Ties That Bind - Bay Area Council Economic Institute

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Ties That Bind
Startups and Turnarounds on a Grand Scale
In the period since China joined the WTO, U.S. companies have been aggressively increasing
their market share through mergers and acquisitions across a range of sectors. Investment is
flowing to China through both private equity (large cap) and venture capital (small cap).
The opportunities presented by State Owned Enterprises (SOEs) are complex. The distressed
condition and opaque accounting practices of many SOEs, the complex multi-agency review and
public auction processes for state-owned and legal person shares, and the inability to exit
through a foreign IPO, has limited enthusiasm for transactions. As an investment banker put it,
“due diligence can be like peeling an onion—the more you peel, the more you cry.” Still, SOEs
represent an opportunity for leveraged buyout specialists to pick up and restructure distressed
assets at favorable prices, de-list and turn them around, and partner with investment banks to
match them with foreign partners.
For most investors, the preferred method of foreign ownership is through offshore holding
companies in Hong Kong, the Cayman Islands, British Virgin Islands, or other favorable locations.
Such offshore entities may be opened and closed, bought and sold, merged or restructured
with little or no Chinese government intervention. While a NASDAQ or New York Stock Exchange
listing may have cache, listings have gravitated toward the Hong Kong Exchanges more
recently—Bank of China is a case in point—to avoid Sarbanes-Oxley and other strict U.S. corporate
governance regulations perceived as unduly burdensome.
Investment transactions in China today may have any of several objectives:
� Rapid entry, presence and brand identity in the China market through M&A
� Vertical integration to achieve scale, synergies and global reach
� Restructure or rollup of companies to prepare for acquisition or IPO
Whether the source is an equity partnership or a venture capital (VC) fund, the strategies are
similar: Build an experienced, credible management team; clean up the balance sheet; implement
global finance and accounting practices; streamline operations; and strengthen the core business
through M&A and vertical integration as needed.
Growing investment opportunity is reflected in increased interest in China by venture capital. A
survey of 505 venture capitalists worldwide, conducted by Deloitte and the National Venture
Capital Association during the second quarter of 2006, identified China and India as the top two
foreign countries where U.S. venture firms plan to put their money in the next five years. Both
countries are viewed as places where 1) it is less expensive to build businesses; 2) there is an
emerging entrepreneurial culture, and 3) there is a high quality deal flow. While India scored
highest in terms of access to quality entrepreneurs, China was the leader in terms of access to
foreign markets. China’s three main impediments to investing for U.S. venture capitalists surveyed
were intellectual property concerns, travel time and effort, and lack of knowledge/expertise
in the business environment. Another is the absence of a liquid IPO market in
China, which leads VC-funded enterprises to go public on the NASDAQ, in Hong Kong or on
other foreign exchanges.