Asia’s News Source avcj.com June 03 2014 Volume 27 Number 20

EDITOR’S VIEWPOINT The PE spotlight turns back to China Page 3 NEWS , , 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 Renminbi managers grapple with an institutional challenge Page 20 GRAPHICAL ANALYSIS The VC rainmakers China : Control or not control? How entrepreneur ecosystems are changing China’s venture market Page 9 Page 23

FOCUS FOCUS

Untapped market A scale conundrum Insurers consider offshore fund options Page 12 PE reconsiders China exposure Page 17

PRE-CONFERENCE ISSUE AVCJ PRIVATE EQUITY AND FORUM CHINA 2014 Anything is possible if you work with the right partner

Unlocking liquidity for private equity www.collercapital.com London, New York, Hong Kong EDITOR’S VIEWPOINT [email protected]

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

Senior Research Manager Helen Lee Research Associates Herbert Yum, Isas Chu, INVESTORS HAVE NOT BEEN CHASING AS $55 billion raised, new capital for China-focused Jason Chong, Kaho Mak hard as they used to on opportunities in Chinese vehicles has been slowly declining with last Circulation Manager private equity these past few years. It’s not hard year’s total dropping below the $20 billion mark. Sally Yip to understand why: the combination of slowing However, preliminary year-to-date data indicate Circulation Administrator Prudence Lau economic conditions, frequently unrealistic that the situation is stabilizing with close to $9.7 Subscription Sales Executive valuations, the temporary closure of the IPO billion raised by 34 funds – pushing the total Jade Chan amount of China-focused private equity capital market, a government in transition have made Manager, Delegate Sales opportunities elsewhere seem more attractive in to more than $205 billion. Pauline Chen the short term. The return of the IPO market is not the only Director, Business Development There are, however, plenty of reasons for reason to take another hard look at China. There Darryl Mag remaining bullish no China, not least because are a number of encouraging developments such Manager, Business Development several of the factors listed above have to some as domestic companies’ increasing propensity Anil Nathani, Samuel Lau extent abated. to use M&A, instead of R&D, as an instrument of Sales Coordinator Since the reopening of the domestic growth. These same companies are also gradually Debbie Koo IPO market last December, foreign investors opening up to investing in, collaborating with, have rushed into China, with overseas capital and selling to private equity firms. Conference Managers Jonathon Cohen, Sarah Doyle, accounting for 68% of the $440 million raised Developments are not restricted to the Conference Administrator in the first quarter of 2014. We’ve also observed private sector. The government is also playing a Amelie Poon a rise in the number of completed deals and role in making the private equity industry more Conference Coordinator Fiona Keung, Jovial Chung successful exits in the past six months as PE and attractive with the easing of regulations, broader VC firms regain their momentum. financial reforms and the launch of free trade Publishing Director The recent $1.7 billion listing of JD.com – “the zones. Allen Lee Amazon.com of China” – has resulted in great, There can be little doubt that the Chinese Managing Director though still mostly paper, profits for its backers. private industry is in the process of recapturing Jonathon Whiteley The company is still trading at a 30% premium not so much its former glories, as a more rational to its IPO price, which may be a prelude what and value-oriented equilibrium. happens when Alibaba Group goes public this Incisive Media summer. Will this public market euphoria boil Unit 1401 Devon House, Taikoo Place over to the private equity scene? That remains to 979 King’s Road, Quarry Bay, Hong Kong be seen but early signs look promising. Allen Lee T. (852) 3411-4900 Statistics from our research team reflect this Publishing Director F. (852) 3411-4999 E. [email protected] change. Since peaking in 2011 with a staggering Asian Venture Capital Journal URL. avcj.com

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Number 20 | Volume 27 | June 03 2014 | avcj.com 3

NEWS

Carlyle acquires Japanese Chinese warehousing developer and operator ASIA PACIFIC e-Shang. APG and e-Shang - which was noodle snack maker founded in 2011 by two local entrepreneurs David Pierce appointed has acquired a controlling in conjunction with - will also stake in Oyatsu Company, the Japanese establish a joint venture to build modern logistics Asia head of HQ Capital manufacturer of Baby-Star ramen snacks. real estate assets across China. David Pierce, previously a partner at FLAG Financial details were not disclosed but sources Squadron Asia, has been appointed managing put the value of the deal at more than JPY20 China’s Alibaba to buy 10% director and head of Asia at Harald Quandt (HQ) billion yen ($194 million) for a 51% stake. Capital. The firm, a private investment group Set up in 1948, the company is based in stake in Singapore Post owned by the Harald Quandt family of Germany, Tsu in western Japan’s Mie prefecture and Alibaba Group has agreed to buy a 10.35% has approximately $12 billion in assets under has a workforce of around 370. Its flagship stake in Singapore Post (SingPost) for S$312.5 management. product, Baby-Star ramen snacks, has been sold million ($249 million), becoming the second- domestically since 1959. Made from the by- largest shareholder in the national postal service product of noodle manufacturing, the snack is provider. In addition to selling 30 million ordinary AUSTRALASIA also available in China, Hong Kong, South Korea shares, the listed company is issuing 190.096 million new shares to Alibaba Investment at PEP exits Australia’s Peters S$1.42 apiece. Ice Cream to UK’s R&R Mobile app analytics firm (PEP) has exited Australia’s Peters Ice Cream to PE-backed UK ice cream App Annie raises $17m company R&R. Local reports value the deal at Mobile app analytics platform App Annie has around A$450 million ($416 million). Peters’ most raised $17 million in new funding from existing popular brands include Drumstick, Connoisseur, investors IDG Capital Partners, Partners Peters Original and Maxibon. PEP acquired Peters and .The company has now raised from Swiss food and beverage giant Nestlé for $39 million in total. around $304 million in 2012. Hony completes $569m sell PEP to list Australian paper and Vietnam. Oyatsu currently has three facilities in Mie and is currently planning to establish its down of CSPC Pharma maker Asaleo for $642m first overseas manufacturing base in Asia. The has made a partial exit from Chinese Pacific Equity Partners-owned paper maker company - which will continue to be headed by generic drugs maker CSPC Pharmaceutical Asaleo Care, formerly known as SCA Hygiene President Yoshiaki Matsuda - generated sales of Group, generating HK$4.41 billion ($569 million). Australasia, is looking to raise A$690 million ($642 JPY18.2 billion for the year ended July 2013. Hony-owned Joyful Horizon sold 600 million million) in what would be the biggest Australian This is the first deal from Carlyle Japan shares in CSPC to third parties and 105.88 million IPO this year. Asaleo, formerly is jointly owned Partners III, a vehicle launched in May last year shares to an entity owned by Dongchen Cai, by PEP and Swedish paper products company with a target of around $1 billion. Carlyle’s last the company’s chairman, at HK$6.25 apiece, Svenska Cellulosa Aktiebolaget (SCA) significant in the country was in 2012, according to a regulatory filing. when it bought cleaning services provider GREATER CHINA Diversey for about JPY30 billion. SIG commits $20m to China discount site 51Fanli 3i exits auto parts firm to of investment led by Sequoia Capital. Chinese SIG China has committed $20 million in a Series microblogging website Sina Weibo also B round of funding to 51Fanli, a Shanghai-based Chinese buyer participated in the round. online discount aggregation site. The site has 3i has sold Hilite International, a German suppler previously obtained $10 million from Qiming of auto engine and transmission parts, to China’s Apax to invest $15m in Venture Partners and Steamboat Ventures in AVIC Electromechanical Systems for EUR473 2011, AVCJ Research’s records show. million ($643.8 million), generating a 2.1x return. Zhaopin alongside IPO Hilite makes products intended to improve car Zhaopin, a Chinese recruitment website which Charm Communications fuel efficiency and reduce emissions. 3i acquired has previously raised capital from several VC the company in 2011 for EUR190 million in an firms, will receive $15 million from accepts CMC buyout offer all-equity transaction. alongside a US IPO. Chinese advertising agency Charm Communications has accepted a take-private Sequoia leads $100m APG invests $650m in PE- offer from a consortium backed by China Media Capital (CMC) that values the NASDAQ- round for China news app backed e-Shang listed company at around $180 million. The Toutiao, a Chinese mobile news app operator, Dutch APG Asset Management consortium, led by He Dang, Charm’s chairman has received $100 million in a Series C round will invest up to $650 million for a 20% stake in and founder, will acquire all outstanding

Number 20 | Volume 27 | June 03 2014 | avcj.com 5 NEWS

American Depository Shares that it doesn’t Sequoia raises $530m for $12.5 million payable after two years. already own for $4.70 apiece. India fund PE-backed Café Coffee Day Sequoia Capital has raised $530 million for NORTH ASIA its fourth India-focused fund, which has an eyes $1b India IPO expanded remit to take in opportunities in Café Coffee Day - the Indian café chain backed Sequoia leads $100m Southeast Asia as well. by KKR, Standard Chartered Private Equity (SCPE) The fund will primarily invest in the and New Silk Route Advisors (NSR) - is said to be round for e-commerce firm technology, consumer and healthcare sectors. considering an IPO next year.The company may South Korean e-commerce platform Coupang The team is particularly interested in mobile, seek a valuation of about $1 billion and plans to has raised a $100 million round of funding led by online payment, big data, software-as-a-service, file a draft prospectus with the Securities and Sequoia Capital that is said to value the company cloud computing, enterprise software and Exchange Board of India (SEBI) later this year. at more than $1 billion. A number of existing medical and lifestyle-related opportunities. Check investors also participated in the round. sizes will range from a few hundred thousand Piramal Capital merges PE dollars to $50 million. and lending arms AIP Japan to launch $300m Piramal Capital has merged its real estate private healthcare focused fund equity fund management business - Indiareit - Asia Investment Partners (AIP) Japan is launching and its real estate-focused non-banking financial its sixth healthcare-focused fund, which will company (NBFC). The combined entity is known specifically target the elderly care home as Piramal Fund Management (PFM). Piramal segment. The fund is looking to raise JPY30 Capital is the finance arm of Piramal Enterprises, billion ($295 million). the flagship company of Piramal Group. Japan Industrial Solutions SOUTHEAST ASIA invests $98m in Unitika Turnaround specialist Japan Industrial Solutions KKR agrees $1.1b deal for (JIS) has agreed to acquire a stake in listed textiles Sequoia has been active in India for eight manufacturer Unitika for JPY10 billion ($98 years, making seed, venture and growth Singapore’s Goodpack million). JIS Fund 1 will purchase 10,000 new class investments. It has backed around 75 companies, KKR has agreed to buy Goodpack, the world’s C preferred shares. including search engine Just Dial, which went largest manufacturer of intermediate bulk public in May 2013, raising $174 million, and containers (IBCs), for S$1.4 billion ($1.1 billion). It outsourcing firm GlobalLogic, which was sold to plans to delist the company from the Singapore SOUTH ASIA Apax Partners last October. exchange. The private equity firm will pay The new fund takes the total committed S$2.50 per share for all outstanding shares in the Clearwater in partial exit capital to the firm’s India funds to around $2 company through a scheme of arrangement. from Diamond Power Infra billion. The first entity, Sequoia Capital India Growth Fund I, raised $400 million in 2006. GGV leads $15m round for Asia special situations Clearwater According to AVCJ Research, two funds followed Capital Partners has part-exited India’s Diamond in 2007 - a second growth fund of $725 million taxi-booking app Power Infrastructure by selling a 5.5% stake for and an early-stage vehicle of $300 million. GGV Capital has led a Series B round of funding INR271 million ($4.57 million) via an open market worth more than $15 million for GrabTaxi, a transaction. Southeast Asia-focused taxi-booking mobile media company Bertelsmann have teamed up phone app. Qunar, a NASDAQ-listed Chinese Providence to buy stake in to invest in Pepperfry.com, an Indian online travel platform that is majority-owned by Baidu, marketplace specializing in furniture and home also participated alongside existing investor India shopping JV accessories. The size of the investment was not Vertex Ventures. Partners has acquired a 50% disclosed, but local media put it at around $15 interest in home-shopping channel Star CJ million. Clearwater sells jack-up rig Network India from Star Group. The business is a to Middle East buyer joint venture with Korea-based CJ O Shopping. VC-backed medical The size of the transaction is said to be in excess Asia special situations investor Clearwater Capital of $50 million. CJ O Shopping will retain its advisory bought by Ebix Partners has sold a jack-up rig built in a Singapore interest in the venture. Healthcare Magic, an India-based medical shipyard to a drilling services partnership advisory service that won early backing from between the Saudi Arabian government and Bertelsmann, NVP back Accel Partners, has been acquired by NASDAQ- Schlumberger. The Keppel FELS B Class jack-up listed on-demand software and e-commerce rig is the first of two Clearwater placed in late furniture marketplace services provider Ebix. Ebix has paid $6 million in 2013. Keppel FELS is a network of offshore yards (NVP) and international cash for the business plus an earn-out of up to owned by Singapore’s Keppel Offshore & Marine.

6 avcj.com | June 03 2014 | Volume 27 | Number 20 LP_SecCred_TombAd_AVCJ_Web-V_DR032814.pdf 1 4/2/14 11:45 AM

This announcement appears as a matter of record only. February 2014

Innovative Directions in Alternative Investing

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

Co-Lead Arrangers Citibank, N.A. Wells Fargo Bank, N.A.

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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

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© 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3 510 室, 200120 电话: +86 21 6030 0600 COVER STORY [email protected]

创新无极限 The virtuous circle China’s VC market is evolving as funds started by or raised from founders of first-generation internet firms. Innovation Concerns about conflicts of interest must be addressed, but the influence of their ecosystems will grow

JUST OVER TWO YEARS AGO, ANDREW Venture capital fundraising in China for the first Vision Knight’s Wei reports a similar without Teoh passed up a role on Chinese e-commerce five months of 2014 reached $5.2 billion, beating experience between his two funds. Institutional giant Alibaba Group’s mega IPO for a career the totals for the previous two years in full. players account for 70% of the Fund II corpus but helping companies get started on the journey There is a cyclical element to this. Nearly half it was a very different story the first time around. that might end in a public listing. The world will the capital raised went to Legend Capital, GGV “With Fund I it is very difficult to win the limits soon find out whether Alibaba Group can live Capital, , trust from institutions because you have no up to the hype. Teoh, meanwhile, is preoccupied and DCM. They all raised their previous vehicles track record and your strategy needs time to be with Ameba Capital, the VC firm he founded with between 2010 and 2012 so were expected proved,” Wei says. “We went for high net worth the former CFO of Kingsoft Holdings. to return to market in 2013-2014. This almost entrepreneurs. We wanted them not just to put in “A lot of people asked me why I was leaving synchronized activity is in part responsible for the money but also be part of our network. In Fund I a potentially $200 billion company, but I went China VC fundraising spikes in 2011 and 2008. we had four institutional investors and they were to Alibaba to really learn how companies work, But this old guard is increasingly all introduced by entrepreneurs’ family offices.” having previously been only on the advisory side,” complemented by the new. , a Even though space in Vision Knight Capital Teoh explains. “I always wanted to start my own tech-focused private equity firm, recently closed Fund II was limited, the number of entrepreneurs business and every step in my career has been its second fund at $1.1 billion. The firm was set participating has actually doubled to 36. Wei geared towards that goal.” up by David Yu and Jack Ma, founders of Target likens them to buying an premium: Previously a banker in the tech, media and Media and Alibaba, respectively. “You don’t need them immediately but maybe telecom (TMT) space, Teoh joined Alibaba in Vision Knight Capital, founded by ex-Alibaba. you will need them in the future.” Half the deals in 2005 to focus on corporate development. This com CEO David Wei raised $550 million for its Fund I came through entrepreneur introductions, included participating in Yahoo’s investment in 2005 and the IPO of B2B division Alibaba.com. 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 He moved on to corporate finance where his last “We went for high net worth entrepreneurs. We 以及面向中国投资的私募基金、成长型基金和创投 major project was the $1.6 billion deal that likes specialized in serving private equity, growth equity and of Silver Lake and Temasek Holdings get equity in wanted them not just to put in money but also 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 the company. be part of our network” – David Wei Teoh’s present existence is far removed in assisting funds located or investing in China. 国经验。 pure dollar terms. Ameba raised $25 million for its debut fund, principally from successful second fund. Vision Knight targets the consumer- but there is no guarantee of the same happening 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 entrepreneurs and tech sector investors. It technology space and, given the partners’ in Fund II. Value-add could come through day-to- has backed 22 start-ups, has three exits in the operating backgrounds, classifies itself as a PE day consulting on portfolio companies. 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 pipeline, and is now preparing to launch a firm. Partners, founded by super GGV Capital is one of a number of established successor fund with a bigger target. angel, Kingsoft veteran and Xiaomi CEO Lei Jun, players that carves out an entrepreneur sidecar 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 closed its second fund at $525 million. vehicle alongside its main fund in order to create A rising tide Other angel investors have also launched an alignment of interest with potentially useful 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 Ameba is just one member of a new vanguard vehicles, notably ZhenFund, created by Bob players in the technology space. Hans Tung, of Chinese PE and VC firms that is able to raise Xue and Victor Wang, founders of US-listed New managing partner at GGV, explains that while 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 money by dipping into the growing ecosystem Oriental Education, in conjunction with Sequoia the firm’s ties to the likes of Baidu, Alibaba and $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。 of domestic entrepreneurs. Either started by Capital, and C.C. Zhuang, co-founder of travel site Tencent Holdings (the BATs) are well established, or raised from founders of successful first- Qunar, who started Crystal Stream Capital. it wants to maintain relationships with executives generation internet businesses, these funds have There is one fully-fledged VC spin-out. The from businesses in the tiers below. a pedigree that is rooted extensive deal-sourcing TMT investment team from IDG Capital Partners “You have first-generation entrepreneurs networks and proven operational ability. departed last year to form Banyan Capital and and VCs. They know each other, they started “A lot of people have made money in the they closed their debut vehicle at $206 million businesses together, and now they are putting tech sector and some of them are coming into in January. The LPs are predominantly CEOs money into businesses started by second- the buy side, self-funding or raising capital from of companies they backed while at IDG. This generation entrepreneurs,” says Lye Thiam Koh, within their circle,” Teoh adds. “You are going to compares to Yunfeng raising its first fund almost principal at Northgate Capital. “Experience and see more and more of that. Not only people like exclusively from a set of leading founding partner capital is being recycled into the system and 科律律师事务所 myself, but also guys leaving the big VC firms entrepreneurs. However, the firm managed making it more robust.” to form their own funds and raise money from to diversify its LP base for Fund II, picking up This phenomenon is by no means www.cooley.com people they know.” allocations from several institutional players. unprecedented. The virtuous circle is well-

© 2014 Cooley LLP, IFC - Tower 2, Level 35, Unit 3510, 8 Century Avenue, Pudong New Area, Shanghai, 200120, China, +86 21 6030 0600 9 中国上海浦东新区世纪大道8号国金中心二期35楼3 510 室, 200120 电话: +86 21 6030 0600 Number 20 | Volume 27 | June 03 2014 | avcj.com COVER STORY [email protected]

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

10 avcj.com | June 03 2014 | Volume 27 | Number 20 COVER STORY [email protected]

community and classic complaints about a lack because they don’t need to,” an LP adds. “People companies in the TMT, healthcare and education of transparency doesn’t help the perception don’t know how many funds there will be. They spaces have raised nearly $2.5 billion from five issue. GGV’s Tung admits that China is more don’t have to form the LP-GP relationship. A lot offerings so far in 2014, more than any full- incestuous than the US because there are fewer of institutional investors are not familiar with this year total on record. Six companies generated professional managers, although he adds that from the first generation of GPs.” proceeds of $657.3 million last year, a marked they are less inclined to flip start-ups. These fears have yet to be fully realized and improvement on 2012 when confidence in Northgate’s Koh adds that LPs look closely the transition from entrepreneur-dominated Chinese stocks collapsed for a while. Trade sales at the ability of individuals within a VC firm to Fund I to institution-dominated Fund II have been similarly robust, reaching a record remain impartial and independent. “It is good experienced by several players suggests LPs are high of $4.5 billion from 27 deals in 2013 and the to have certain affiliations when you are just comfortable with what they are seeing. For some nearly $1 billion for the first five months of this starting and the industry is young but perhaps institutions, there might be an acceptable trade- year. less so as it matures,” he says. “If you look at the off between a slightly lower level of transparency As the fervor over Alibaba suggests, US today you don’t see VCs that are affiliated and the bumper returns that come through valuations are heady and the venture capital to Cisco, Microsoft or Google because they are exposure to strong start-ups that emerge from a industry itself is cyclical. The virtuous circle independent.” particular ecosystem. represents a fundamental shift and it is here to Governance is another concern. LPs are wary HarbourVest’s Shan adds that the new stay, but it remains to be seen how LPs behave of being denied access to timely information that managers offer strategies that are tailored to the when the market turns. allows them to track fund performance because needs of the market, taking a deeper dive into Do they become less accommodating the manager hasn’t put in place strong reporting specific sub-segments and thereby allowing LPs towards newer GPs or will these managers infrastructure. It comes down to whether they to be more selective and refine their strategies. outride the storm, supported by their industry see the value in creating a long-term institutional knowledge and operational capabilities? franchise or, as one industry participant puts it, Still singing “I wouldn’t be surprised if there are more “taking the low-hanging fruit because there is a The important caveat is that all this is taking groups raising their first funds in the next couple relationship.” The latter approach doesn’t bode place at a time when the market is going up. of years, provided the market is doing well and well for the performance of subsequent funds Fundraising has spiked thanks to established there is enough liquidity in the system, “ says once the fruit runs out. players coming back to market and new entrants J.P. Gan, managing partner at Qiming Venture “They don’t have the urgency to work really breaking through, but performance is also a Partners. “As long as music keeps on playing hard as some of the more professional firms factor. everybody will be happy, but the question on developing a strategy and building a team PE-backed IPOs on US exchanges by remains when the music will stop.”

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To subscribe, call Sally Yip at +(852) 3411 4921 or email [email protected] avcj.com FOCUS [email protected] 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?

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

12 avcj.com | June 03 2014 | Volume 27 | Number 20 FOCUS [email protected]

2007, acquiring a minority stake in Belgian- Dutch financial services group Fortis, with a view to purchasing half of the company’s Strategic angle asset management unit. However, the plan was scrapped as Fortis fell victim to the global Chinese corporates, both state-owned and private-held, were the first batch of domestic financial crisis. Ping An had to write down most institutions to invest overseas, including making commitments to private equity funds. It is part of of its RMB23.8 billion investment when Fortis was a broad effort by the Chinese government to encourage “local champions” to build international nationalized and sold off in 2008. Two years ago, exposure as a means of accessing new technologies, assets and expertise. the insurer filed an international arbitration claim Last month, Shanghai-listed Hainan Zhenghe Industrial Group agreed to invest $130 million to try and recover some of the losses. in First Reserve’s latest energy-focused PE fund. The commercial property firm said it wanted to Regardless of the asset class, insurance expand its portfolio to cover petroleum and natural gas business. Under the agreement, Zhenghe companies want to understand the risks fully not only has co-investment rights in North American deals but will also set up an Asian-focused before participating. As such, although they have fund with First Reserve. made contacts with foreign GPs and service “Given, First Reserve is one of the largest fund investors in the global energy sector, in my providers, and studied overseas private equity opinion, this LP investment is more skewed towards being a strategic investment rather than portfolios, progress is slow. As one industry purely motivated from an asset allocation perspective,” says Vincent Ng, a partner at Atlantic- participant puts it to AVCJ, “Every insurer is Pacific Capital. “Investors making such strategic investments are generally motivated with watching and waiting to see who will be the first obtaining benefits like getting access to co-investment or learning about the sector to to invest and what they are investing in order to build knowledge for future direct investment needs.” obtain more reference.” In contrast to sovereign wealth funds and insurance companies, Chinese corporates with cash Under the CIRC’s rules, insurers are only in their pockets and a desire for PE exposure are not a standard target market for GPs. As such, allowed to participate in private equity only they can be difficult to identify. They also come in different forms and have varying motivations, as an LP, which isn’t actually what they want. for example one corporate might have a large amount of offshore assets while another wants to There is a desire to make direct investments cover renminbi assets into US dollars. independently and, with this in mind, China Life Another issue concerns capital outflows. Chinese companies require approval from different is building its asset management subsidiary to authorities before committing to an overseas PE fund. invest in fixed income and public and private “For the state-owned enterprises, or private companies in China, if they don’t already have equities. The company wants to source capital US dollars, they have to get approvals from the National Development and Reform Commission from its parent and ultimately raise funds from and the State Administration of Foreign Exchange. Even companies that already operate overseas third parties. need some approvals. This process can be long and painful,” says Lorna Chen, a partner with “It seems to be in the DNA of Chinese Shearman & Sterling. enterprises that they first try to do something on their own before investing or partnering or soliciting the services of an outside party,” originally a subsidiary of John Hancock Insurance. Hong Kong-listed subsidiaries. says Chris Lerner, head of the China practice for “However, direct investment will not be our “Restrictions on Chinese insurers’ overseas Eaton Partners. “In our early conversations with core business; our main job is seeking out the asset allocation will be relaxed over the next five Chinese insurance companies, we find this to be best fund managers.” Qu says. years. However, much of their income comes true as well. We expect them to an LP, but when from selling products to mainland Chinese, we meet them we find their primary interest Regulatory obstacles so they don’t have that many offshore assets,” lies in raising a direct or joint venture fund that For all the CIRC’s reforms, regulatory uncertainty says Promise Advisors’ Wang. “It is still not clear leverages their network and platform.” remains the final – some would say decisive whether onshore assets could be transferred China Re is one of the few to think from a LP – factor in restricting the pace of overseas offshore to make investments.” perspective, adopting a passive attitude towards investment. There is lack of guidance on specific However, this doesn’t limit the opportunity asset allocation and using fund managers, processes, such as whether insurers have to get for China-based insurance companies to learn according to Vincent Wang, managing director at approval on a deal-by-deal basis. from their Hong Kong-listed counterparts, consultancy Promise Advisors. “We want to invest overseas, but the regulator which have greater exposure to international China Re originated from the People’s has a more conservative attitude towards investment markets. In this way they can build Insurance Company of China (PICC) and remains offshore investments, especially when we talk up their capabilities over a variety of asset classes the country’s only state-controlled reinsurer. It about product innovation,” says one insurer. and emerge as more mature LPs, perhaps with an set up a two-man alternative investment team in “Anything that isn’t listed in the guidance we appetite for PE – although approaches may vary. 2011 to cover private equity and real assets. The can’t do and lobbying takes a long time. At some “Over the next five years, Chinese institutions, team now numbers 12. point the rules will have to be revised to reflect including most of the insurance companies, The insurer has just $100-200 million the reality.” won’t classify themselves clearly as LPs, GPs or earmarked for deployment with offshore GPs At present, the CIRC’s guidance only covers fund-of-funds. They will try to invest across all over the next two years. There is a bias towards requirements for fund size, the manager’s paid- asset classes by playing different roles. It’s an bigger funds and plans to develop mid-market in capital and team size. Another gray area is evolving process,” says says Dayi Sun, managing exposure via the fund-of-funds route. The group’s whether offshore assets can be used in overseas director at Jade Invest. “Western institutions ultimate aim is to establish itself as a fund-of- investments, which would offer a way around all have also experienced that. When they realized funds, following in the footsteps of overseas the red tape. China Life, Ping An, China Taiping they didn’t have expertise in a certain area, they counterparts HarbourVest Partners, which was Life, China Pacific Insurance and PICC all have narrowed their focus.”

Number 20 | Volume 27 | June 03 2014 | avcj.com 13 TRANSPARENCY. CONFIDENCE. TRUST.

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Greater China: Sammy Lai (黎大汉), [email protected] Shanghai: David Lu (吕海歌), [email protected] Hong Kong: Andy Wong (王克智), [email protected] 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 Q: To what extent are you Q: How does Magic Stone covering the Chinese market fundraising is been on the now seeing specialization, position itself in this changing for more than a decade and we slide these past two years. particularly in terms of sector, environment? can offer expertise in this area. What is the problem? among renminbi GPs? A: We don’t refer to ourselves as a The other half of the capital A: It’s difficult for managers to A: We call the last decade the traditional fund-of-funds – we we raise is for direct and co- raise capital at the moment. “golden PE market” – a lot of are a hybrid fund manager. investment. The most important issue is the renminbi fund managers could Half of the capital we raise lack of long-term intuitional easily raise capital and make Q: You previously were investors. Insurance companies good returns by relying on a pre- considering launching a and the National Social Security IPO strategy. The IPO market shut dedicated secondaries fund. TRANSPARENCY. Fund (NSSF) are evolving into down last year, and although What happened and how important LPs. All fund managers it has since re-opened, these closely are you involved in the in China have big expectations pre-IPO mangers have become secondaries market? CONFIDENCE. for insurance companies less attractive. The renminbi in particular. However, the funds market is consolidating A: We are not raising secondaries institutional market has yet to and this will continue. We now fund but we are active in TRUST. mature. For example, insurance prefer to back real value-added secondaries deals in China. We companies are still not really players, often with a particular use the secondaries market to active investors in private sector focus. Where we do go shorten our j-curve as well as equity funds as LPs. First, the into generalist funds, they must to invest in funds of different China Insurance Regulatory have a stable team and a proven vintages. That is important to Some things can’t be bought, sold or traded. Commission (CIRC) restricts track record. our strategy. There are a lot them from investing more than of individual LPs that entered Clients have relied on Duff & Phelps to help protect these fundamental ideals for 10% of their total assets in the Q: China is still a - “We now prefer the market without really more than 80 years. We deliver objective advice in the areas of valuation, dispute asset class, and then they have driven market, but does understanding the long term consulting, M&A and restructuring. Balancing proven technical skills with deep to report to the regulator on a a predominantly buyout- to back real and low liquidity nature of industry expertise, we help our clients address their most complex financial needs. deal-by-deal basis. Second, they focused fund now represent a the asset class. They signed all are not comfortable with the viable strategy? value-added the legal documents but then www.duffandphelps.cn management fees that must A: A lot of US dollar managers have players, often three years later they say they be paid to GPs. And third, they wanted to do buyouts over the cannot continue. We will source are also restricted in terms of past few years but the market with a particular these positions via GPs that we the managers they are able to wasn’t ready for it. Now I think sector focus. know well. These firms would back. A GP must have at least there are opportunities for GPs sometimes rather come to us Greater China: Sammy Lai (黎大汉), [email protected] RMB3 billion ($480 million) in raising reasonable size buyout on Where we do go than put a secondary position on and both the US dollar and renminbi the open market. Shanghai: David Lu (吕海歌), [email protected] a lot of emerging renminbi- sides. You increasingly find into generalist denominated GPs don’t qualify. entrepreneurs want to get out of funds, they Q: Would you ever deal with Hong Kong: Andy Wong (王克智), [email protected] their companies, but the second these individual LPs as Q: What are insurance companies generation doesn’t want to take must have a investors in your funds? doing in terms of developing over the business. They have A: We tend not to deal with them their private equity often been educated overseas, stable team and directly. When we come across investment teams? they might have experience a proven track these high-net-worth individuals, A: Currently every insurance working for investment banks, we often try to persuade them company has an investment and they have no desire to take record” to set up their own department but many of over a real operating business. and then educate them on how them are staffed by just 2-3 US dollar managers have to allocate to allocate resources professionals. They don’t have more professional skills and is allocated to selected fund globally, not just in China, and enough time to do due diligence experience in this space, but the managers through a comingled not just in private equity but also and often rely on third-party renminbi funds will find it easier fund-of-funds. We follow in fixed income, hedge funds, financial advisory firms to assist to structure deals from a legal emerging GPs especially closely and so on, so they can diversify them with it. perspective. because our team has been risk.

Number 20 | Volume 27 | June 03 2014 | avcj.com 15

FOCUS [email protected] 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

NORD ANGLIA EDUCATION OPENED ITS 12-month total since 2008. The other was CVC from that vintage – Xueda Education Group, TAL first school in China 12 years ago. The British Capital Partners’ acquisition of a majority stake Education Group, Global Education & Technology International School Shanghai had an initial in EIC, which provides counseling services for Group and Ambow Education – listed in the US capacity of 100 places. Fast forward to the students who want to go overseas, for a reported in 2010, although Ambow is now the subject of a present, the facility now has space for 1,800, $200 million. liquidation order. having grown lock-step with the Pudong district New Oriental remains the largest private in which it resides. New channels educational services provider in China, but The company, which was taken private by Three channels have traditionally been most Zhaoyu Zheng, a principal at ZhenFund, a Baring Private Equity Asia in 2008 and re-listed popular among PE and VC investors in Chinese seed vehicle set up by the co-founders of New in the US last month, owns five schools in China. education: private schools along the lines of Nord Oriental in conjunction with Sequoia Capital, They are part of a network of 27 covering Asia, Anglia, which caters to kindergarten through notes that the model is under stress. “In the past the Middle East, Europe and North America that Year 12 (K12), test preparation and after school supply was equal to demand and competition teach the UK curriculum to more than 17,000 education services, and vocational training. The wasn’t that furious,” Zheng says. “They continue students. Three of the four other China-based business models within these silos are evolving, to spend money acquiring customers, rent for establishments have more than doubled in centers and teacher salaries are increasing, but capacity since acquisition. China accounted for classsizes and profit per class are in decline.” 36% of Nord Anglia’s pro forma revenue of $323.7 “Education is much New Oriental had 2.5 million student million for the year ended August 2013. enrolments last year and a network of 57 schools, Speaking to AVCJ last year, Baring Asia CEO less scalable than a 669 learning centers and 32 bookstores across Jean Eric Salata identified three fundamentally lot of PE and VC guys 50 cities, as well as 8.5 million registered online attractive characteristics of education: customers users. It begs the question, how big is too big, tend to pay for courses up front; once students initially thought” – J.P. Gan especially without the insulation of substantial enroll they usually don’t leave until graduation; barriers to entry. and the industry is not easy to penetrate, with reputation, curricula and credentials essential in the top tier. PE investment in China's education sector For Nord Anglia specifically, he might have 350 20 added that success depends on identifying 300 a market niche. Nearly all of the company’s 250 students in China are expatriates, leveraging an 15 200 exclusive but growing constituency in the tier- one cities of Beijing, Shanghai and Guangzhou. 150 Deals

US$ million 10 It represents a capital-intensive yet niche play in 100 a market in which a nationwide footprint is hard 50 to develop. 0 0 “Education is much less scalable than a lot 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 YTD of PE and VC guys initially thought,” says J.P. Gan, No. of deals Amount (US$m) managing partner at Qiming Venture Partners. Source: AVCJ Research “The business has been cash rich but difficult to expand geographically. There hasn’t been nearly as much consolidation as one might think.” however. Few seek to emulate the likes of New Last October, completed the Qiming invested in several classroom-based Oriental Education, ChinaEdu Corp. and China $140 million acquisition of a majority stake in education businesses before turning its attention Distance Education Holdings, all of which went RISE China, a provider of after-school English to online solutions and backing TutorGroup, an public between 2006 and 2008 on the back of language programs for pre-kindergarten through English-language tuition platform. The VC firm plans to create large, nationwide networks of K6. The company has 34 directly-owned schools participated in a Series B round worth $100 language training and test preparation providers. in Beijing, Shanghai and Guangzhou and a million for TutorGroup earlier this year, led by Their success gave birth to a host of similar further 126 schools run by franchisees. Lihong Alibaba Group and Temasek Holdings. It was one investments, which saw deal flow jump from Wang, a managing director at Bain, is bullish on of two transactions largely responsible for PE and $39.4 million across nine transactions in 2006 the market opportunity – there are 26 million VC investment in the education sector reaching to $251.6 million and 19 deals in 2007, followed 3-12 year-olds in China’s 100 largest cities and $329.5 million so far this year, higher than any by $337.4 million and 16 deals in 2008. Four even if only a fraction can afford RISE’s services it

Number 20 | Volume 27 | June 03 2014 | avcj.com 17 Financial and Services

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still makes for a strong demand base – but notes charitable organizations and therefore not liable a premium for classroom interaction. that local conditions vary. for tax. The reality can be a lot more muddied ZhenFund claims to have found a middle “Recruiting students and delivering good and it leads to disputes over valuations and other ground and it lies in standardization and what Institutional Investor results in Beijing may not be the same for schools transaction terms, with sellers saying they’ve Zheng describes as “flipping the classroom.” in Shanghai,” she says. “We’ve had better results never paid certain taxes and buyers wanting to One of the fund’s portfolio companies, 17zuoye. in Beijing, but after 3-4 years we think we have err on the side of caution. com, works with more than 10,000 primary cracked the code in Shanghai, and then we However, arguably the biggest growing schools nationwide on English and mathematics opened up in Guangzhou two years ago and it’s pain is quality control as the network expands. tuition. It supplies targeted education programs Services ramping up. It is a big market but scalability is One private equity investor recalls conducting comprising lesson plans and test materials that not automatic.” preliminary due diligence on a company that are intended to change the classroom from tutored students sitting certified financial teacher-led to activity-led. FTI Consulting is a global business advisory firm dedicated to helping organisations protect and Expansion issues analyst (CFA) examinations and sending a team “Traditionally the teacher has been the enhance enterprise value in an increasingly complex legal, regulatory and economic Other obstacles are more practical in nature. member along to one of the classes. “He said, ‘We biggest obstacle to scalability,” Zheng says. “The environment. Education is a cash generative business, with can’t invest because one of the instructors is a businesses we are trying to invest in position students paying for courses up front, but it is sophomore I tutored in college and who doesn’t the teacher more as an organizer and this We have over 20 years of experience in the PRC supported by our 150 professionals based also capital intensive. Building out a network of have a CFA,” the investor relates. “There are a lot of lowers the requirements. This lowers the cost of across our three offices in Beijing, Guangzhou and Shanghai. Our dedicated Financial and schools requires investment in premises, staff and quality issues.” the classroom and raises the efficiency of the Institutional Investors team in the PRC provides a range of services, including: marketing before the first student walks in. For some investors, the solution is not learning process.” On the regulatory front, the Ministry of to pursue scale at any cost. RISE wanted to It is part of a wider theme that involves Education has bureaus in each province and city establish a presence in lower tier markets in targeting businesses with the potential to OUR SERVICES that is responsible for issuing licenses. Stephen order to strengthen the brand and offset the lead their respective segments, steering clear Ip, education sector lead for transaction services threat of local copycats without overstretching of mature and competitive areas such as PRE-LENDING REVIEWS INTERIM MANAGEMENT at KPMG China recalls working with a client keen itself financially and operationally. Recruiting test preparation. This may lead investors into n Financial due diligence n Independent and experienced onshore legal to enter the Qingdao market only to be told that n Reputational due diligence representatives, directors, CFOs, controllers the authorities were no longer issuing licenses n Experienced operational expertise n Turn key management solutions for a particular kind of training operation. This “We are happy to invest but there are natural n Fundamental analysis of the underlying n Post-acquisition integration support can usually be addressed by purchasing a license from an existing local player, but this throws up constraints in terms of quality principals and business n Crisis management its own set of challenges. teachers” – Lihong Wang “A lot of the incumbents are small players with NON-PERFORMING LOAN REVIEWS ORGANISED WIND DOWNS a handful of schools or learning centers. They n Portfolio reviews n Creditor/employee management are very entrepreneurial and it might be difficult franchisees was the logical solution. Bain’s Wang specialist areas – both RISE and ZhenFund are n Individual debtor reviews n Interim management/cash monitoring for an investor to buy one operator in Qingdao, does not expect the company to aggressively interested in teaching methods that are more n Compliance reviews requested by regulatory n Asset realisation and distribution another in Dalian and a third in Jinan,” Ip says. expand its directly-owned business in these cities holistic, removed from the learning by rote still authorities “Every city has its own competitive dynamic. It’s because of quality and cost issues and so as not popular in state schools – but it is not an obstacle not that you can’t get scale, it just takes a time.” to undermine existing franchisees. to achieving scale. He notes that many investors simply target RISE will primarily focus on its core markets, TutorGroup started as an offline business ONSHORE DEBT RESTRUCTURING ADVISORY larger companies with 100 or more centers, where demand among its current client base in Taiwan and expanded online as it launched n Fraud and financial investigations either directly owned or franchised out, because remains untapped. The company has introduced in the mainland. The company, which now n Independent onshore advisor to syndicate they don’t want to start from scratch. But do summer programs whereby students spend time specializes in English-language training for adults, lenders and investors prospective targets make for appetizing business in English-speaking countries and also a middle is now moving into Chinese language services n Development and execution of exit strategies partners? school program – covering K7 and K8 – for those as well as exploring opportunities teaching that maximise value The existing principal is often the individual who want to continue in the RISE system with a English in non-Chinese markets. Qiming’s Gan who holds the license and it can be difficult view to pursuing higher education overseas. notes that Alibaba Group’s marketplace Taobao to replace them with management that can “If you can keep kids in your school longer it and US-listed social network YY.com have simultaneously handle the academic, operational is much more profitable. We have a 70% renewal launched platforms that essentially link teachers and compliance burden that comes with scaling rate, compared to the industry average of 30- with students across multiple academic and up a business. There are plenty of anecdotes 50%, and that means we don’t have to spend as vocational pursuits. It is too early to say whether about schools with poor accounting, which much on sales and marketing,” Wang says. “With these giants will end up dominating pure online complicates due diligence. Given companies may a large school base we generate enough cash education but their ambitions do encourage offer a variety of different programs at different to open new schools – and we are not talking specialists to remain specialized. price points and with different class sizes, 20-30 a year, but less than 10. We are happy to “The days of the big education providers investors want to tie revenues to the relevant invest but there are natural constraints in terms going public in the US and having lots of centers programs in order to build up a picture of where of quality principals and teachers.” nationwide offering test preparation and after the money is coming from. school services everywhere – that situation To find out how FTI Consulting can help your business, Hidden liabilities are routinely cited as a The tech effect bolted a long time ago,” says KPMG’s Ip. “The type please visit www.fticonsulting.com potential pitfall. Teachers’ employment contracts Technology is potentially the great leveler, but of players you have left are probably going to must be scrutinized to ensure that the correct online models don’t work for all. A seven-year-old be more technology-driven, with some sort of social security payments are being made. in RISE’s programs can’t spend an hour in front a competitive advantage that could make it easier Many education companies also claim they are computer screen; besides, parents are also paying to scale a business.”

Number 20 | Volume 27 | June 03 2014 | avcj.com 19 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 US- dollar funds. It requires a level of institutionalization that most have never seen before

AFTER THREE YEARS AND ABOUT 12 fingers of one hand. They include consumer- interact with sophisticated global institutional renminbi-denominated funds, JD Capital – focused Tiantu Capital and hedge fund player investors,” says Frankie Fang, a managing director formerly known as Jiuding Capital – raised its first Greenwoods Asset Management, both of which at LGT Capital Partners. US dollar fund in 2010. The firm, having surprised are eyeing first closes. Harvest Capital, formerly Four years ago these firms had little reason many with its aggressive domestic pre-IPO Sino-Can Harvest Capital (SCHC), has already to question themselves. In 2011, renminbi strategy, received commitments totaling $120 crossed the line, closing its second US dollar fund fundraising was at its peak, with about $35 billion million. LPs included a string of fund-of-funds, last month at $300 million. going into 261 vehicles, up from $21 billion in plus Temasek Holdings-owned Vertex Ventures, Oriental Venture Capital finally 2010. German insurer Allianz and the BMW Foundation. continues to preserve and is now nearly a The likes JD, Shenzhen Fortune Venture JD has now returned with a successor first close of $50 million, having set a target of Capital and Oriental Fortune Capital were on the vehicle, which has a target of $200 million and $100 million for a fund that launched in 2010. crest of a wave. Shenzhen Fortune raised RMB6 is expected to reach a final close in the next few Fund-of-funds and family offices are the major billion across nine funds to 2010, while JD had approximately RMB3 billion under management. High net worth individuals (HNWIs) were flocking US dollar fundraising versus renminbi fundraising by capital raised to these firms in response to stellar pre-IPO plays. 100 The moratorium on new listings soon put paid to the exuberance. Renminbi fundraising 80 fell from $24 billion in 2012 to $15 billion in 2013, and only 16 local funds have attracted 60 commitments of $3 billion so far this year. Investors lost interest when the promised returns % 40 didn’t materialize and the already fragmented pool of individual capital for which managers 20 were competing dried up. “Individuals are not a sustainable source of 0 2008 2009 2010 2011 2012 2013 2014 YTD capital,” says one Chinese fund manager. “When US dollar Renminbi we make a for the fund, they simply Source: AVCJ Research 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 months. Vertex and Allianz are among those contributors. Plenty of others have abandoned as the overall economy slows. It’s hard to survive understood to have re-upped. similar plans or put them on hold due to a relying only on domestic LPs.” According to industry sources, at least 30 lukewarm response from offshore investors. Some have gone out of business but others more managers who established themselves in have survived. They are looking to raise capital the local currency business have launched or Times of transition from more reliable offshore sources and diversify are preparing to launch debut US dollar funds. Approaching US dollar LPs requires a completely their LP bases, but talk is much easier than A few more, JD among them, are back in the different approach to what renminbi managers execution. For many GPs, fundraising means market for second funds. They are typically are accustomed to in the domestic market. The networking with HNWIs at friends’ dinner parties. the private equity affiliates of Chinese banks, professionals sitting on the other side of the table “I would describe raising money corporations and hedge funds, but there are a usually have clear in-house criteria for picking the internationally as coming down to how ready the few independents in the mix as well. best fund managers. With little track record to go renminbi fund managers are to be transparent. If Not everyone gets a smooth ride. by, the LPs must answer the following question: Is an LP asks a question and the fund manager says, “A lot of fund managers with renminbi this just a one-off, speculative effort, or is this GP ‘Give me two weeks to get back to you,’ that is backgrounds are trying to raise US dollars,” ready to create a sustainable US dollar business? going to cause delays in the fundraising process,” notes one renminbi manager who shares “The real learning process only starts when says Conrad Yan, a partner from Campbell their aspirations. “It started last year when the they seek to establish their first US dollar fund. Lutyens. domestic IPO market was shut last year, but it’s Few of these renminbi fund managers have a Cultural differences and communication very hard, particularly if, like us, you are a first thorough roadmap towards institutionalizing the skills are classic obstacles. These managers do time fund.” US dollar fund business. Part of the reason is that not have the advantages of Hony Capital and Those that are capable of closing a US they probably only focus on deal making without CDH Investments, whose founders had worked dollar fund could probably be counted on the internalizing what that entails, especially how to overseas and could claim a familiarity with the

20 avcj.com | June 03 2014 | Volume 27 | Number 20 ANALYSIS [email protected]

Western institutional mindset. As a result, they Group – by following a similar investment thesis. million for its first US dollar fund in 2010, when are perceived to be less well organized. And they need US dollars to do it. renminbi fundraising was at its peak, and more “I heard plenty of stories of good fund “When we met some renminbi GPs and asked than half of the investors were existing LPs in managers with good track records going on a them which sectors they will invest their new renminbi vehicles, who had US dollar assets to road show and meeting potential LPs in overseas funds in, many said TMT but when we looked invest. markets. The fund principal and placement at their investment portfolios, there was no “We raise US dollar fund because we want agent are there, but throughout the meeting background for doing that. It doesn’t make any to attract more institutional investors,” says the principal doesn’t say a word,” observes Lorna sense to us,” says Ally Zhang, managing director Margaret Shao, managing director at Shenzhen Chen, a partner with Shearman & Sterling. “No at Siguler Guff. Fortune. “It’s easier to start raising capital from matter how good track the record is, if they can’t LPs also need to be convinced that managers our existing LPs who are comfortable investing in communicate well or correctly to the potential can resolve the corporate governance issues that us. Asia-based fund-of-funds, insurance or family LPs, it’s no use.” arise when operating US dollar and renminbi offices with offices in Hong Kong or Singapore International LPs evaluate renminbi GPs in funds. The LP base for each vehicle is different are also more accessible for us because we can much the same way as US dollar managers: they and internal resources must be deployed in a communicate in Chinese and they are more want to see a consistent value creation strategy manner that ensures an alignment of interest familiar with the local markets.” that can be supported by performance numbers. with every investor. It is not an impossible task Shenzhen Fortune has yet to finish deploying The numbers might be there – some domestic – Hony and CDH are among those that handle its first fund and Shao is cautious about returning managers have earned multiples of 10-20x it – but transparency is paramount. to the market for a second vehicle. The renminbi through pre-IPO deals – but faith in the strategy “These emerging fund managers have done business is where the firm’s expertise lies and it is not. Managers who rely on multiples arbitrage a lot of pre-IPO investments and some are not will remain the key element. for returns tend to have difficulty differentiating suitable or not open to US dollar investments. The small and focused approach may work themselves from the mainstream. There is no Sometimes picking US dollars to invest may slow for Shenzhen Fortune, but JD has its sights set value creation narrative. down the process. In that context, when you higher. The firm wants to become a “mega asset “When you are approaching US dollar focused have a good investment, from which fund will management” firm by aggressively diversifying its LPs and you show them a $100 million fund you allocate capital?” asks an international LP, business across multiple platforms. This includes portfolio with 25 investments – each one a small who has backed one renminbi fund. offering co-investments to LPs. ticket investment, with a short holding period According to sources familiar with the and majority are pre-IPO type of investments, the Same bed, different dreams situation, this was part of the rationale for overall level of interest may be quite limited. You Even if a local manager presents a compelling Vertex backing JD in the first place. One of the may have been able to generate relatively high investment narrative and impresses the LP, there co-investments from the first US dollar fund was IRRs but it’s not a very compelling story to tell to is no guarantee that an allocation will follow. A Wuxi Huadong Heavy Machinery. Vertex owned a the international LPs,” says Vincent Ng, a partner fund with a $200 million corpus may simply be 28% stake in the company prior to its IPO in 2012. at Atlantic-Pacific Capital. too small for an LP with a minimum check size “Vertex tends to do more direct investments. It invests in the fund to access more co-investment opportunities in China,” one LP says. Renminbi fundraising Raising a US dollar fund represents a step 35,000 300 into the unknown for renminbi fund managers and it could prove to be a key step if they are to 20,000 250 25,000 establish familiarize themselves with international 200 capital markets and ultimately become larger 20,000 150 scale, global players. The expectation is that US

15,000 Funds dollar funds will remain relatively modest in size US$ million 100 10,000 over the next five years, ranging from $100-300 5,000 50 million, as it takes time to build up their domain 0 0 expertise. 2008 2009 2010 2011 2012 2013 2014 YTD Based on the speed at which the domestic No. of funds Amount (US$m) market is maturing to embrace new deal Source: AVCJ Research structures and strategic approaches, the current gap in terms of culture, experience and understanding is by no means unbridgeable. GPs don’t help themselves by pursuing more and a maximum permitted exposure to a single “Professionals in this market are very quick specialist strategies in an opportunistic, almost entity. Beyond that, the risk-return profile might studies: the strategies, what to say, and how to haphazard, manner. There is a go after whatever not be a good fit. adjust all happen quickly,” says Chris Lerner, head sector is currently in vogue, regardless of whether Fund-of-funds, which have on-the-ground of the China practice for Eaton Partners. “A fund they have sufficient domain expertise. resources that allow them to take more that called itself a pre-IPO manager two years Inspired by the recent telecom, media and calculated risks on managers with little or no ago, now says it focuses on trade sales. The issue technology (TMT) boom, renminbi survivalists track record, are a good starting point. Family is grasping what they really do – not what they have sought to leverage the enthusiasm for offices may also take an interest. say they do – and how that is institutionalized Chinese technology companies listing overseas – Shenzhen Fortune Venture Capital, however, across the team into a repeatable formula for such as e-commerce players JD.com and Alibaba went even closer to home. The firm raised $75 success.”

Number 20 | Volume 27 | June 03 2014 | avcj.com 21

GRAPHICAL ANALYSIS [email protected] 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 Largest buyouts that by transaction type by deal size involved a change in control

35,000 Buyouts: 15 Change of control: 15 RMB deals: 6 30,000 Amount Investee Investor (US$m) 25,000 SouFun Holdings ; Apax Partners 336.6 20,000 2010 ASIMCO Technologies Bain Capital 150.0 15,000 Allyes Online Media Silver Lake 124.0 US$ million 10,000 Standard Water Themes Investment Partners 100.0 5,000 FUJI Food and Catering Services Anhui Province Venture Investment; 84.5 Guangdong Huaheng Energy; Tsinghua 0 Redbud 2010

Undisclosed amount 35,000 Other < US$50m Buyouts: 18 Change of control: 11 RMB deals: 3 US$51-100m 30,000 Start-up/early stage Amount PIPE US$101-200m Investee Investor (US$m) 25,000 Growth/pre-IPO > US$201m Shanghai Jahwa Group Shenzhen Ping'an Innovation Capital 806.0 20,000 Buyout 2011 China Fire & Security Group Bain Capital 257.8 15,000

US$ million Golden Jaguar Group Apax Partners 250.0 10,000 Qinhuangdao Yaohua Glass Hony Capital; IFC 100.0 5,000 Sunrise Duty Free Stores Boyu Capital 100.0 0 2011

Undisclosed amount Buyouts: 29 Change of control: 15 RMB deals: 6 35,000 Other < US$50m US$51-100m 30,000 Start-up/early stage Amount PIPE US$101-200m Investee Investor (US$m) 25,000 Growth/pre-IPO > US$201m Luye Pharma Group CDH Investments; New Horizon; CITIC 510.2 20,000 Private Equity; AXA Private Equity Buyout 2012 15,000 HCP Holding TPG Capital 500.0

US$ million Shaanxi Bicon Pharmaceuticals PAG Capital 250.0 10,000 Shenzhen ZTE NetView Unitas Capital 207.3 5,000 Technology 0 China Yeehoo Group Lunar Capital 100.0 2012

Undisclosed amount 35,000 Other < US$50m Buyouts: 26 Change of control: 15 RMB deals: 11 US$51-100m 30,000 Start-up/early stage Amount PIPE US$101-200m Investee Investor (US$m) 25,000 Growth/pre-IPO > US$201m China New Town Development China Development Bank Capital 185.8 20,000 Buyout 2013 RISE China Bain Capital 140.0 15,000 China Hydroelectric NewQuest Capital Partners 77.7 US$ million 10,000 Guizhou Yonghong Food Lunar Capital 50.0 5,000 TNT Hoau CITIC Private Equity 40.2 0 2013

Other Undisclosed amount Start-up/early stage < US$50m PIPE US$51-100m Growth/pre-IPO US$101-200m Buyout > US$201m Source: AVCJ research

Number 20 | Volume 27 | June 03 2014 | avcj.com 23 15th Annual Private Equity & Venture Forum Japan 2014 26-27 June, Conrad Tokyo

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