Asia’s Private Equity News Source

avcj.com June 03 2014 Volume 27 Number 20

EDITOR’S VIEWPOINT

The PE spotlight turns back to China Page 3

NEWS

3i, Accel, Apax, Carlyle, Clearwater, Hony, HQ Capital, KKR, PEP, Piramal Capital, Providence, Sequoia, SIG Page 5

INDUSTRY Q&A

Magic Stone Alternative Investments’ Jenny Zeng Page 15

ANALYSIS

The VC rainmakers How entrepreneur ecosystems are changing China’s venture market FOCUS

Page 9

Renminbi managers grapple with an institutional challenge Page 20

GRAPHICAL ANALYSIS

China buyouts: Control or not control? Page 23

FOCUS

Untapped market A scale conundrum Insurers consider offshore fund options PRE-CONFERENCE ISSUE

Page 12

PE reconsiders China education exposure

AVCJ PRIVATE EQUITY AND VENTURE CAPITAL FORUM CHINA 2014

Page 17

Anything is possible if you work with the right partner Unlocking liquidity for private equity investors www.collercapital.com

London, New York, Hong Kong

EDITOR’S VIEWPOINT [email protected]

Red heat INVESTORS HAVE NOT BEEN CHASING AS hard as they used to on opportunities in Chinese private equity these past few years. It’s not hard to understand why: the combination of slowing economic conditions, frequently unrealistic valuations, the temporary closure of the IPO market, a government in transition have made opportunities elsewhere seem more attractive in the short term. There are, however, plenty of reasons for remaining bullish no China, not least because several of the factors listed above have to some extent abated. Since the reopening of the domestic IPO market last December, foreign investors have rushed into China, with overseas capital accounting for 68% of the $440 million raised in the first quarter of 2014. We’ve also observed a rise in the number of completed deals and successful exits in the past six months as PE and VC firms regain their momentum. The recent $1.7 billion listing of JD.com – “the Amazon.com of China” – has resulted in great, though still mostly paper, profits for its backers. The company is still trading at a 30% premium to its IPO price, which may be a prelude what happens when Alibaba Group goes public this summer. Will this public market euphoria boil over to the private equity scene? That remains to be seen but early signs look promising. Statistics from our research team reflect this change. Since peaking in 2011 with a staggering

Managing Editor Tim Burroughs (852) 3411 4909 Staff Writers Andrew Woodman (852) 3411 4852 Winnie Liu (852) 3411 4907 Creative Director Dicky Tang Designers Catherine Chau, Edith Leung, Mansfield Hor, Tony Chow

$55 billion raised, new capital for China-focused vehicles has been slowly declining with last year’s total dropping below the $20 billion mark. However, preliminary year-to-date data indicate that the situation is stabilizing with close to $9.7 billion raised by 34 funds – pushing the total amount of China-focused private equity capital to more than $205 billion. The return of the IPO market is not the only reason to take another hard look at China. There are a number of encouraging developments such as domestic companies’ increasing propensity to use M&A, instead of R&D, as an instrument of growth. These same companies are also gradually opening up to investing in, collaborating with, and selling to private equity firms. Developments are not restricted to the private sector. The government is also playing a role in making the private equity industry more attractive with the easing of regulations, broader financial reforms and the launch of free trade zones. There can be little doubt that the Chinese private industry is in the process of recapturing not so much its former glories, as a more rational and value-oriented equilibrium.

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Beijing Representative Office No.1-2-(2)-B-A554, 1st Building, No.66 Nanshatan, Chaoyang District, Beijing, People’s Republic of China T. (86) 10 5869 6203 F. (86) 10 5869 6205 E. [email protected]

Fundraising in China

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The Publisher reserves all rights herein. Reproduction in whole or in part is permitted only with the written consent of AVCJ Group Limited. ISSN 1817-1648 Copyright © 2014

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Number 20 | Volume 27 | June 03 2014 | avcj.com

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NEWS ASIA PACIFIC

Carlyle acquires Japanese noodle snack maker

David Pierce appointed Asia head of HQ Capital

The Carlyle Group has acquired a controlling stake in Oyatsu Company, the Japanese manufacturer of Baby-Star ramen snacks. Financial details were not disclosed but sources put the value of the deal at more than JPY20 billion yen ($194 million) for a 51% stake. Set up in 1948, the company is based in Tsu in western Japan’s Mie prefecture and has a workforce of around 370. Its flagship product, Baby-Star ramen snacks, has been sold domestically since 1959. Made from the byproduct of noodle manufacturing, the snack is also available in China, Hong Kong, South Korea

David Pierce, previously a partner at FLAG Squadron Asia, has been appointed managing director and head of Asia at Harald Quandt (HQ) Capital. The firm, a private investment group owned by the Harald Quandt family of Germany, has approximately $12 billion in assets under management.

AUSTRALASIA PEP exits Australia’s Peters Ice Cream to UK’s R&R

Pacific Equity Partners-owned paper maker Asaleo Care, formerly known as SCA Hygiene Australasia, is looking to raise A$690 million ($642 million) in what would be the biggest Australian IPO this year. Asaleo, formerly is jointly owned by PEP and Swedish paper products company Svenska Cellulosa Aktiebolaget (SCA)

GREATER CHINA 3i exits auto parts firm to Chinese buyer 3i has sold Hilite International, a German suppler of auto engine and transmission parts, to China’s AVIC Electromechanical Systems for EUR473 million ($643.8 million), generating a 2.1x return. Hilite makes products intended to improve car fuel efficiency and reduce emissions. 3i acquired the company in 2011 for EUR190 million in an all-equity transaction.

Alibaba Group has agreed to buy a 10.35% stake in Singapore Post (SingPost) for S$312.5 million ($249 million), becoming the secondlargest shareholder in the national postal service provider. In addition to selling 30 million ordinary shares, the listed company is issuing 190.096 million new shares to Alibaba Investment at S$1.42 apiece.

Mobile app analytics platform App Annie has raised $17 million in new funding from existing investors IDG Capital Partners, Greycroft Partners and Sequoia Capital.The company has now raised $39 million in total.

and Vietnam. Oyatsu currently has three facilities in Mie and is currently planning to establish its first overseas manufacturing base in Asia. The company - which will continue to be headed by President Yoshiaki Matsuda - generated sales of JPY18.2 billion for the year ended July 2013. This is the first deal from Carlyle Japan Partners III, a vehicle launched in May last year with a target of around $1 billion. Carlyle’s last significant buyout in the country was in 2012, when it bought cleaning services provider Diversey for about JPY30 billion.

of investment led by Sequoia Capital. Chinese microblogging website Sina Weibo also participated in the round.

Apax to invest $15m in Zhaopin alongside IPO Zhaopin, a Chinese recruitment website which has previously raised capital from several VC firms, will receive $15 million from Apax Partners alongside a US IPO.

Sequoia leads $100m round for China news app

APG invests $650m in PEbacked e-Shang

Toutiao, a Chinese mobile news app operator, has received $100 million in a Series C round

Dutch pension fund APG Asset Management will invest up to $650 million for a 20% stake in

Number 20 | Volume 27 | June 03 2014 | avcj.com

China’s Alibaba to buy 10% stake in Singapore Post

Mobile app analytics firm App Annie raises $17m

Pacific Equity Partners (PEP) has exited Australia’s Peters Ice Cream to PE-backed UK ice cream company R&R. Local reports value the deal at around A$450 million ($416 million). Peters’ most popular brands include Drumstick, Connoisseur, Peters Original and Maxibon. PEP acquired Peters from Swiss food and beverage giant Nestlé for around $304 million in 2012.

PEP to list Australian paper maker Asaleo for $642m

Chinese warehousing developer and operator e-Shang. APG and e-Shang - which was founded in 2011 by two local entrepreneurs in conjunction with Warburg Pincus - will also establish a joint venture to build modern logistics real estate assets across China.

Hony completes $569m sell down of CSPC Pharma Hony Capital has made a partial exit from Chinese generic drugs maker CSPC Pharmaceutical Group, generating HK$4.41 billion ($569 million). Hony-owned Joyful Horizon sold 600 million shares in CSPC to third parties and 105.88 million shares to an entity owned by Dongchen Cai, the company’s chairman, at HK$6.25 apiece, according to a regulatory filing.

SIG commits $20m to China discount site 51Fanli SIG China has committed $20 million in a Series B round of funding to 51Fanli, a Shanghai-based online discount aggregation site. The site has previously obtained $10 million from Qiming Venture Partners and Steamboat Ventures in 2011, AVCJ Research’s records show.

Charm Communications accepts CMC buyout offer Chinese advertising agency Charm Communications has accepted a take-private offer from a consortium backed by China Media Capital (CMC) that values the NASDAQlisted company at around $180 million. The consortium, led by He Dang, Charm’s chairman and founder, will acquire all outstanding

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NEWS American Depository Shares that it doesn’t already own for $4.70 apiece.

Sequoia raises $530m for India fund

NORTH ASIA

Sequoia Capital has raised $530 million for its fourth India-focused fund, which has an expanded remit to take in opportunities in Southeast Asia as well. The fund will primarily invest in the technology, consumer and healthcare sectors. The team is particularly interested in mobile, online payment, big data, software-as-a-service, cloud computing, enterprise software and medical and lifestyle-related opportunities. Check sizes will range from a few hundred thousand dollars to $50 million.

Sequoia leads $100m round for e-commerce firm South Korean e-commerce platform Coupang has raised a $100 million round of funding led by Sequoia Capital that is said to value the company at more than $1 billion. A number of existing investors also participated in the round.

AIP Japan to launch $300m healthcare focused fund

Japan Industrial Solutions invests $98m in Unitika

SOUTH ASIA Clearwater in partial exit from Diamond Power Infra Asia special situations investor Clearwater Capital Partners has part-exited India’s Diamond Power Infrastructure by selling a 5.5% stake for INR271 million ($4.57 million) via an open market transaction.

Providence to buy stake in India shopping JV Providence Equity Partners has acquired a 50% interest in home-shopping channel Star CJ Network India from Star Group. The business is a joint venture with Korea-based CJ O Shopping. The size of the transaction is said to be in excess of $50 million. CJ O Shopping will retain its interest in the venture.

Bertelsmann, NVP back furniture marketplace Norwest Venture Partners (NVP) and international

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PE-backed Café Coffee Day eyes $1b India IPO Café Coffee Day - the Indian café chain backed by KKR, Standard Chartered Private Equity (SCPE) and New Silk Route Advisors (NSR) - is said to be considering an IPO next year.The company may seek a valuation of about $1 billion and plans to file a draft prospectus with the Securities and Exchange Board of India (SEBI) later this year.

Piramal Capital merges PE and lending arms Piramal Capital has merged its real estate private equity fund management business - Indiareit and its real estate-focused non-banking financial company (NBFC). The combined entity is known as Piramal Fund Management (PFM). Piramal Capital is the finance arm of Piramal Enterprises, the flagship company of Piramal Group.

Asia Investment Partners (AIP) Japan is launching its sixth healthcare-focused fund, which will specifically target the elderly care home segment. The fund is looking to raise JPY30 billion ($295 million).

Turnaround specialist Japan Industrial Solutions (JIS) has agreed to acquire a stake in listed textiles manufacturer Unitika for JPY10 billion ($98 million). JIS Fund 1 will purchase 10,000 new class C preferred shares.

$12.5 million payable after two years.

SOUTHEAST ASIA Sequoia has been active in India for eight years, making seed, venture and growth investments. It has backed around 75 companies, including search engine Just Dial, which went public in May 2013, raising $174 million, and outsourcing firm GlobalLogic, which was sold to Apax Partners last October. The new fund takes the total committed capital to the firm’s India funds to around $2 billion. The first entity, Sequoia Capital India Growth Fund I, raised $400 million in 2006. According to AVCJ Research, two funds followed in 2007 - a second growth fund of $725 million and an early-stage vehicle of $300 million.

media company Bertelsmann have teamed up to invest in Pepperfry.com, an Indian online marketplace specializing in furniture and home accessories. The size of the investment was not disclosed, but local media put it at around $15 million.

VC-backed medical advisory bought by Ebix Healthcare Magic, an India-based medical advisory service that won early backing from Accel Partners, has been acquired by NASDAQlisted on-demand software and e-commerce services provider Ebix. Ebix has paid $6 million in cash for the business plus an earn-out of up to

KKR agrees $1.1b deal for Singapore’s Goodpack KKR has agreed to buy Goodpack, the world’s largest manufacturer of intermediate bulk containers (IBCs), for S$1.4 billion ($1.1 billion). It plans to delist the company from the Singapore exchange. The private equity firm will pay S$2.50 per share for all outstanding shares in the company through a scheme of arrangement.

GGV leads $15m round for taxi-booking app GGV Capital has led a Series B round of funding worth more than $15 million for GrabTaxi, a Southeast Asia-focused taxi-booking mobile phone app. Qunar, a NASDAQ-listed Chinese travel platform that is majority-owned by Baidu, also participated alongside existing investor Vertex Ventures.

Clearwater sells jack-up rig to Middle East buyer Asia special situations investor Clearwater Capital Partners has sold a jack-up rig built in a Singapore shipyard to a drilling services partnership between the Saudi Arabian government and Schlumberger. The Keppel FELS B Class jack-up rig is the first of two Clearwater placed in late 2013. Keppel FELS is a network of offshore yards owned by Singapore’s Keppel Offshore & Marine.

avcj.com | June 03 2014 | Volume 27 | Number 20

This announcement appears as a matter of record only.

Innovative Directions in Alternative Investing

$1,025,000,000 Senior Secured Revolving Credit Facility Provided to

Lexington Partners Co-Lead Arrangers Citibank, N.A. Wells Fargo Bank, N.A. Administrative Agent Citibank, N.A. Lenders Citibank, N.A. Wells Fargo Bank, N.A. Bank of America, N.A. Lloyds Bank PLC

February 2014

创新无极限

Innovation without limits

Cooley’s Global Private Investment Funds group is highly

科律的全球私募投资基金业务组致力于为位于中国

specialized in serving private equity, growth equity and

以及面向中国投资的私募基金、成长型基金和创投

venture capital clients. We have extensive experience

基金提供高度专业化的服务并拥有丰富的全球及中

assisting funds located or investing in China.

国经验。

We have been involved in the China investment funds

自1989 年起科律就一直参与中国私募投资基金市

market since 1989—longer than any other global law firm.

场的法律服务，起步早于任何其他全球性律师事务

We form more dollar-denominated China venture capital

所。科律协助成立的专注投资中国的创投美元基金

and growth equity funds than any law firm worldwide. In

和成长型美元基金在数量上远超过任何其他律师事

2014 year-to-date, we have organized in excess of USD

务所。自2014年至今，我们协助成立的中国创投

$1.6 billion in China venture capital and private equity funds.

基金和私募基金规模已超过16亿美元。

科律律师事务所 www.cooley.com © 2014 Cooley LLP, IFC - Tower 2, Level 35, Unit 3510, 8 Century Avenue, Pudong New Area, Shanghai, 200120, China, +86 21 6030 0600 中国上海浦东新区世纪大道8号国金中心二期35楼3510室, 200120 电话: +86 21 6030 0600

COVER STORY

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The virtuous circle

China’s VC market is evolving as funds started by or raised from founders of first-generation internet firms. Concerns about conflicts of interest must be addressed, but the influence of their ecosystems will grow JUST OVER TWO YEARS AGO, ANDREW Teoh passed up a role on Chinese e-commerce giant Alibaba Group’s mega IPO for a career helping companies get started on the journey that might end in a public listing. The world will soon find out whether Alibaba Group can live up to the hype. Teoh, meanwhile, is preoccupied with Ameba Capital, the VC firm he founded with the former CFO of Kingsoft Holdings. “A lot of people asked me why I was leaving a potentially $200 billion company, but I went to Alibaba to really learn how companies work, having previously been only on the advisory side,” Teoh explains. “I always wanted to start my own business and every step in my career has been geared towards that goal.” Previously a banker in the tech, media and telecom (TMT) space, Teoh joined Alibaba in 2005 to focus on corporate development. This included participating in Yahoo’s investment in 2005 and the IPO of B2B division Alibaba.com. He moved on to corporate finance where his last major project was the $1.6 billion deal that likes of Silver Lake and Temasek Holdings get equity in the company. Teoh’s present existence is far removed in pure dollar terms. Ameba raised $25 million for its debut fund, principally from successful entrepreneurs and tech sector investors. It has backed 22 start-ups, has three exits in the pipeline, and is now preparing to launch a successor fund with a bigger target.

A rising tide Ameba is just one member of a new vanguard of Chinese PE and VC firms that is able to raise money by dipping into the growing ecosystem of domestic entrepreneurs. Either started by or raised from founders of successful firstgeneration internet businesses, these funds have a pedigree that is rooted extensive deal-sourcing networks and proven operational ability. “A lot of people have made money in the tech sector and some of them are coming into the buy side, self-funding or raising capital from within their circle,” Teoh adds. “You are going to see more and more of that. Not only people like myself, but also guys leaving the big VC firms to form their own funds and raise money from people they know.”

Number 20 | Volume 27 | June 03 2014 | avcj.com

Venture capital fundraising in China for the first five months of 2014 reached $5.2 billion, beating the totals for the previous two years in full. There is a cyclical element to this. Nearly half the capital raised went to Legend Capital, GGV Capital, Matrix Partners, Qiming Venture Partners and DCM. They all raised their previous vehicles between 2010 and 2012 so were expected to return to market in 2013-2014. This almost synchronized activity is in part responsible for the China VC fundraising spikes in 2011 and 2008. But this old guard is increasingly complemented by the new. Yunfeng Capital, a tech-focused private equity firm, recently closed its second fund at $1.1 billion. The firm was set up by David Yu and Jack Ma, founders of Target Media and Alibaba, respectively. Vision Knight Capital, founded by ex-Alibaba. com CEO David Wei raised $550 million for its

Vision Knight’s Wei reports a similar experience between his two funds. Institutional players account for 70% of the Fund II corpus but it was a very different story the first time around. “With Fund I it is very difficult to win the trust from institutions because you have no track record and your strategy needs time to be proved,” Wei says. “We went for high net worth entrepreneurs. We wanted them not just to put in money but also be part of our network. In Fund I we had four institutional investors and they were all introduced by entrepreneurs’ family offices.” Even though space in Vision Knight Capital Fund II was limited, the number of entrepreneurs participating has actually doubled to 36. Wei likens them to buying an insurance premium: “You don’t need them immediately but maybe you will need them in the future.” Half the deals in Fund I came through entrepreneur introductions,

“We went for high net worth entrepreneurs. We wanted them not just to put in money but also – David Wei be part of our network” second fund. Vision Knight targets the consumertechnology space and, given the partners’ operating backgrounds, classifies itself as a PE firm. Shunwei Capital Partners, founded by super angel, Kingsoft veteran and Xiaomi CEO Lei Jun, closed its second fund at $525 million. Other angel investors have also launched vehicles, notably ZhenFund, created by Bob Xue and Victor Wang, founders of US-listed New Oriental Education, in conjunction with Sequoia Capital, and C.C. Zhuang, co-founder of travel site Qunar, who started Crystal Stream Capital. There is one fully-fledged VC spin-out. The TMT investment team from IDG Capital Partners departed last year to form Banyan Capital and they closed their debut vehicle at $206 million in January. The LPs are predominantly CEOs of companies they backed while at IDG. This compares to Yunfeng raising its first fund almost exclusively from a set of leading founding partner entrepreneurs. However, the firm managed to diversify its LP base for Fund II, picking up allocations from several institutional players.

but there is no guarantee of the same happening in Fund II. Value-add could come through day-today consulting on portfolio companies. GGV Capital is one of a number of established players that carves out an entrepreneur sidecar vehicle alongside its main fund in order to create an alignment of interest with potentially useful players in the technology space. Hans Tung, managing partner at GGV, explains that while the firm’s ties to the likes of Baidu, Alibaba and Tencent Holdings (the BATs) are well established, it wants to maintain relationships with executives from businesses in the tiers below. “You have first-generation entrepreneurs and VCs. They know each other, they started businesses together, and now they are putting money into businesses started by secondgeneration entrepreneurs,” says Lye Thiam Koh, principal at Northgate Capital. “Experience and capital is being recycled into the system and making it more robust.” This phenomenon is by no means unprecedented. The virtuous circle is well-

9

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“But there is also a big difference between talking about investing money and being a custodian of money. If you have a background in finance the compliance side becomes instinctive. Some entrepreneurs will struggle if they don’t have the patience to deal with the administrative side, and that’s not only being a fiduciary but also managing a team.” The implication is that not everyone is cut out to manage money once their LP base stretches beyond friends and family and into institutional territory. It is worth noting that Vision Knight’s Wei and Ameba’s Teoh both forged careers in finance before moving into operations. At Shunwei, Lei Jun teamed up with Tuck Lye Koh, previously of GIC Private and C.V. Starr. As such, Teoh considers himself to be part of the Alibaba ecosystem but not typical of it.

become an aggressive M&A player and is said to have backed several VC funds. Now online retailer JD.com have gone public it is expected to embark on a series of acquisitions and online video provider Youku Tudou may do the same. It begs the question when ecosystems become a vice rather than a virtue. There are certainly risk factors involved, not least that a fund perceived to be aligned with a particular company could essentially become an extension of its M&A efforts. Then and now Alibaba has invested alongside Yunfeng on That China is now following suit is a sign of the several occasions and then Yunfeng participated deepening investor and entrepreneur pool. in the 2011 investment in Alibaba that featured The contrast with the environment less than 10 Silver Lake and Temasek. years ago couldn’t be starker. In 2005, having Alibaba committed $100 million to Yunfeng’s co-founded online travel agency Ctrip and taken second fund and the company said in its IPO it public, Neil Shen formerly entered the VC filing that the alliance is beneficial to its business. space as managing partner of Sequoia Capital’s The LP tie-up “formalized an China franchise. While he may well institutional relationship” with the have been able to raise a fund Recently closed China VC and tech-focused PE funds GP. “We expect that, through its independently, Shen opted to align expertise, knowledge base and with the brand, knowledge base Amount Predecessor Predecessor Fund Date closed (US$m) closed size (US$m) extensive network of contacts in and fundraising expertise of a US private equity in China, Yunfeng firm. Yunfeng Fund II May-14 1,100.0 Jun-10 307 Capital will assist us in developing Sally Shan, head of China at LC Fund VI May-14 500.0 May-11 515 a range of relevant strategic HarbourVest Partners, describes GGV Capital V* May-14 622.0 Aug-12 509 investment opportunities,” it said. then and now as China PE 1.0 Matrix Partners China III Apr-14 350.0 Apr-11 350 Teoh is upfront about the versus China PE 2.0. In 1.0, GPs perceived conflicts that might would leverage whatever affiliations Vision Knight Capital Fund II Apr-14 550.0 Mar-13 250 arise if Tencent were to emerge they could to get started, whether Qiming Venture Partners IV Mar-14 500.0 May-11 450 as a strong partner for a portfolio it was a US VC firm or a Chinese DCM Ventures China Fund Mar-14 330.0 Jun-10 400 company in an Ameba fund with corporation like Legend Holdings or (DCM VII)* LPs including current and former CITIC Group. Banyan Partners Fund I Jan-14 206.0 members of Alibaba and Kingsoft. “The supply of capital was * Also invests in US “We have also invested alongside limited and trust and credibility Source: AVCJ Research Baidu, non-BAT strategic corporates were hard to gain among the LPs and typical VC funds, so it’s pretty without a track record,” she says. neutral across the fund,” he says. “At the end of “Under China PE 2.0, there are Chinese individuals He expects more spin-outs but with a view to starting pure operating businesses, not funds. the day the portfolio company is number one and organizations participating as LPs. The deal The other obstacle is simply time. Many and we want to be objective.” sourcing opportunities and ways to create value entrepreneurs remain fully occupied by the He stresses that marketing efforts for and secure exits are deeper..” businesses through which they made their Fund II will be based on exits – as evidence Derek Sulger, now a partner at consumerfortunes and not in a position to make angel of a systematic business model – not Alibaba focused buyout firm Lunar Capital, was in a investments, let alone set up institutional funds. connections. Vision Knight’s portfolio also has similar position to Shen nearly a decade ago. “It takes a lot of work to raise a professional fund minimal Alibaba crossover and Wei expresses a He had founded wireless value-added services and I don’t think many entrepreneurs will do it,” similar view on fundraising. “It helps to open the provider Linktone and taken it to NASDAQ says GGV’s Tung. “They would put money into door, but it doesn’t mean too much when you the year after Ctrip. Sulger was approached by raise money. It doesn’t prove you are a good fund several US VC firms looking to set up China-based sidecar vehicles instead.” manager.” affiliates but ultimately chose to go it alone in PE. The general consensus is it best to remain Sulger identifies two qualities that made Shen Risk factors independent as long as possible and only bring stand out. First, he was an entrepreneur with While the Alibaba ecosystem may have made in a strategic partner if there is a particular need experience of running a business and this had the most visible contribution to Chinese private – and then make a selection based on what best inculcated a belief in the value proposition of equity – with Vision Knight, Ameba and Yunfeng serves the portfolio company. As one industry making investments in platform-like companies – the full scale of funds, start-ups, M&A events participant observes, Alibaba brings money and and using them to find other synergistic and LP commitments that can in some way be credibility but is hands-off in its approach, leaving opportunities. Second, he previously worked as a traced back to alumni of the BATs is virtually the entrepreneur to address issues. Baidu and banker and then as a CFO. impossible to fathom. And it doesn’t stop there. Tencent, meanwhile, are known for using their “The guys who have raised funds have Another ecosystem has arguably sprung up clout to bring user traffic to start-ups. something they deeply believed in and the around the Lei Jun-Kingsoft-Xiaomi axis; Qihoo The relatively small size of China’s start-up stubbornness of an entrepreneur,” Sulger says. 360, a US-listed antivirus software developer has established in Silicon Valley and perhaps best exemplified by the “PayPal mafia,” named for the start-up money-transfer service sold to eBay in 2002. PayPal alumni have since set up, joined, merged or invested in a vast array of VC firms and start-ups, including the likes of YouTube, Yelp, LinkedIn and Tesla Motors. The mafia epithet has since been attached to networks emanating from Facebook and Twitter.

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avcj.com | June 03 2014 | Volume 27 | Number 20

COVER STORY

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community and classic complaints about a lack of transparency doesn’t help the perception issue. GGV’s Tung admits that China is more incestuous than the US because there are fewer professional managers, although he adds that they are less inclined to flip start-ups. Northgate’s Koh adds that LPs look closely at the ability of individuals within a VC firm to remain impartial and independent. “It is good to have certain affiliations when you are just starting and the industry is young but perhaps less so as it matures,” he says. “If you look at the US today you don’t see VCs that are affiliated to Cisco, Microsoft or Google because they are independent.” Governance is another concern. LPs are wary of being denied access to timely information that allows them to track fund performance because the manager hasn’t put in place strong reporting infrastructure. It comes down to whether they see the value in creating a long-term institutional franchise or, as one industry participant puts it, “taking the low-hanging fruit because there is a relationship.” The latter approach doesn’t bode well for the performance of subsequent funds once the fruit runs out. “They don’t have the urgency to work really hard as some of the more professional firms on developing a strategy and building a team

because they don’t need to,” an LP adds. “People don’t know how many funds there will be. They don’t have to form the LP-GP relationship. A lot of institutional investors are not familiar with this from the first generation of GPs.” These fears have yet to be fully realized and the transition from entrepreneur-dominated Fund I to institution-dominated Fund II experienced by several players suggests LPs are comfortable with what they are seeing. For some institutions, there might be an acceptable tradeoff between a slightly lower level of transparency and the bumper returns that come through exposure to strong start-ups that emerge from a particular ecosystem. HarbourVest’s Shan adds that the new managers offer strategies that are tailored to the needs of the market, taking a deeper dive into specific sub-segments and thereby allowing LPs to be more selective and refine their strategies.

Still singing The important caveat is that all this is taking place at a time when the market is going up. Fundraising has spiked thanks to established players coming back to market and new entrants breaking through, but performance is also a factor. PE-backed IPOs on US exchanges by

companies in the TMT, healthcare and education spaces have raised nearly $2.5 billion from five offerings so far in 2014, more than any fullyear total on record. Six companies generated proceeds of $657.3 million last year, a marked improvement on 2012 when confidence in Chinese stocks collapsed for a while. Trade sales have been similarly robust, reaching a record high of $4.5 billion from 27 deals in 2013 and the nearly $1 billion for the first five months of this year. As the fervor over Alibaba suggests, valuations are heady and the venture capital industry itself is cyclical. The virtuous circle represents a fundamental shift and it is here to stay, but it remains to be seen how LPs behave when the market turns. Do they become less accommodating towards newer GPs or will these managers outride the storm, supported by their industry knowledge and operational capabilities? “I wouldn’t be surprised if there are more groups raising their first funds in the next couple of years, provided the market is doing well and there is enough liquidity in the system, “ says J.P. Gan, managing partner at Qiming Venture Partners. “As long as music keeps on playing everybody will be happy, but the question remains when the music will stop.”

The most authoritative and comprehensive guide to private equity investors in Asia Asian Private Equity Online Directory The Asian Private Equity Online Directory is the most comprehensive online directory on private equity and venture capital in Asia. It is easy to navigate, enabling access to a listing of around 3,900 Asian private equity firms and over 9,600 professionals. For a free trial, please visit asianfn.com/VCDemo. To subscribe, call Sally Yip at +(852) 3411 4921 or email [email protected] avcj.com

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Tortoise, not hare Foreign private equity firms see Chinese insurers as an untapped yet potentially lucrative LP market. But how soon might these institutions have the will and skill set to put capital to work? insurers were only allowed to invest in domestic Ng, a partner at Atlantic-Pacific Capital. “But as a CHINESE INSURERS ARE TAKING BABY PE from 2011. The following year the cap on whole, not all China-based insurance companies steps. More than 18 months after receiving exposure to private funds and companies was are actually active in making investments in the go-ahead to invest in offshore private raised to 10% from 5%. Earlier in 2014, the international funds.” equity funds, few have made the leap. China regulators decreed that investments in public For many, the primary focus is still funds in Reinsurance (China Re) was the first, committing and private equities combined could account for the domestic market or looking at opportunities $30 million to KKR’s eleventh North American 30% of the total assets. for direct deals. Where overseas allocations have fund, which closed last October at $8.3 billion – a “Theoretically, insurers’ appetite towards come under consideration, it tends to be in the classic safe bet. private equity should be increasing as the CIRC is context of diversifying risk. As one insurer tells Industry participants expect much more from easing curbs,” says John Qu, vice general manager this relatively untapped LP constituency, not least AVCJ, chasing high returns is the number two of asset management at China Re. “However, priority. The primary concern is that exposure to because of their huge asset bases and longthey may not be as excited about it as people are renminbi-denominated funds ties their fortunes dated liabilities are well suited to private equity. anticipating.” to those of the domestic economy. For their part, insurers are said to be building inInsurers are essentially still approaching the Chinese insurers’ overall offshore investment house investment teams and exploring channels asset class with a public markets mindset. They is capped at 15% of total assets, including for converting onshore premiums into offshore are thinking in terms of immediate results, not fix-income products and private equity fund capital. developing programs to construct private equity investments. No insurer is anywhere near With the China Insurance Regulatory portfolios that generate longer-term returns. approaching this threshold. China Life Insurance Commission (CIRC) taking a significant step to “They understand there should be liberalize the rules, insurers might a return premium in the long term be poised to become a significant however a short term J-curve can target market for international GPs, be challenging during the buildup joining the likes of China Investment Investor Type Assets (US$b) phase,” explains Frankie Fang, China Corporation (CIC) and the State China Investment Corporation Sovereign wealth fund 575 representative at LGT Capital Partners. Administration of Foreign Exchange “The majority of their holdings are (SAFE). State Administration of Foreign Sovereign wealth fund 568 Exchange still in the public equities and the The question is not so much if but bond markets where the insurance how soon and how much. Should China Minsheng Banking Corp Bank 553 companies have greater visibility and investor relations departments China Life Insurance Insurance company 333 liquidity.” be factoring a potential bumper Export-Import Bank of China Bank 253 insurance allocation into their National Social Security Fund Sovereign wealth fund 180 projections for the next 3-5 years? Brand awareness Even when insurers begin to Pacific Asset Management Asset manager 132 venture overseas, they will inevitably Big ambitions TEDA Investment Holding Investment company 129 gravitate towards established brand “Chinese insurers are preparing for Taikang Asset Management Asset manager 93 names, along the lines of China Re’s it. Quite a few of them have started New China Life Insurance Insurance company 86 commitment to KKR, which remains doing research into what they can *List does not include private equity firms and fund of funds managers. the sole offshore manager in its or can’t do when making alternative Source: Preqin portfolio. Reputation, longevity and investments, but the process is very track record featured prominently in slow and it takes time to understand and Ping An Insurance, the two largest players the selection criteria. the international market,” says Lorna Chen, by premiums, each have more than RMB1 trillion “It’s more difficult for us to select overseas GPs partner with Shearman & Sterling. “When will in assets, which means around RMB150 billion because we don’t know much about them and it they take the first steps? It depends. There’re could feasibly be deployed overseas. is not as easy to communicate with them as with several factors.” “There will only be small steps at this stage,” domestic managers,” says Qu. “When we looked First of all, not every insurer has decided the aforementioned insurer adds. “There will be at previous KKR vehicles in the same series, there whether or not it will make private equity some overseas investments over the next two were virtually no losses. Performance might not allocations outside of China and how significant years, but not much. It takes time to build up the be as strong as some others, but returns have a role the asset class should play in their wider team and assess performance once investments been very stable.” portfolio. have been made. We will only accelerate our Wariness is also the product of past failure, “It’s definitely a group of LPs with a lot of pace once we get used to it.” albeit not in private equity. Ping An made its growth potential and a lot of people are trying This lack of familiarity is due to the fact that first high-profile foreign direct investment in to establish contacts in the market,” says Vincent

Top China LPs by assets

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avcj.com | June 03 2014 | Volume 27 | Number 20

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2007, acquiring a minority stake in BelgianDutch financial services group Fortis, with a view to purchasing half of the company’s asset management unit. However, the plan was scrapped as Fortis fell victim to the global financial crisis. Ping An had to write down most of its RMB23.8 billion investment when Fortis was nationalized and sold off in 2008. Two years ago, the insurer filed an international arbitration claim to try and recover some of the losses. Regardless of the asset class, insurance companies want to understand the risks fully before participating. As such, although they have made contacts with foreign GPs and service providers, and studied overseas private equity portfolios, progress is slow. As one industry participant puts it to AVCJ, “Every insurer is watching and waiting to see who will be the first to invest and what they are investing in order to obtain more reference.” Under the CIRC’s rules, insurers are only allowed to participate in private equity only as an LP, which isn’t actually what they want. There is a desire to make direct investments independently and, with this in mind, China Life is building its asset management subsidiary to invest in fixed income and public and private equities. The company wants to source capital from its parent and ultimately raise funds from third parties. “It seems to be in the DNA of Chinese enterprises that they first try to do something on their own before investing or partnering or soliciting the services of an outside party,” says Chris Lerner, head of the China practice for Eaton Partners. “In our early conversations with Chinese insurance companies, we find this to be true as well. We expect them to an LP, but when we meet them we find their primary interest lies in raising a direct or joint venture fund that leverages their network and platform.” China Re is one of the few to think from a LP perspective, adopting a passive attitude towards asset allocation and using fund managers, according to Vincent Wang, managing director at consultancy Promise Advisors. China Re originated from the People’s Insurance Company of China (PICC) and remains the country’s only state-controlled reinsurer. It set up a two-man alternative investment team in 2011 to cover private equity and real assets. The team now numbers 12. The insurer has just $100-200 million earmarked for deployment with offshore GPs over the next two years. There is a bias towards bigger funds and plans to develop mid-market exposure via the fund-of-funds route. The group’s ultimate aim is to establish itself as a fund-offunds, following in the footsteps of overseas counterparts HarbourVest Partners, which was

Number 20 | Volume 27 | June 03 2014 | avcj.com

Strategic angle Chinese corporates, both state-owned and private-held, were the first batch of domestic institutions to invest overseas, including making commitments to private equity funds. It is part of a broad effort by the Chinese government to encourage “local champions” to build international exposure as a means of accessing new technologies, assets and expertise. Last month, Shanghai-listed Hainan Zhenghe Industrial Group agreed to invest $130 million in First Reserve’s latest energy-focused PE fund. The commercial property firm said it wanted to expand its portfolio to cover petroleum and natural gas business. Under the agreement, Zhenghe not only has co-investment rights in North American deals but will also set up an Asian-focused fund with First Reserve. “Given, First Reserve is one of the largest fund investors in the global energy sector, in my opinion, this LP investment is more skewed towards being a strategic investment rather than purely motivated from an asset allocation perspective,” says Vincent Ng, a partner at AtlanticPacific Capital. “Investors making such strategic investments are generally motivated with obtaining benefits like getting access to co-investment deal flow or learning about the sector to build knowledge for future direct investment needs.” In contrast to sovereign wealth funds and insurance companies, Chinese corporates with cash in their pockets and a desire for PE exposure are not a standard target market for GPs. As such, they can be difficult to identify. They also come in different forms and have varying motivations, for example one corporate might have a large amount of offshore assets while another wants to cover renminbi assets into US dollars. Another issue concerns capital outflows. Chinese companies require approval from different authorities before committing to an overseas PE fund. “For the state-owned enterprises, or private companies in China, if they don’t already have US dollars, they have to get approvals from the National Development and Reform Commission and the State Administration of Foreign Exchange. Even companies that already operate overseas need some approvals. This process can be long and painful,” says Lorna Chen, a partner with Shearman & Sterling.

originally a subsidiary of John Hancock Insurance. “However, direct investment will not be our core business; our main job is seeking out the best fund managers.” Qu says.

Regulatory obstacles For all the CIRC’s reforms, regulatory uncertainty remains the final – some would say decisive – factor in restricting the pace of overseas investment. There is lack of guidance on specific processes, such as whether insurers have to get approval on a deal-by-deal basis. “We want to invest overseas, but the regulator has a more conservative attitude towards offshore investments, especially when we talk about product innovation,” says one insurer. “Anything that isn’t listed in the guidance we can’t do and lobbying takes a long time. At some point the rules will have to be revised to reflect the reality.” At present, the CIRC’s guidance only covers requirements for fund size, the manager’s paidin capital and team size. Another gray area is whether offshore assets can be used in overseas investments, which would offer a way around all the red tape. China Life, Ping An, China Taiping Life, China Pacific Insurance and PICC all have

Hong Kong-listed subsidiaries. “Restrictions on Chinese insurers’ overseas asset allocation will be relaxed over the next five years. However, much of their income comes from selling products to mainland Chinese, so they don’t have that many offshore assets,” says Promise Advisors’ Wang. “It is still not clear whether onshore assets could be transferred offshore to make investments.” However, this doesn’t limit the opportunity for China-based insurance companies to learn from their Hong Kong-listed counterparts, which have greater exposure to international investment markets. In this way they can build up their capabilities over a variety of asset classes and emerge as more mature LPs, perhaps with an appetite for PE – although approaches may vary. “Over the next five years, Chinese institutions, including most of the insurance companies, won’t classify themselves clearly as LPs, GPs or fund-of-funds. They will try to invest across all asset classes by playing different roles. It’s an evolving process,” says says Dayi Sun, managing director at Jade Invest. “Western institutions have also experienced that. When they realized they didn’t have expertise in a certain area, they narrowed their focus.”

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JENNY ZENG | INDUSTRY Q&A [email protected]

Magic touch Jenny Zeng, managing partner of Magic Stone Alternative Investments, shares her views on emerging Chinese LPs, specialization among fund managers, and opportunities in the secondaries space Q: Renminbi-denominated fundraising is been on the slide these past two years. What is the problem? A: It’s difficult for managers to raise capital at the moment. The most important issue is the lack of long-term intuitional investors. Insurance companies and the National Social Security Fund (NSSF) are evolving into important LPs. All fund managers in China have big expectations for insurance companies in particular. However, the institutional market has yet to mature. For example, insurance companies are still not really active investors in private equity funds as LPs. First, the China Insurance Regulatory Commission (CIRC) restricts them from investing more than 10% of their total assets in the asset class, and then they have to report to the regulator on a deal-by-deal basis. Second, they are not comfortable with the management fees that must be paid to GPs. And third, they are also restricted in terms of the managers they are able to back. A GP must have at least RMB3 billion ($480 million) in assets under management and a lot of emerging renminbidenominated GPs don’t qualify. Q: What are insurance companies doing in terms of developing their private equity investment teams? A: Currently every insurance company has an investment department but many of them are staffed by just 2-3 professionals. They don’t have enough time to do due diligence and often rely on third-party financial advisory firms to assist them with it.

Q: To what extent are you now seeing specialization, particularly in terms of sector, among renminbi GPs? A: We call the last decade the “golden PE market” – a lot of renminbi fund managers could easily raise capital and make good returns by relying on a preIPO strategy. The IPO market shut down last year, and although it has since re-opened, these pre-IPO mangers have become less attractive. The renminbi funds market is consolidating and this will continue. We now prefer to back real value-added players, often with a particular sector focus. Where we do go into generalist funds, they must have a stable team and a proven track record.

Q: How does Magic Stone position itself in this changing environment? A: We don’t refer to ourselves as a traditional fund-of-funds – we are a hybrid fund manager. Half of the capital we raise

Q: China is still a growth capitaldriven market, but does a predominantly buyoutfocused fund now represent a viable strategy? A: A lot of US dollar managers have wanted to do buyouts over the past few years but the market wasn’t ready for it. Now I think there are opportunities for GPs raising reasonable size buyout on both the US dollar and renminbi sides. You increasingly find entrepreneurs want to get out of their companies, but the second generation doesn’t want to take over the business. They have often been educated overseas, they might have experience working for investment banks, and they have no desire to take over a real operating business. US dollar managers have more professional skills and experience in this space, but the renminbi funds will find it easier to structure deals from a legal perspective.

“We now prefer to back real value-added players, often with a particular sector focus. Where we do go into generalist funds, they must have a stable team and a proven track record”

Number 20 | Volume 27 | June 03 2014 | avcj.com

covering the Chinese market for more than a decade and we can offer expertise in this area. The other half of the capital we raise is for direct and coinvestment. Q: You previously were considering launching a dedicated secondaries fund. What happened and how closely are you involved in the secondaries market?

is allocated to selected fund managers through a comingled fund-of-funds. We follow emerging GPs especially closely because our team has been

A: We are not raising secondaries fund but we are active in secondaries deals in China. We use the secondaries market to shorten our j-curve as well as to invest in funds of different vintages. That is important to our strategy. There are a lot of individual LPs that entered the market without really understanding the long term and low liquidity nature of the asset class. They signed all the legal documents but then three years later they say they cannot continue. We will source these positions via GPs that we know well. These firms would sometimes rather come to us than put a secondary position on the open market. Q: Would you ever deal with these individual LPs as investors in your funds? A: We tend not to deal with them directly. When we come across these high-net-worth individuals, we often try to persuade them to set up their own family office and then educate them on how to allocate to allocate resources globally, not just in China, and not just in private equity but also in fixed income, hedge funds, and so on, so they can diversify risk.

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Competitive edge Five months into 2014 and PE activity in China’s education sector is at its highest level in six years. Wary of the issues tied to creating a large footprint, investors are picking their segments and geographies carefully

Number 20 | Volume 27 | June 03 2014 | avcj.com

12-month total since 2008. The other was CVC Capital Partners’ acquisition of a majority stake in EIC, which provides counseling services for students who want to go overseas, for a reported $200 million.

New channels Three channels have traditionally been most popular among PE and VC investors in Chinese education: private schools along the lines of Nord Anglia, which caters to kindergarten through Year 12 (K12), test preparation and after school education services, and vocational training. The business models within these silos are evolving,

“Education is much less scalable than a lot of PE and VC guys initially thought” – J.P. Gan

from that vintage – Xueda Education Group, TAL Education Group, Global Education & Technology Group and Ambow Education – listed in the US in 2010, although Ambow is now the subject of a liquidation order. New Oriental remains the largest private educational services provider in China, but Zhaoyu Zheng, a principal at ZhenFund, a seed vehicle set up by the co-founders of New Oriental in conjunction with Sequoia Capital, notes that the model is under stress. “In the past supply was equal to demand and competition wasn’t that furious,” Zheng says. “They continue to spend money acquiring customers, rent for centers and teacher salaries are increasing, but classsizes and profit per class are in decline.” New Oriental had 2.5 million student enrolments last year and a network of 57 schools, 669 learning centers and 32 bookstores across 50 cities, as well as 8.5 million registered online users. It begs the question, how big is too big, especially without the insulation of substantial barriers to entry.

PE investment in China's education sector 350

20

300 250

15

200

Deals

US$ million

NORD ANGLIA EDUCATION OPENED ITS first school in China 12 years ago. The British International School Shanghai had an initial capacity of 100 places. Fast forward to the present, the facility now has space for 1,800, having grown lock-step with the Pudong district in which it resides. The company, which was taken private by Baring Private Equity Asia in 2008 and re-listed in the US last month, owns five schools in China. They are part of a network of 27 covering Asia, the Middle East, Europe and North America that teach the UK curriculum to more than 17,000 students. Three of the four other China-based establishments have more than doubled in capacity since acquisition. China accounted for 36% of Nord Anglia’s pro forma revenue of $323.7 million for the year ended August 2013. Speaking to AVCJ last year, Baring Asia CEO Jean Eric Salata identified three fundamentally attractive characteristics of education: customers tend to pay for courses up front; once students enroll they usually don’t leave until graduation; and the industry is not easy to penetrate, with reputation, curricula and credentials essential in the top tier. For Nord Anglia specifically, he might have added that success depends on identifying a market niche. Nearly all of the company’s students in China are expatriates, leveraging an exclusive but growing constituency in the tierone cities of Beijing, Shanghai and Guangzhou. It represents a capital-intensive yet niche play in a market in which a nationwide footprint is hard to develop. “Education is much less scalable than a lot of PE and VC guys initially thought,” says J.P. Gan, managing partner at Qiming Venture Partners. “The business has been cash rich but difficult to expand geographically. There hasn’t been nearly as much consolidation as one might think.” Qiming invested in several classroom-based education businesses before turning its attention to online solutions and backing TutorGroup, an English-language tuition platform. The VC firm participated in a Series B round worth $100 million for TutorGroup earlier this year, led by Alibaba Group and Temasek Holdings. It was one of two transactions largely responsible for PE and VC investment in the education sector reaching $329.5 million so far this year, higher than any

150

10

100 50 0

0 2004

2005

No. of deals

2006

2007

2008

2009

2010

Amount (US$m)

2011

2012

2013

2014 YTD

Source: AVCJ Research

however. Few seek to emulate the likes of New Oriental Education, ChinaEdu Corp. and China Distance Education Holdings, all of which went public between 2006 and 2008 on the back of plans to create large, nationwide networks of language training and test preparation providers. Their success gave birth to a host of similar investments, which saw deal flow jump from $39.4 million across nine transactions in 2006 to $251.6 million and 19 deals in 2007, followed by $337.4 million and 16 deals in 2008. Four

Last October, Bain Capital completed the $140 million acquisition of a majority stake in RISE China, a provider of after-school English language programs for pre-kindergarten through K6. The company has 34 directly-owned schools in Beijing, Shanghai and Guangzhou and a further 126 schools run by franchisees. Lihong Wang, a managing director at Bain, is bullish on the market opportunity – there are 26 million 3-12 year-olds in China’s 100 largest cities and even if only a fraction can afford RISE’s services it

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still makes for a strong demand base – but notes that local conditions vary. “Recruiting students and delivering good results in Beijing may not be the same for schools in Shanghai,” she says. “We’ve had better results in Beijing, but after 3-4 years we think we have cracked the code in Shanghai, and then we opened up in Guangzhou two years ago and it’s ramping up. It is a big market but scalability is not automatic.”

Expansion issues Other obstacles are more practical in nature. Education is a cash generative business, with students paying for courses up front, but it is also capital intensive. Building out a network of schools requires investment in premises, staff and marketing before the first student walks in. On the regulatory front, the Ministry of Education has bureaus in each province and city that is responsible for issuing licenses. Stephen Ip, education sector lead for transaction services at KPMG China recalls working with a client keen to enter the Qingdao market only to be told that the authorities were no longer issuing licenses for a particular kind of training operation. This can usually be addressed by purchasing a license from an existing local player, but this throws up its own set of challenges. “A lot of the incumbents are small players with a handful of schools or learning centers. They are very entrepreneurial and it might be difficult for an investor to buy one operator in Qingdao, another in Dalian and a third in Jinan,” Ip says. “Every city has its own competitive dynamic. It’s not that you can’t get scale, it just takes a time.” He notes that many investors simply target larger companies with 100 or more centers, either directly owned or franchised out, because they don’t want to start from scratch. But do prospective targets make for appetizing business partners? The existing principal is often the individual who holds the license and it can be difficult to replace them with management that can simultaneously handle the academic, operational and compliance burden that comes with scaling up a business. There are plenty of anecdotes about schools with poor accounting, which complicates due diligence. Given companies may offer a variety of different programs at different price points and with different class sizes, investors want to tie revenues to the relevant programs in order to build up a picture of where the money is coming from. Hidden liabilities are routinely cited as a potential pitfall. Teachers’ employment contracts must be scrutinized to ensure that the correct social security payments are being made. Many education companies also claim they are

Number 20 | Volume 27 | June 03 2014 | avcj.com

charitable organizations and therefore not liable for tax. The reality can be a lot more muddied and it leads to disputes over valuations and other transaction terms, with sellers saying they’ve never paid certain taxes and buyers wanting to err on the side of caution. However, arguably the biggest growing pain is quality control as the network expands. One private equity investor recalls conducting preliminary due diligence on a company that tutored students sitting certified financial analyst (CFA) examinations and sending a team member along to one of the classes. “He said, ‘We can’t invest because one of the instructors is a sophomore I tutored in college and who doesn’t have a CFA,” the investor relates. “There are a lot of quality issues.” For some investors, the solution is not to pursue scale at any cost. RISE wanted to establish a presence in lower tier markets in order to strengthen the brand and offset the threat of local copycats without overstretching itself financially and operationally. Recruiting

a premium for classroom interaction. ZhenFund claims to have found a middle ground and it lies in standardization and what Zheng describes as “flipping the classroom.” One of the fund’s portfolio companies, 17zuoye. com, works with more than 10,000 primary schools nationwide on English and mathematics tuition. It supplies targeted education programs comprising lesson plans and test materials that are intended to change the classroom from teacher-led to activity-led. “Traditionally the teacher has been the biggest obstacle to scalability,” Zheng says. “The businesses we are trying to invest in position the teacher more as an organizer and this lowers the requirements. This lowers the cost of the classroom and raises the efficiency of the learning process.” It is part of a wider theme that involves targeting businesses with the potential to lead their respective segments, steering clear of mature and competitive areas such as test preparation. This may lead investors into

“We are happy to invest but there are natural constraints in terms of quality principals and – Lihong Wang teachers”  franchisees was the logical solution. Bain’s Wang does not expect the company to aggressively expand its directly-owned business in these cities because of quality and cost issues and so as not to undermine existing franchisees. RISE will primarily focus on its core markets, where demand among its current client base remains untapped. The company has introduced summer programs whereby students spend time in English-speaking countries and also a middle school program – covering K7 and K8 – for those who want to continue in the RISE system with a view to pursuing higher education overseas. “If you can keep kids in your school longer it is much more profitable. We have a 70% renewal rate, compared to the industry average of 3050%, and that means we don’t have to spend as much on sales and marketing,” Wang says. “With a large school base we generate enough cash to open new schools – and we are not talking 20-30 a year, but less than 10. We are happy to invest but there are natural constraints in terms of quality principals and teachers.”

The tech effect Technology is potentially the great leveler, but online models don’t work for all. A seven-year-old in RISE’s programs can’t spend an hour in front a computer screen; besides, parents are also paying

specialist areas – both RISE and ZhenFund are interested in teaching methods that are more holistic, removed from the learning by rote still popular in state schools – but it is not an obstacle to achieving scale. TutorGroup started as an offline business in Taiwan and expanded online as it launched in the mainland. The company, which now specializes in English-language training for adults, is now moving into Chinese language services as well as exploring opportunities teaching English in non-Chinese markets. Qiming’s Gan notes that Alibaba Group’s marketplace Taobao and US-listed social network YY.com have launched platforms that essentially link teachers with students across multiple academic and vocational pursuits. It is too early to say whether these giants will end up dominating pure online education but their ambitions do encourage specialists to remain specialized. “The days of the big education providers going public in the US and having lots of centers nationwide offering test preparation and after school services everywhere – that situation bolted a long time ago,” says KPMG’s Ip. “The type of players you have left are probably going to be more technology-driven, with some sort of competitive advantage that could make it easier to scale a business.”

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ANALYSIS [email protected]

Beyond the comfort zone An increasing number of Chinese GPs that made their names in the renminbi space are looking to raise USdollar funds. It requires a level of institutionalization that most have never seen before AFTER THREE YEARS AND ABOUT 12 renminbi-denominated funds, JD Capital – formerly known as Jiuding Capital – raised its first US dollar fund in 2010. The firm, having surprised many with its aggressive domestic pre-IPO strategy, received commitments totaling $120 million. LPs included a string of fund-of-funds, plus Temasek Holdings-owned Vertex Ventures, German insurer Allianz and the BMW Foundation. JD has now returned with a successor vehicle, which has a target of $200 million and is expected to reach a final close in the next few

fingers of one hand. They include consumerfocused Tiantu Capital and hedge fund player Greenwoods Asset Management, both of which are eyeing first closes. Harvest Capital, formerly Sino-Can Harvest Capital (SCHC), has already crossed the line, closing its second US dollar fund last month at $300 million. Shenzhen Oriental Venture Capital finally continues to preserve and is now nearly a first close of $50 million, having set a target of $100 million for a fund that launched in 2010. Fund-of-funds and family offices are the major

US dollar fundraising versus renminbi fundraising by capital raised 100 80

%

60 40 20 0

2008 US dollar

2009

2010 Renminbi

2011

2012

2013

2014 YTD

Source: AVCJ Research

months. Vertex and Allianz are among those understood to have re-upped. According to industry sources, at least 30 more managers who established themselves in the local currency business have launched or are preparing to launch debut US dollar funds. A few more, JD among them, are back in the market for second funds. They are typically the private equity affiliates of Chinese banks, corporations and hedge funds, but there are a few independents in the mix as well. Not everyone gets a smooth ride. “A lot of fund managers with renminbi backgrounds are trying to raise US dollars,” notes one renminbi manager who shares their aspirations. “It started last year when the domestic IPO market was shut last year, but it’s very hard, particularly if, like us, you are a first time fund.” Those that are capable of closing a US dollar fund could probably be counted on the

20

contributors. Plenty of others have abandoned similar plans or put them on hold due to a lukewarm response from offshore investors.

Times of transition Approaching US dollar LPs requires a completely different approach to what renminbi managers are accustomed to in the domestic market. The professionals sitting on the other side of the table usually have clear in-house criteria for picking the best fund managers. With little track record to go by, the LPs must answer the following question: Is this just a one-off, speculative effort, or is this GP ready to create a sustainable US dollar business? “The real learning process only starts when they seek to establish their first US dollar fund. Few of these renminbi fund managers have a thorough roadmap towards institutionalizing the US dollar fund business. Part of the reason is that they probably only focus on deal making without internalizing what that entails, especially how to

interact with sophisticated global institutional investors,” says Frankie Fang, a managing director at LGT Capital Partners. Four years ago these firms had little reason to question themselves. In 2011, renminbi fundraising was at its peak, with about $35 billion going into 261 vehicles, up from $21 billion in 2010. The likes JD, Shenzhen Fortune Venture Capital and Oriental Fortune Capital were on the crest of a wave. Shenzhen Fortune raised RMB6 billion across nine funds to 2010, while JD had approximately RMB3 billion under management. High net worth individuals (HNWIs) were flocking to these firms in response to stellar pre-IPO plays. The moratorium on new listings soon put paid to the exuberance. Renminbi fundraising fell from $24 billion in 2012 to $15 billion in 2013, and only 16 local funds have attracted commitments of $3 billion so far this year. Investors lost interest when the promised returns didn’t materialize and the already fragmented pool of individual capital for which managers were competing dried up. “Individuals are not a sustainable source of capital,” says one Chinese fund manager. “When we make a capital call for the fund, they simply say, ‘Sorry, I don’t have enough money now.’ It’s also difficult to ask China enterprises for money because their financial results might deteriorate as the overall economy slows. It’s hard to survive relying only on domestic LPs.” Some have gone out of business but others have survived. They are looking to raise capital from more reliable offshore sources and diversify their LP bases, but talk is much easier than execution. For many GPs, fundraising means networking with HNWIs at friends’ dinner parties. “I would describe raising money internationally as coming down to how ready the renminbi fund managers are to be transparent. If an LP asks a question and the fund manager says, ‘Give me two weeks to get back to you,’ that is going to cause delays in the fundraising process,” says Conrad Yan, a partner from Campbell Lutyens. Cultural differences and communication skills are classic obstacles. These managers do not have the advantages of Hony Capital and CDH Investments, whose founders had worked overseas and could claim a familiarity with the

avcj.com | June 03 2014 | Volume 27 | Number 20

ANALYSIS

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Western institutional mindset. As a result, they are perceived to be less well organized. “I heard plenty of stories of good fund managers with good track records going on a road show and meeting potential LPs in overseas markets. The fund principal and placement agent are there, but throughout the meeting the principal doesn’t say a word,” observes Lorna Chen, a partner with Shearman & Sterling. “No matter how good track the record is, if they can’t communicate well or correctly to the potential LPs, it’s no use.” International LPs evaluate renminbi GPs in much the same way as US dollar managers: they want to see a consistent value creation strategy that can be supported by performance numbers. The numbers might be there – some domestic managers have earned multiples of 10-20x through pre-IPO deals – but faith in the strategy is not. Managers who rely on multiples arbitrage for returns tend to have difficulty differentiating themselves from the mainstream. There is no value creation narrative. “When you are approaching US dollar focused LPs and you show them a $100 million fund portfolio with 25 investments – each one a small ticket investment, with a short holding period and majority are pre-IPO type of investments, the overall level of interest may be quite limited. You may have been able to generate relatively high IRRs but it’s not a very compelling story to tell to the international LPs,” says Vincent Ng, a partner at Atlantic-Pacific Capital.

Group – by following a similar investment thesis. And they need US dollars to do it. “When we met some renminbi GPs and asked them which sectors they will invest their new funds in, many said TMT but when we looked at their investment portfolios, there was no background for doing that. It doesn’t make any sense to us,” says Ally Zhang, managing director at Siguler Guff. LPs also need to be convinced that managers can resolve the corporate governance issues that arise when operating US dollar and renminbi funds. The LP base for each vehicle is different and internal resources must be deployed in a manner that ensures an alignment of interest with every investor. It is not an impossible task – Hony and CDH are among those that handle it – but transparency is paramount. “These emerging fund managers have done a lot of pre-IPO investments and some are not suitable or not open to US dollar investments. Sometimes picking US dollars to invest may slow down the process. In that context, when you have a good investment, from which fund will you allocate capital?” asks an international LP, who has backed one renminbi fund.

Same bed, different dreams Even if a local manager presents a compelling investment narrative and impresses the LP, there is no guarantee that an allocation will follow. A fund with a $200 million corpus may simply be too small for an LP with a minimum check size

35,000

300

20,000

250

25,000

200

20,000

150

15,000 10,000

100

5,000

50

0

Funds

US$ million

Renminbi fundraising

0 2008

2009

2010

No. of funds

2011

2012

2013

2014 YTD

Amount (US$m)

Source: AVCJ Research

GPs don’t help themselves by pursuing more specialist strategies in an opportunistic, almost haphazard, manner. There is a go after whatever sector is currently in vogue, regardless of whether they have sufficient domain expertise. Inspired by the recent telecom, media and technology (TMT) boom, renminbi survivalists have sought to leverage the enthusiasm for Chinese technology companies listing overseas – such as e-commerce players JD.com and Alibaba

Number 20 | Volume 27 | June 03 2014 | avcj.com

and a maximum permitted exposure to a single entity. Beyond that, the risk-return profile might not be a good fit. Fund-of-funds, which have on-the-ground resources that allow them to take more calculated risks on managers with little or no track record, are a good starting point. Family offices may also take an interest. Shenzhen Fortune Venture Capital, however, went even closer to home. The firm raised $75

million for its first US dollar fund in 2010, when renminbi fundraising was at its peak, and more than half of the investors were existing LPs in renminbi vehicles, who had US dollar assets to invest. “We raise US dollar fund because we want to attract more institutional investors,” says Margaret Shao, managing director at Shenzhen Fortune. “It’s easier to start raising capital from our existing LPs who are comfortable investing in us. Asia-based fund-of-funds, insurance or family offices with offices in Hong Kong or Singapore are also more accessible for us because we can communicate in Chinese and they are more familiar with the local markets.” Shenzhen Fortune has yet to finish deploying its first fund and Shao is cautious about returning to the market for a second vehicle. The renminbi business is where the firm’s expertise lies and it will remain the key element. The small and focused approach may work for Shenzhen Fortune, but JD has its sights set higher. The firm wants to become a “mega asset management” firm by aggressively diversifying its business across multiple platforms. This includes offering co-investments to LPs. According to sources familiar with the situation, this was part of the rationale for Vertex backing JD in the first place. One of the co-investments from the first US dollar fund was Wuxi Huadong Heavy Machinery. Vertex owned a 28% stake in the company prior to its IPO in 2012. “Vertex tends to do more direct investments. It invests in the fund to access more co-investment opportunities in China,” one LP says. Raising a US dollar fund represents a step into the unknown for renminbi fund managers and it could prove to be a key step if they are to establish familiarize themselves with international capital markets and ultimately become larger scale, global players. The expectation is that US dollar funds will remain relatively modest in size over the next five years, ranging from $100-300 million, as it takes time to build up their domain expertise. Based on the speed at which the domestic market is maturing to embrace new deal structures and strategic approaches, the current gap in terms of culture, experience and understanding is by no means unbridgeable. “Professionals in this market are very quick studies: the strategies, what to say, and how to adjust all happen quickly,” says Chris Lerner, head of the China practice for Eaton Partners. “A fund that called itself a pre-IPO manager two years ago, now says it focuses on trade sales. The issue is grasping what they really do – not what they say they do – and how that is institutionalized across the team into a repeatable formula for success.”

21

GRAPHICAL ANALYSIS

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The control paradigm China remains a predominantly growth capital market but PE investors claim to see a growing number of control transactions. It is a nascent movement and the numbers can be deceptive Private equity investment Private equity buyouts by transaction type by deal size

Buyouts: 15

35,000

2010

US$ million

30,000

Change of control: 15

Investee

25,000 20,000

2010

15,000 10,000 5,000

2011

US$ million

30,000 25,000 20,000 15,000

Other Start-up/early stage PIPE Growth/pre-IPO Buyout

Undisclosed amount < US$50m US$51-100m US$101-200m > US$201m 2011

10,000 5,000

RMB deals: 6 Amount (US$m)

Investor

SouFun Holdings

General Atlantic; Apax Partners

336.6

ASIMCO Technologies

Bain Capital

150.0

Allyes Online Media

Silver Lake

124.0

Standard Water

Themes Investment Partners

100.0

FUJI Food and Catering Services

Anhui Province Venture Investment; Guangdong Huaheng Energy; Tsinghua Redbud

0

35,000

Buyouts: 18

Change of control: 11

Investee

84.5

RMB deals: 3 Amount (US$m)

Investor

Shanghai Jahwa Group

Shenzhen Ping'an Innovation Capital

806.0

China Fire & Security Group

Bain Capital

257.8

Golden Jaguar Group

Apax Partners

250.0

Qinhuangdao Yaohua Glass

Hony Capital; IFC

100.0

Sunrise Duty Free Stores

Boyu Capital

100.0

0

35,000

2012

US$ million

30,000 25,000 20,000 15,000

Other Start-up/early stage PIPE Growth/pre-IPO Buyout

Undisclosed amount < US$50m US$51-100m US$101-200m > US$201m 2012

10,000 5,000 0

35,000

US$ million

30,000

2013

Largest buyouts that involved a change in control

25,000 20,000

Other Start-up/early stage PIPE Growth/pre-IPO Buyout

15,000

Undisclosed amount < US$50m US$51-100m US$101-200m > US$201m 2013

10,000 5,000

Buyouts: 29

Change of control: 15

RMB deals: 6 Amount (US$m)

Investee

Investor

Luye Pharma Group

CDH Investments; New Horizon; CITIC Private Equity; AXA Private Equity

510.2

HCP Holding

TPG Capital

500.0

Shaanxi Bicon Pharmaceuticals

PAG Capital

250.0

Shenzhen ZTE NetView Technology

Unitas Capital

207.3

China Yeehoo Group

Lunar Capital

100.0

Buyouts: 26

Change of control: 15

Investee

RMB deals: 11

Investor

Amount (US$m)

China New Town Development

China Development Bank Capital

185.8

RISE China

Bain Capital

140.0

China Hydroelectric

NewQuest Capital Partners

77.7

Guizhou Yonghong Food

Lunar Capital

50.0

TNT Hoau

CITIC Private Equity

40.2

0

Other Start-up/early stage PIPE Growth/pre-IPO Buyout

Number 20 | Volume 27 | June 03 2014 | avcj.com

Undisclosed amount < US$50m US$51-100m US$101-200m > US$201m

Source: AVCJ research

23

15th Annual Private Equity & Venture Forum

Japan 2014 26-27 June, Conrad Tokyo

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PROSPERING IN THE NEW JAPAN

More than 100 limited partners have already registered for the AVCJ Japan Forum, including representatives from: Abu Dhabi Investment Council

HarbourVest Partners

Nomura Private Equity Capital Co.

Adams Street Partners, LLC

Intel Treasury

Nomura Trust and Banking Co.

AISIN Employees’ Pension Fund

International Finance Corporation (IFC) Norinchukin Trust

AlpInvest Partners

Jade Invest

Okayama Metal and Machinery

Alternative Investment Capital

Japan Bank For International

Pension Fund

Argenthal

Cooperation

ORIX Corporation

Asia Investment Advisors

Kyushu Railway Company

Osaka Gas Pension Fund

Bank of Tokyo-Mitsubishi UFJ

Macquarie Group

Pantheon Ventures

BlackRock Private Equity Partners

Marubeni Corporation

Portfolio Advisors, LLC

Capital Dynamics Co.

MassMutual Life Insurance Company

SEIRYU Asset Management

Cogent Partners, LP

Milltrust International LLP

Shinkin Central Bank

Daido Life Insurance Company

Mitsubishi Corporation Asset

SL Capital Partners

Dai-ichi Life Insurance Company

Management

StepStone

DBJ Asset Management Co.

Mitsubishi UFJ Trust and Banking

Sumitomo Mitsui Banking Corporation

DBJ Capital

Corporation

Sumitomo Mitsui Trust Bank

Denso Pension Fund

Mitsui & Co. Global Investment

Sumitomo Mitsui Trust Capital Co.

Development Bank of Japan

Mitsui & Co.

Terrasias Capital

Duskin Pension Fund

Mitsui & Co., Principal Investments

The Bank of Tokyo-Mitsubishi UFJ

FLAG Squadron Asia

Mizuho Asset Management Co.

The Dai-ichi Life Insurance Company

Gibraltar Life Insurance

Mizuho Global Alternative Investments

The Norinchukin Trust & Banking Co.

Government Pension Investment Fund

Mizuho Trust & Banking Co.

Hamilton Lane

Nissay Asset Management

Tokio Marine Asset Management Co. … and many others!

For the latest programme and speaker line-up, please visit avcjjapan.com

Contact us Registration Enquiries: Carolyn Law T: +852 3411 4837 E: [email protected] Sponsorship Enquiries: Darryl Mag T: +852 3411 4919 E: [email protected] Speaker Enquiries: Sarah Doyle T: +852 3411 4842 E: [email protected] Asia Series Sponsor

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