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

industry standard where the top five manufacturers held a70% share of the world market, the top five in China onlyaccounted for about 20% of the domestic market. Zhao andhis team believed the industry was poised for consolidation,following the trend already occurring in many other sectorsthat were striving to enhance efficiency through larger scale.Hony also observed the considerable cyclicality in theindustry, and forecasted that prices would peak in late2004 or early 2005 before beginning a two‐year downturn.(See Exhibit 2 for an illustration of glass industry cyclicality.)Tactically, these forecasts guided Hony’s timetable for thebuyout and the subsequent IPO in early 2005.China Glass Holdings OverviewJiangsu Glass, located about halfway between Beijing andShanghai, was owned primarily by the municipal governmentof Suqian (a city in northern Jiangsu Province), with minoritystakes held by two other government‐owned assetmanagement companies. In 1996, the company had sufferedhuge losses and Suqian Vice Mayor Zhou Cheng wasappointed as the new CEO. He was given a mandate by thegovernment to clean house and turn around the money‐losingoperation. Although Zhou knew virtually nothing about theglass manufacturing industry, he quickly set out to streamlinethe company by disposing of all non‐essential assets, such asa hospital, a health clinic, schools and other facilities typicallyowned and operated by SOEs in China. He also revampedthe company’s balance sheet by successfully orchestrating amajor debt restructuring.The turnaround of Jiangsu Glass, led by Zhou, graduallybegan to transform the company into one of China’s mostefficient float glass producers, albeit with a relatively smallproduction capacity, even by domestic Chinese standards.Before the Hony investment, Jiangsu Glass had two floatglass production lines with a combined daily capacity of 900tons. Accounting for just 2% of the domestic market, it wasranked tenth in size among Chinese flat glass producers. Butit was number one in terms of return on total assets (beforetax and interest), according to the China Building MaterialsQuantity Supervision Association.Notwithstanding this impressive turnaround, by 2003the municipal government had decided to privatize JiangsuGlass, paying heed to the 2002 Party Congress directivethat “the government is not in the business of runningbusinesses”, and therefore every effort would be made bythe government to divest itself of businesses in highlycompetitive industries. In China, this significant policy shiftwas widely heralded as “state steps back, people stepforward”. Having successfully restructured the company,Zhou faced the challenge of severing ties with the localgovernment and competing as a private company.Just as Hony was being launched in mid‐2003, Hony CEOJohn Zhao arranged to meet Zhou for the first time. Althoughtheir initial encounter lasted less than an hour, even at thisearly stage the two CEOs concluded that they were thinkingalong similar lines about how to execute a buyout of thecompany and what was required to transform Jiangsu Glassinto one of China’s premier flat glass manufacturers. Theyshared the conviction that the trend in China’s flat glassindustry was moving irreversibly towards greater consolidation,resulting in fewer and larger companies. In order to thrive inthis more competitive environment, Jiangsu Glass wouldneed to rapidly expand production. This in turn would requireaccess to both additional financial resources and industryexpertise. But instead of looking for a glass industry playeras an acquirer/investor, Jiangsu Glass preferred to workwith Hony, a private equity player. Zhou explained: “Ideallywe wanted to work with an investor like Hony that sharedour vision about how to grow the company. We would nothave maintained our independence and control if wemerged with a competitor from the industry.”The Hony‐China Glass TransactionAn alignment of interestsUnlike many private equity transactions that are marked byprotracted negotiations and at least some tension betweenbuyer and seller, Hony’s purchase of Jiangsu Glass wasfacilitated by a commonality of interests and objectivesamong the three principal stakeholders:• The company owner: The Suqian municipal governmentwas a highly motivated seller. As the Mayor explained,“The privatization of SOEs under our control was partof the larger Chinese policy to reduce the government’sfinancial burden and strengthen the private sector’s rolein the economy. We agreed with this new emphasis bythe central government because we were overburdenedby responsibilities to oversee SOEs, and unable to providethem with the financial resources they needed to growand compete.”• The company management: CEO Zhou Cheng explained:“We knew the Chinese glass industry was undergoingrapid consolidation that would increasingly favour a fewof the largest players, and therefore we could not surviveas currently structured. Either we would be acquired byone of our larger competitors, or we needed to becomean acquirer, which would take additional capital.”• The private equity investor: The Jiangsu Glass profile waswell-suited to the investment criteria established by therecently created Hony Capital. According to Zhao: “We wereactively seeking buyout opportunities [privatizations], andconstruction materials were a very good bet in a countrygrowing consistently at a 10% annual rate. Moreover, thesingle most important criteria for us was a high level ofconfidence in management, and after my first conversationwith Zhou Cheng I believed he was a person we could workwith. Just as we were getting started, Jiangsu Glasspresented us with an excellent investment opportunity.”118 Case studies: Hony Capital and China Glass HoldingsThe Global Economic Impact of Private Equity Report 2008