseeable future, andwill influence public policies and investor behaviour.Hony CapitalHony origins and backgroundHony Capital was founded in January 2003 with aninvestment of $38 million from a single investor, LegendHoldings, one of China’s best‐known companies. Legendwas established as a personal computer business with11 engineers in 1984 by the government‐owned ChineseAcademy of Sciences, and became internationally recognizedwhen one of its subsidiaries, Lenovo (previously namedLegend Computers), acquired IBM’s personal computerbusiness in 2005. Although widely viewed as one of China’sgreatest “private” sector success stories, today 65% ofLegend Holdings is still owned by the state‐owned ChineseAcademy of Sciences.When Liu Chuanzhi, founder of Legend Computers andpresident of Legend Holdings, launched Hony Capital, mostlarge Chinese companies were state‐owned enterprises(SOEs). Obtaining government approval for buyouts involvednavigating through a complicated maze of regulatory andpolitical hurdles that few understood. But Liu, with his longexperience building Legend, understood what the governmentwas trying to achieve during the gradual transition to a marketeconomy, and he proved adept at manoeuvring within thebureaucracy. His vision for Hony from the outset was to applyLegend’s knowledge of government, its financial resourcesand its expertise managing successful Chinese companies toselectively acquire SOEs, restructure them, and then exit. Hebelieved that China had reached a critical juncture that waslikely to create untold opportunities for the nascent privateequity industry:“First, China’s traditional industries all have huge roomfor growth, so the returns on private equity can be evenhigher than those on venture capital. In other countries, thereare limits to the growth of traditional industries, but in Chinatraditional industries like construction materials, textiles orfood and beverages have limited risk and very fast growth,so they are very suited to private equity investment.“Second, because private enterprises in China lackresources, private equity can act like irrigation, stimulatingqualitative change as soon as it enters.“Third, private equity serves as a good tool for China to reformstate‐enterprise ownership and management‐incentivesystems. … Private equity can value enterprises andmanagement at market prices, allowing state enterprisesto reform in a more acceptable fashion.” 3Liu’s first task was to find a leader for Legend’s new fund.To this end he turned to John Zhao, a senior advisor to theCEO of Lenovo. Zhao had grown up in Jiangsu province,attended Nanjing University, worked briefly as an engineerat the state‐owned Jiangsu Electronics Company beforeimmigrating to the United States to pursue graduate studies.Zhao had earned two Masters of Science degrees and anMBA from Northwestern University’s Kellogg School ofBusiness in Chicago before spending about 10 yearsworking in a number of high‐tech companies and SiliconValley start‐ups. He returned to China in 2002, first to workas a senior advisor to Lenovo’s CEO, and then as HonyCapital’s first CEO. Reflecting on his decision to return toChina after he had successfully settled in the US, Zhaoexplained: “China is my roots. In my mind, there was nodoubt that this is where I would eventually return.”Pursuing Liu’s vision, Zhao immediately began to build HonyCapital into one of China’s first private equity funds, foundedand fully staffed by Chinese. By 2007, Hony had grown to27 professionals, including seven managing directors, twodirectors, and one vice president. With the exception of oneforeign employee, the team remains virtually 100% Chinese,most of whom were not Western-educated and came fromoperational, rather than financial, backgrounds. According toZhao, hiring a world-class professional staff was one of hisbiggest challenges. He believed that success in the ChinesePE market required a very different kind of professional, andhe proactively recruited individuals who had in‐depth localknowledge and strong operating expertise.2In 2006 the average deal size in China was about $45 million, and only $30 million in India. (“Asia Private Equity Overview, 2007”, Bain and Company,March 2007).3Yu Ning and Song Yanjua, “Defining Private Equity’s Future in China”, Caijing Magazine, published on www.wsj.com, 12 July 2007.116 Case studies: Hony Capital and China Glass HoldingsThe Global Economic Impact of Private Equity Report 2008