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

Hony’s Chinese name means ambition and perseverance,two traits considered critically important for all Honyprofessionals. New recruits were given two books that theywere expected to have read by the end of their first weekon the job. One was The House of Morgan: An AmericanBanking Dynasty and the Rise of Modern Finance. 4 The bookresonated with Zhao because of the apparent similaritiesbetween the US at the turn of the 20th century andpresent‐day China. He believed that Morgan’s rise a centuryago captured the essence of Hony’s opportunity now. Thesecond book, Goldman Sachs: The Culture of Success, 5focused on the embedded culture that contributed to theinvestment bank’s sustained success, and reflected Zhao’svision for Hony. “The people of Goldman Sachs are intenseand proud,” wrote one of Goldman’s leaders in the 1993annual review, “and they aren’t willing to settle for less thanbeing the very best in each of our significant operations.” 6In addition to building a professional staff, the new CEObegan to flesh out Hony’s investment strategy. Thoughfew transactions existed at the time, Zhao never waveredfrom Liu’s vision of creating a private equity fund whoseprimary focus would be on purchasing controlling stakesin Chinese SOEs. Zhao first hired McKinsey & Companyto conduct a top‐down analysis of 99 broad sectors inthe Chinese economy. Based on the study, the consultingfirm recommended to Zhao and his team an investmentstrategy that focused on a few high growth sectors suchas pharmaceuticals, heavy equipment and constructionmaterials. Secondary interests included consumer goods,retail, media and financial services. Although float glass wasnot specifically included in McKinsey’s list of recommendedindustries, the Hony team believed that it had potential.Zhao explained that this early exercise with McKinseygave the Hony team focus and discipline as they beganto grow their private equity business.Since the first fund, Hony has gone on to raise twoadditional funds and by 2007 it had about $720 million oftotal committed capital. After relying 100% on Legend for thefirst fund, the second and third funds attracted some of theworld’s most prestigious LP investors, including the StanfordUniversity endowment, Goldman Sachs, Temasek Holdings,the Gates foundations and the Rothschild family. (SeeExhibit 1 for summary information on Hony Capital funds.)The Hony investment model“In the simplest terms,” Zhao explained, “we’re acompany builder. The key success factor in our businessis post‐investment execution.” Of course, the leaders ofmany private equity firms might express a similar view, butwhen Zhao elaborated on Hony’s investment model, someof the major differences between the Chinese and Westernapproaches to buyouts became apparent. As Zhao explained:“Hony’s deals differ in at least a half‐dozen ways fromtypical buyout deals in the US and Europe. We focus onprivatizations of state‐owned enterprises rather than publiclylisted private‐sector companies; given the state of China’scredit markets, leverage is not a significant factor in ourtransactions; we will not do a deal that involves significantasset stripping or major layoffs; we do an enormous amountof due diligence on management because we are onlyinterested in deals where we have full confidence in theexisting management team; and possibly of greatestimportance, we must have a high level of confidenceearly in the due diligence process that our interests andmanagement’s are fully aligned about what needs to bedone after we invest to build value in the company. We helpthe management team to become market leaders in theirindustry by focusing on formulating strategy and vision.However, we don’t want to be in a position where we haveto interfere with daily operations.”Zhao believed this approach, coupled with the team’sdeep knowledge of Chinese business culture and the policyenvironment, would give Hony a considerable competitiveadvantage as the private equity industry continued to growand mature. Hony was also well placed to continuouslygenerate attractive deal flow, he believed, because histeam recognized the investment opportunities in a market farless efficient than that of developed countries. Hony couldselectively capitalize on these inefficiencies because its localknowledge was extensive and it understood better than mostthe nexus between China’s public policy agenda and therequirements for continued private sector growth. “Very fewvalue‐added investors are looking at the deals we do,” Zhaoexplained. “If we make the right judgments about companymanagers, we will succeed in most cases. China does not yethave a professional management class by Western standards,so making good people decisions is a key factor for success.”Float Glass Industry Overview 7Opportunities in industry consolidation and cyclicalityGlobal demand for flat glass between 1985 and 2004 hadconsistently grown at a rate approximately 1% faster thanglobal GDP, an encouraging sign for investors in a countrysuch as China that had been registering annual GDP increasesof at least 9% for more than two decades. Furthermore, Chinais the single largest country in the glass market, accountingfor about a third of both global production and consumption.Domestic demand was poised to expand further with lawsand regulations requiring building materials to havetechnological innovations and higher energy efficiency.In 2003, when Hony was contemplating the Jiangsu Glassbuyout, China’s flat glass industry was extremely large yethighly fragmented. With China’s economy growing atbreakneck speed, every business related to the constructionindustry was booming. Yet compared to the global glass4Ron Chernow, New York, Grove Press, 2001.5Lisa Endlich, New York, Touchstone, 2000.6Lisa Endlich, Goldman Sachs: The Culture of Success, (New York, Touchstone, 2000), p180.7Materials on the industry overview are adapted from the China Glass Offering Prospectus, published 13 June 2005, p45-52.The Global Economic Impact of Private Equity Report 2008 Case studies: Hony Capital and China Glass Holdings 117