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Asia’s Private Equity News Source avcj.com July 01 2014 Volume 27 Number 24
FOCUSFOCUS
Small beginningsChinese PE firms seek to carve out a niche in the US buyout market Page 7
Location no object VC firms prepare for a cross-border future Page 10
Coming compliance PE poised for a string of FATCA deadlines Page 14
Chinese tech M&A in the US: Gaining momentum
Page 12
Micro trends in the macro Asia private equity fundraising story
Page 3
Baring Asia, CDH, CPPIB, Intel Capital, IDG, Innovation Works, Ironbridge, Lightspeed, Mandarin, PAG, PEP, Riverside, Standard Chartered PE
Page 4
EDITOR’S VIEWPOINT
NEWS
DATA ANALYSIS
PRE-CONFERENCE ISSUE AVCJ PRIVATE EQUITY AND VENTURE CAPITAL FORUM USA 2014
Jessica Archibald of VC-focused fund-of-funds Top Tier Capital Partners
Page 15
INDUSTRY Q&A
Unlocking liquidity for private equity investors
www.collercapital.com London, New York, Hong Kong
Anything is possible if you work with the right partner
Number 24 | Volume 27 | July 01 2014 | avcj.com 3
EDITOR’S [email protected] [email protected]
AT THE HALFWAY POINT OF 2014, WHAT do the private equity fundraising numbers tell us? According to provisional data from AVCJ Research, 82 funds have reached incremental or final closes worth $23.6 billion so far this year. This compares to $25.5 billion raised by 170 funds in the first half of 2013. For 2013 as a whole, 341 vehicles received commitments of $48.4 billion.
Yes, the market remains challenging and capital appears to be gravitating towards a smaller number of managers. The trend is in line with global norms and seems to confirm sentiments LPs have been expressing for at least 12 months: risk-adjusted returns out of Asia haven’t met expectations, and while they remain committed to the region, they are more scrutinizing of GPs’ ability to return capital.
Parse the first half numbers further and the following themes emerge…
Dwindling buyouts: Of total funds raised in 2013, buyout vehicles accounted for 31%. This rose to 34% in the first half of 2014 but the activity is volatile, with the latest round of large pan-regional vehicles moving the needle. Affinity Equity Partners, CVC Capital Partners and TPG Capital all announced final closes in the first half of 2014. While the likes of Baring Private Equity Asia are back in the market – with a hard cap of $3.5 billion on its latest fund – most of the larger players have finished, leaving an interesting collection of middle market firms.
Growth capital struggles: Capital entering growth vehicles has been falling for some time, with $6.4 billion committed to such funds in Asia in the first half of 2014 compared to $21.1 billion in 2013 as a whole. This is largely a China
phenomenon – the 2011 peak in Asia growth capital fundraising coincided with the peak for China and its subsequent decline can be linked to the slowdown in IPOs on the country’s bourses. To be considered viable by LPs, a China strategy must now offer more than ambitious projections for multiples arbitrage. The ability to add value operationally is increasingly important.
China buoyed by VCs: With growth capital players suffering, China fundraising has been bolstered by venture capital. More than $6.7 billion was committed to VC managers in the first half of 2014 – already more than in 2013 as a whole – and most of it went to China. This is in part cyclical: a core group of established players tend to return to market around the same time. However, the recent jump in China tech IPOs plus a growing number of trade sales to domestic internet giants has also piqued interest.
Appetite for distress: Distress funds also raised more in the first half of 2014 than for 2013 in full. Two sizeable funds are responsible for the spike in activity: India-focused Aion Capital raised $825 million while pan-Asian player SSG Capital Partners raised $915 million for its third fund. It is possible that LPs are buying into the potential for alternative forms of financing as certain economies in Asia show signs of weakness. Equally, they may appreciate the fact that distress funds focus on hybrid debt-equity transactions that can start delivering returns earlier.
Tim BurroughsManaging EditorAsian Venture Capital Journal
Inside fundraising Managing Editor
Tim Burroughs (852) 3411 4909 Staff Writers
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Creative Director Dicky Tang Designers
Catherine Chau, Edith Leung, Mansfield Hor, Tony Chow
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Research Associates Herbert Yum, Isas Chu, Jason Chong, Kaho Mak
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Asia PE fundraising by fund type
Source: AVCJ Research
2006 2007 2008 2009 2010 2011 2012 2013 2014YTD
US$
mill
ion
100,000
80,000
60,000
40,000
20,000
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Venture capital OtherBuyout Growth capitalDistress
avcj.com | July 01 2014 | Volume 27 | Number 244
AUSTRALASIA
PE-backed Monash IVF raises $298m in IPOIronbridge Capital exited the majority of its holding in Monash IVF Group as the Australian in vitro fertilization company raised A$315.9 million ($298 million) through an IPO. The PE firm received proceeds of A$168.4 million from the offering and retains about 5% of the company.
Riverside buys Australia orthopedics businessThe Riverside Company has acquired Global Orthopaedic Technologies (GOT), an Australian orthopedic implants manufacturer. Andrew Fox-Smith, a former group president of Stryker Corp, and Duncan Lilley, who held senior roles with the British Standards Institution and SAI Global, partnered with Riverside in the transaction.
Next-owned Hirepool abandons NZ offeringHirepool Group – a New-Zealand equipment rental firm owned by Next Capital – has abandoned plans to raise up to NZ$262 million ($227 million) through an IPO. The company said that Next Capital was comfortable retaining control of Hirepool given the strength of the local economy and the positive outlook for the business. Local media reports said that investors were unwilling to pay the asking price.
Intel Capital backs New Zealand software start-upIntel Capital has invested an undisclosed sum in Performance Lab, an Auckland-headquartered start-up that produces real-time exercise measurement analysis and virtual coaching software. It will use the proceeds to advance product development and accelerate international expansion.
GREATER CHINA
Tencent invests in VC-backed classifieds siteTencent Holdings will pay $736 million for a 19.9% stake in 58.com, a venture capital-backed Chinese classifieds website. The company received funding from SAIF Partners, DCM and Warburg Pincus between 2005 and 2010 and then raised $187 million through a US IPO last
November. 58.com’s platform will be integrated with Tencent’s wide-ranging internet services.
China Shengmu Organic Milk launches $169m IPOChina Shengmu Organic Milk is targeting HK$1.31 billion ($169 million) through an IPO in Hong Kong. At the end of last year, Goldman Sachs and Baring Private Equity Asia together acquired a 15.41% stake in Shengmu
for RMB685.4 million ($110.4 million), while a consortium of investors including Sequoia Capital and BOC Investment bought a 12.54% interest for RMB648.2 million.
Lightspeed China closes Fund II at $260mLightspeed China Partners has reached a final close of $260 million on its second China fund, exceeding the target of $220 million. The fund will follow a similar strategy to that of its predecessor – which closed at $168 million in 2012 – targeting early-stage companies in internet, mobile, technology-enabled services, and enterprise solution areas.
Alibaba picks New York Stock Exchange for IPOChinese e-commerce giant Alibaba Group announced it will apply to be listed on the New York Stock Exchange (NYSE). Alibaba will trade under the symbol BABA.
CDH, China Grand Pharma buy contact lens makerCDH Investments has teamed up with Hong Kong-listed China Grand Pharmaceutical & Healthcare to acquire a 71.25% stake in contact lens maker Shanghai Weicon Optical for $78.75 million. CDH will pay $21 million for a 19% stake in Shanghai Weicon, with a China Grand Pharma subsidiary covering the rest of the transaction. They will put in an additional $15 million to support the company’s business growth.
VC-backed Xunlei jumps 24% on debutXunlei, a Chinese file-sharing and download management platform backed by a string of VC firms, saw its stock gain 24% on its first day of trading on NASDAQ following a $88 million IPO. The company sold 7.32 shares at $12 apiece. After opening at $14.21 last Tuesday, the stock peaked at $15.55 before settling back to $14.90.
Mandarin sees China angle for Italian textiles makerMandarin Capital Partners and Private Equity Partners have acquired control of Milan-based Industrie Chimiche Forestali SpA (ICF), which develops adhesives and textiles for the footwear industry. They plan to expand the business beyond European markets, particularly in China. Mandarin Capital paid EUR18 million ($24.5 million) for an approximately 92% stake in ICF.
PEP exits as Asaleo Care IPO raises $616mPacific Equity Partners (PEP) made a full exit from Asaleo Care as the hygiene and paper products manufacturer raised A$655.7 million ($616.6 million) through an IPO. It is the second-largest offering in Australia this year. Asaleo sold 406.7 million shares at A$1.65 apiece. The stock opened at A$1.71 when it began trading last Friday before closing at A$1.65. As of Monday, it was trading at a slight premium to the IPO price.
Asaleo, formerly known as SCA Hygiene Australasia, was jointly owned by PEP and
Swedish paper products company Svenska Cellulosa Aktiebolaget (SCA). The private equity firm invested SCA’s Australasian business in 2011 at an enterprise valuation of A$570 million to create the joint venture. SCA received SEK3.2 billion (then approximately $500 million) for divesting 50% of the equity.
PEP and its co-investors exited their 49.5% holding, receiving A$325.8 million. SCA did not sell any shares but the new issue has diluted its stake from 50% to 32.7%. PEP had already taken money out of the business through a A$562.7 million refinancing in February that saw A$250.8 million returned to shareholders. SCA also acquired preference shares from PEP, leaving each party with an equal interest in the business.
Asaleo reported pro forma revenue of A$625.1 million in 2013, up from A$617.3 million in 2011. Net profit has nearly doubled to A$61.5 million over the same period.
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avcj.com | July 01 2014 | Volume 27 | Number 246
China sees first PE-backed IPOs in four monthsThe first two PE-backed Chinese companies to go public on domestic bourses in fourth months saw their shares jump more than 40% on the Shenzhen Stock Exchange. Wuxi Xuelang Environmental Technology, a waste incineration firm backed by Boxin Capital and Jangsu Jolmo Venture Capital Management, raised RMB294.6 million ($47.4 million), while Feitian Technologies, an information security products maker backed by JD Capital, raised RMB787 million.
Longmaster acquires IDG-backed health site 39.netLongmaster Information & Technology, a Shenzhen-listed software developer, has bought Chinese healthcare portal 39.net for RMB650 million ($105 million), allowing IDG Capital Partners to exit. Longmaster will buy 100% of Guangzhou Qisheng Information Technology, 39.net’s operator, in a cash-plus-shares deal.
CDH-backed Beijing Digital Telecom eyes $152m IPOBeijing Digital Telecom (BDT), China’s largest mobile telecom retail chain, which is backed by 3i Group and CDH Investments, plans to raise up to HK$1.18 billion ($152 million) through an IPO in Hong Kong. CDH invested RMB87 million ($14 million) in 2007, picking up a 14.25% stake, while 3i acquired a 17.42% interest for RMB107 million.
Innovation Works exits Elex Technology via trade saleBeijing-based incubator Innovation Works has sold its entire 3.49% stake in mobile games platform Elex Technology to Chinese Universe Publishing and Media for RMB70 million ($11 million). The Shanghai-listed media group will pay RMB2.66 billion in cash and shares for Elex.
NORTH ASIA
Baring Asia agrees Japan electronics buyoutBaring Private Equity Asia has agreed to acquire the audio-video operations of Japanese car electronics maker Pioneer Corp. alongside Pioneer’s rival Onkyo Corp. Baring will take a 51% stake in Pioneer Home Electronics Corp. which produces audio equipment and DVD players. The ownership of the remaining 49% will be decided by the three parties.
Standard Chartered PE backs Korea’s AJ Networks
Standard Chartered Private Equity (SCPE) has invested $60 million in AJ Networks, the largest shareholder in listed South Korean car rental business AJ Rent A Car. Established in 2000, AJ Networks rents out office IT equipment, pallets,
aerial lifts and construction equipment, in addition to cars.
PAG buys Commerzbank’s Japan real estate businessA PAG-led consortium has acquired a portfolio of around EUR700 million ($954 million) in primary subordinated loans held by Commerzbank’s Japan real estate subsidiary, plus local operations and staff. The buyers include PAG’s Secured Capital REP V, special situations funds managed by an affiliate of PAG, and Canada Pension Plan Investment Board.
SOUTH ASIA
CPPIB commits $322m to Indian infrastructureCanada Pension Plan Investment Board (CPPIB) has agreed to invest INR20 billion ($322 million) across two equal tranches in L&T Infrastructure Development Projects, a subsidiary of India’s largest engineering and construction company, Larsen & Toubro. CPPIB will subscribe to preference shares in the L&T unit. These will convert into a minority equity stake.
Cisco allocates $40m to Indian start-upsCisco Investments, the VC arm of Cisco, has allocated $40 million to fund early-stage companies in India. Part of the firm’s “India innovation” program, the capital will be used to support the development of new products and technologies that are relevant to India and other emerging markets.
Intel Capital commits $10m to HelpshiftIntel Capital has led a $10 million Series A round of funding for Helpshift, a customer relationship management platform for mobile apps based in Pune and San Francisco. Visionnaire Ventures also participated, as did existing investors True Ventures and Nexus Venture Partners.
Bertelsmann backs India’s Nirvana VenturesGlobal media group Bertelsmann has made an LP commitment to Digital Nirvana Fund, an India-focused vehicle that supports start-ups in the digital space. The manager, Nirvana Venture Advisors, currently has two funds worth $40.5 million between them.
Abe’s third arrow is Japan PE’s ‘best-ever chance’Prime Minister Shinzo Abe’s third arrow of structural reform could present the best-ever opportunity for a resurgent Japan, industry participants told the AVCJ Japan Forum in Tokyo. Abe’s “three arrows” economic strategy was launched over a year ago. The first two arrows comprised short-term monetary and fiscal measures, such as quantitative easing and interest rate adjustment. However, recent months have seen the government and the business community focus on the third arrow of regulatory change and long-term structural reform.
“Private equity has been in Japan since 1987 and we have seen the ups and down of many
administrations,” said Anthony Miller, CEO of PAG Japan. “But I will go out on a limb and say that this is best chance I have ever seen for Japan.”
“The current government has shown that it is determined to grow the country’s economy again, which is something we haven’t seen in 10 years or more,” said Kei Mizukami, senior managing director with CVC Asia Pacific Japan. He added that a consensus among corporations and consumers with regards to reform had helped add momentum to growth.
Hiro Hirano, CEO of KKR Japan, said he was more cautiously optimistic, but stressed there had certainly been an improvement in sentiment compared to the pessimism of a decade ago. “I would say it is better to describe the third arrow as a thousand needles of reform that need to be implemented and introduced,” he said. “Some of those needles are working very well but some still need to be redefined.”
NEWS
Number 24 | Volume 27 | July 01 2014 | avcj.com 7
COVER [email protected]
FROM MASSAGE CHAIRS TO POCKET projectors, Brookstone’s eclectic range of lifestyle products looks set to launch in China. The US-based retailer, which started out as a catalogue business in the 1960s but grew to more than 300 outlets nationwide, has been struggling for the past seven years and filed for bankruptcy protection in April ahead of a planned sale.
The owner of domestic gift shop chain Spencer’s was expected to play the white knight, but last week a Delaware judge confirmed that a Chinese consortium would buy Brookstone for around $137 million. The company is expected to emerge from bankruptcy in July and from there embark on a journey that will lead to new markets and, hopefully, commercial rejuvenation.
Chinese PE firm Sailing Capital led the deal with support from Sanpower Group, which earlier this year acquired a majority stake in UK retailer House of Fraser. Sailing was set up by Shanghai International Group two years ago with the express purpose of making investments overseas, adopting a Western-style fund structure and hiring executives with Western experience. This is its first foray in the US.
Sailing should be a poster child for the Chinese outbound story. The firm is keen invest in overseas assets with unrealized China growth potential – in areas ranging from industrial manufacturing to consumer goods – and is happy to work alongside other PE investors in a minority capacity, provided it gets governance rights and a path to liquidity. Intermediaries and PE firms are bringing deals to Sailing’s attention, but the phone isn’t ringing off the hook.
“Historically, the firm has kept a low profile so there aren’t as many inbound calls as people would like right now,” a source close to Sailing tells AVCJ. “It is also a new firm and still in the process of building its record. All of this works fine on paper, but you have to believe it works.”
For all the hype about Chinese private equity firms going overseas, they have yet to make a significant imprint on the US market. This is not for lack of interest. While some firms are held back by a lack of familiarity with M&A in America, others have the competency but not the local recognition as effective deal closers.
“We are seeing a tremendous amount of activity. It is suddenly becoming real; Chinese PE
firms are looking overseas,” says Bob Partridge, managing partner for Greater China transaction advisory services at EY. “In the last three months we’ve had about 15 of these deals, although none have been announced and it’s still too early to tell if they will go through.”
Behind the numbersThe fundamental thesis makes sense. Since 2000, China’s economy has grown more than seven-fold, climbing from sixth to second in the global rankings. Virtually every multinational has a sizeable presence in China, whether it sells industrial equipment to factories or hamburgers to consumers. It is also a market of increasing strategic importance to middle-market US players that have yet to realize the full potential of their brands in Asia. A company flat-lining domestically could be revitalized overseas.
Chinese outbound M&A stands at $27.2
billion so far this year across 186 transactions, according to Thomson Reuters. In the US, $1.8 billion has been deployed in 33 deals. While the global numbers indicate a general upward trend – Chinese companies spent $65.5 billion on acquisitions in 2013, more than four times the 2006 figure – the US data are more sporadic. The spikes in activity are explained by a cluster of mega-deals, from Lenovo Group’s $1.75 billion acquisition of the IBM PC business in 2004 to Shuanghui International’s $7.3 billion purchase
of Smithfield Foods in 2013. The sub-$500 million deals that might appeal to Chinese or Asian private equity firms don’t make much of a mark.
CITIC Capital Partners has been the most prolific practitioner in the US, completing a string of deals out of its international funds, relying on a dedicated US team. Brookstone is Sailing’s first transaction in the country and FountainVest Partners is expected to follow in due course with its debut US deal, buying a majority stake in auto components manufacturer Key Safety Systems.
The mismatch between hype and reality – or, to be more generous, expressions of interest and acts of execution – is in part due to the outbound thesis only recently becoming part of many China GPs’ remit. “It is becoming more of a mainstream strategy,” says Brian Doyle, managing partner at CITIC. “People realize that in buying an American company with a lot of exposure and growth in China you get the best of American
governance and financing and management teams but the China upside as well.”
In this nascent phase of activity, however, there are two further, interrelated reasons that explain why transacting deals is a challenge. Both can equally be applied to Chinese strategic players also seeking acquisitions in the US. First, most middle-market assets come to market via a competitive process. Second, sellers are wary of Chinese buyers’ ability to get deals over the finishing line.
From theory to practiceChinese private equity firms’ growing interest in US acquisitions has yet to translate into meaningful deal flow. These relatively new arrivals need time to familiarize themselves with a competitive market
China M&A in the US by target sector
Source: S&P Capital IQ
1Q 2011 2Q 2011 3Q 2011 4Q 2011 1Q 2012 2Q 2012 3Q 2012 4Q 2012 1Q 2013
Dea
ls
80
60
40
20
0
OtherIT
Consumer FinancialsHealthcareEnergy Industrials
Materials
avcj.com | July 01 2014 | Volume 27 | Number 248
“The attitude is often, ‘Yes, I’m getting a great price but I would have to enforce my rights against a Chinese buyer and I don’t trust the Chinese courts. I’d rather use you as a stalking horse to bring the second bidder higher and even if they don’t match you I’ll take them because of the certainty of closing,’” says Daniel Dusek, a partner at Skadden Arps. “We advise our clients that they have this perceived jurisdictional disadvantage so they must find other ways to make bids appear a bit more attractive.”
Dusek is currently working on two deals in which Chinese groups are trying to buy US assets with a view to opening up new growth channels in China. One involves a well-known Chinese PE firm and the other a consortium of Hong
Kong and Taiwan high net worth individuals. It is the latter buyer that would likely raise alarm bells with US sellers who read the headlines surrounding the collapsed bid for AIG’s aircraft leasing business by a Chinese consortium. The legal battle is ongoing over a portion of the $4.8 billion transaction held in escrow in Beijing.
However, a lot of recent Chinese interest in US assets comes from unions that may be similarly loose. In addition to the likes of CITIC, FountainVest, Hony Capital, CDH Investments, Hopu Investments and Fosun Group, three of the Big Four Chinese state-owned banks are said to be looking for deals, operating not so much through formal institutional funds as vehicles that may include sovereign or strategic money. The difference between capital commitment and capital intent is not lost on sellers.
“One of the problems is when you have a new fund with bank A partnering sovereign wealth fund B plus another source of capital, there are a lot of dynamics there. When this new fund competes against a US PE house in an auction, the seller sees the new fund as the highest closing risk because it doesn’t have a track record of closing deals,” says EY’s Partridge. “They have capital but it will take a while before they figure out how to win a competitive bid.”
Other issues may include a lack of familiarity with the US auction process and the speed of action it might require, a particular concern in consortium situations where multiple parties must affirm a deal; cultural barriers, which may lead to discomfort with the responsibilities that come with owning a US business, such as pension liabilities; concerns about getting US regulatory approvals and financing; and a fear of overpaying for assets.
Getting comfortableThese obstacles can be surmounted simply by employing investment professionals with experience of US deals. A global buyout firm will have the expected level of competence
but move down the scale through pan-regional private equity firms to China-only players and the talent pool becomes shallower.
According to one industry participant, while it is not unusual for the senior executive working on a transaction to be familiar with the US, many of his subordinates are completely untested in such environments. “You would be surprised how little experience from a US perspective these deal teams have,” he says. “They may have a sophisticated counsel and financial advisors, but we’ve seen situations in which the seller asks, ‘Do these guys have no idea what they are signing up to?’”
There are various means of assuaging discomfort on the financial side. A sum is normally placed in escrow to cover expenses and break fees should the deal fail to go through. In many cases the money is held outside of China to avoid a repetition of the AIG situation. Skadden Arps’ Dusek notes that an increasing number of Chinese buyers are willing to include representation and warranty insurance in deals so that there is no post-closing indemnity by sellers. With pricing at 2-3% of the insured amount it can be a compelling way to cover risk while simultaneously making the bid more attractive to the seller.
Comfort also comes from working with a local private equity partner. Both sides stand to benefit from such arrangements: the Chinese PE firm gets access to deal flow in the US and the US counterpart is able to pass responsibility for due diligence, management and development of the China business to someone with resources on the ground. This has been the case in all of CITIC’s deals in the US, but as it stands, there is little sign of other Chinese PE firms doing the same.
“It has opened up a lot of deals, but it’s not easy to partner with a US PE firm,” says CITIC Capital’s Doyle. “You have to build these relationships over time.”
Engineered Controls International (ECI), a value manufacturer bought late last year in conjunction with Windjammer Capital, is a case in point. The seller was Sentinel Capital Partners, which two years earlier was CITIC’s partner in the acquisition of casters manufacturer Colson Group. By the time Sentinel was preparing to exit ECI, CITIC was familiar with the PE firm’s portfolio and recognized it as an asset with a China growth angle. Contact was made with an investment professional at Windjammer who previously worked at Sentinel and a new alliance was formed.
Audax Group became acquainted with the Chinese firm through similar circumstances. About five years ago, CITIC Capital conducted due diligence on one of Audax’s portfolio companies in partnership with another private equity firm. That deal didn’t go through but Audax and CITIC have since teamed up on acquisitions of two industrial manufacturers, Elgin Equipment and Aavid Thermalloy.
“I wanted to know why there were two parties at the table and once I understood their value proposition we developed a direct relationship and have done two deals together,” recalls Oliver Ewart, a managing director at Audax. “It would have been possible to buy these companies on our own – execution doesn’t require Chinese capabilities and the businesses are run well out of the US – but we thought it would be a better to have a Chinese partner in terms of evaluating the deal and ultimately building the business.”
Challenges emerge in the absence of established ties. Partnership deals between private equity firms are fiercely negotiated under any circumstances and when a US mid-market firm enters into a deal China may be one of a number of considerations – “China is often an element of the investment thesis but it is not the tipping point,” Ewart adds. In certain cases they will also factor the risks attached to dealing with an unknown foreign partner into the economics and terms of the transaction.
EY’s Partridge recalls one situation in which the prospective Chinese buyer sought out a
COVER [email protected]
Chinese M&A in the US
Source: Thomson Reuters
15,000
10,000
5,000
0
US$
mill
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200620052004 20082007 2009 2011 2013 2014YTD
2010 2012
US private equity firm as a co-investor because there was an expectation that the business might one day be split in two. In this context, to appear credible to company management, the buyer wanted a local partner. But he agrees that US PE firms are wary of entering into such arrangements.
“The difficulties are clear in some of these negotiations as they try to get to a place
where both parties feel they have a real joint venture in how they go about it,” Partridge adds. “Partnerships provide an opportunity for US firms to look at deals they might have otherwise excluded themselves from, but it will take a while before they get comfortable doing that.”
Balance of powerAt the same time, the balance of power in these partnerships may be tilting in favor
of the Chinese PE firms, which would make negotiations even more fraught. Mid-market investment banks and other intermediaries typically tasked with selling assets have set up offices in China and routinely show deals to local strategic and private equity players. CITIC’s Doyle estimates that 90% of his US deal flow used to come from US PE firms; now it is more like 50-50.
Deal-sourcing has an impact on the division
of equity and CITIC, having been the minority partner in previous investments, is now looking to take the lead. Indeed, Kenneth Pang, China private equity lead at KPMG, sees no significant trend of Chinese PE investors working with overseas counterparts and doesn’t necessarily expect to see it. Rather, he expects them to run their own deals and bring in foreign managers experienced in overseas transactions.
It is part of a broader evolution that should,
ultimately, see Chinese private equity firms close the skills gap, build up track records in the US and put paid to the negative perceptions. Not everyone will have the resources to make the jump, but the underlying forces driving up China’s share of the global economy suggest the opportunity is only going to get bigger. And if US private equity firms aren’t co-investing alongside their Chinese counterparts, they may be selling to them.
Once again, it sounds great in theory, but industry participants on the US side are waiting to see the realization of this potential. They also put the evolution into a different context: we are seeing a niche widening, not a paradigm shift in the M&A environment. America will remain a competitive market, no matter who the buyer is.
“We are seeing a lot of activity but it’s a gradual process because from a numbers perspective, the market is deep,” says Joe Chang, China CEO and managing director at Lincoln International, which has brokered the sale of four companies to Chinese buyers in the last 18 months.
“There are probably only about two dozen names, including the more industry-specific names as conglomerates set up their own funds. They are operating in a pool of hundreds of thousands of guys in the US looking for deals.”
COVER [email protected]
“We advise our clients that they have this perceived jurisdictional disadvantage so they must find other ways to make bids appear a bit more attractive” – Daniel Dusek
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avcj.com | July 01 2014 | Volume 27 | Number 2410
ALIBABA GROUP’S EARLY SUCCESS was based on its ability to match Chinese suppliers with Western distributors. The Chinese e-commerce giant spread from B2B into the B2C and C2C worlds, with Taobao and TMall cornering the market in domestic consumer demand. Wish, a San Francisco-based mobile shopping app, wants to connect sellers on Taobao and TMall with consumers in the US and Europe.
The company’s target market is the so-called “Diaosi,” a buzzword in the Chinese internet community used to refer to ordinary young people with poor social skills who spend most of their time online. Demand from China’s estimated 400 million Diaosi has spurred growth for the likes of Alibaba and rival retailer JD.com. However, the purchasing potential of overseas Diaosi has yet to be realized.
“The Diaosi user base worldwide is may be three to four times the size of their peers in China. All that purchasing power is being unleashed in lower cities around the world,” says Hans Tung, managing partner at GGV Capital, a Wish investor. “These users are unsatisfied because physical retail channels in their cities are inefficient and broadband PC internet penetration is still relatively low.”
Wish wants to become a mobile shopping channel that offers a wider selection of goods at lower prices than Amazon and WalMart. It claims to have 31 million active users, up from 25 million two months ago, with about 10,000 merchants using its platform to sell goods.
Wish is an example of Sino-US convergence in action. The disruptive impact of mobile internet services – which take time and space as barriers to geographic expansion and reduce them to binary code – is changing consumer behavior. As a result, the target market for companies at the nexus of the technology and consumer spaces has become exponentially larger. What does this mean for the venture capital investors whose remit is to initiate and accelerate such trends?
Increasingly acquisitiveAccording to Thomson Reuters, Chinese outbound investment in the technology sector reached stands at $1.06 billion for 2014 so far, up from $324.5 million in 2013 as a whole. Of this $1.06 billion, $414.6 million has ended up with US-based companies. This compares to
investment of $125.9 million in 2013. Alibaba and Tencent Holdings are among the
most aggressive players. Tencent has deployed $2 billion across 20 investments in the US since 2000, AVCJ Research’s records show, while Alibaba has pumped almost $1 billion into six American start-ups. A number of newly listed tech firms – young enough that their VC backers are mostly still on board – are also embracing M&A opportunities. Online retailer LightInTheBox and mobile app developer Sungy Mobile both made acquisitions in the US last year.
“We are beginning to see how strategic partnerships and M&A are going to increase between China and the US,” says John Ball, founder and managing partner of Steamboat Ventures. “In the last five years, M&A in the China media-tech space has been primarily focused on domestic transactions. But over the next 3-5 years there will be a dramatic increase in outbound M&A as companies become more comfortable and adventurous in expanding into foreign markets through acquisitions.”
Steamboat was among the first VC firms to travel from to China from the US in search of cross-border opportunities, opening offices in Shanghai, Hong Kong and the US in 2000. Four years later the movement was kick-started when Silicon Valley Bank (SVB) took about 25 top-tier US VC firms on a tour of China. SVB itself launched a joint venture with Shanghai Pudong Development Bank and subsequently set up a local VC affiliate, SVB Capital China.
SVB Capital China now has renminbi- and US
dollar-denominated fund-of-funds that back local managers – predominantly the affiliates of US VC firms – as well as making direct investments in Chinese start-ups. “Finally today we have the resources and capabilities in China to match what we have in the US,” says Ming Yeh, who heads up SVB Capital China. “In many ways, we are in leading position to facilitate cross-border transaction opportunities.”
Not long after the SVB trip, Sequoia Capital, Lightspeed Venture Partners and Repoint Ventures arrived in China. KPCB joined them in 2007 and Matrix Partners followed a year later.
At that time, China’s tech sector was a relatively nascent stage, which provided a great opportunity for US firms to introduce technologies from overseas. According to PitchBook, investment by US-based VC firms in China soared to $14.44 billion across 106 deals in 2006, up from $3 billion in 2005. Many investee companies have since gone public, generating handsome returns for their investors.
The capital initially came from global
funds but it wasn’t long before these VC firms established dedicated China vehicles. Sequoia China was set up as early as 2005 and others have followed suit, with Lightspeed raising its first China fund as recently as 2011.
The reality is that as the China opportunity grows, a partial allocation from a global fund might be insufficient. Localization is also driven by China-based teams’ desire for greater autonomy and their US employers’ willingness to accommodate talent in order to retain it.
Beyond bordersChinese tech companies are interested in making investments in the US, while start-ups are targeting Sino-US or global markets from the outset. How can VC investors make money in this melting pot?
No. of deals
US-based VC �rms' investments in China
Source: PitchBook
20,000
15,000
10,000
5,000
0
200
150
100
50
0
US$
mill
ion
Dea
ls
Capital invested (US$m)
2005 2006 20082007 2009 2011 20142010 20132012
Number 24 | Volume 27 | July 01 2014 | avcj.com 11
“VC success depends heavily on the team and partners, and it takes time to build the partnership,” says James Mi, co-founder of Lightspeed China Partners. “It’s difficult for US VCs to expand in China without strong China-based partners and talented people are hard to find.”
However, in the face of increased competition from wholly domestic VC players as well as spin-outs from global firms, collaboration with the US mother ship offers differentiation. Offices in China and Silicon Valley exchange information on emerging trends and new technologies. And when Chinese portfolio companies want to expand overseas, global networks and resources can be put at their disposal.
“Most of VC firms have some US affiliation and these capabilities are important in helping portfolio companies reach counterparts in the US and expand globally,” says Lye-Thiam Koh, principal at Northgate Capital. “But if the firms are investing in early-stage start-ups, I don’t think the global reach angle is that significant. Companies have to grow bigger before making acquisitions.”
With Silicon Valley still considered the center of global tech innovation, some US-based VC
firms invest in China as part of a unified global strategy rather than establish a separate fund. In this way they can build relationships with local Chinese corporates and VC funds that are not only developing Chinese businesses but also taking US-based companies expand into China.
“We have a built a strong portfolio of companies in both China and the US as part of our global investing strategy,” says Carmen Chang, partner and Asia ex-India managing director at NEA. “We believe that the strength of our US portfolio companies and our domain knowledge of the most advanced and critical technologies help our investments in China. Understanding the roadmap as it was forged in the US helps us understand possible new developments in China.”
Strategic twistHowever, it could be argued that Chinese companies have greater scope for geographic expansion than their US counterparts. While US tech firms have generally struggled to establish themselves in China – sometimes due to regulatory restrictions – Chinese players are able
to leverage Chinese communities in new markets. This may already be factored into companies’
respective valuations. US-based messaging platform WhatsApp was sold to Facebook last year for $19 billion; Tecent-owned WeChat, which offers a similar service, is said to be worth around $100 billion. Alibaba and JD.com may also turn out to be worth more than Amazon.
“I completely agree that innovation in Silicon Valley is greater than anywhere else. Yet I don’t compare China to the US because you can say that the US will continue to have more innovative companies for a long time,” GGV’s Tung adds. “What people are missing is that the Chinese internet experience over the last 10 years offers its own micro-innovations. Chinese mobile internet companies will be in a better position to become more global over the next 10 years.”
With this in mind, Tung broke cross-border Sino-US deal flow into “three buckets.” The first bucket comprises US-based companies expanding into China, such as social networking site LinkedIn. Few are expected to be successful due to a lack of understanding of the China market. The second bucket is for leading Chinese tech firms set to go global – entering Southeast Asia, India and Latin America – and the third is for US-based companies whose founders have experience of both markets.
Wish’s founders, former Google and Yahoo employees Peter Szulczewski and Danny Zhang, are an example of a Sino-US combination.
“Increasingly these teams include immigrants from China who have lived in the US for over 10 years, they know the e-commerce marketplace model has worked well for Taobao and TMall in China, but they also have a global perspective because they have successfully adapted to best practices in Silicon Valley and New York,” Tung explains. “These people should be able to adapt proven concepts in China for the global market, with potentially even collaboration from companies in the second bucket.”
The occupants of the second bucket are already well established and they will continue to develop their businesses geographically through M&A. But the start-ups that come onto their radar occupy a space that is increasingly neither Chinese nor international – they are global almost from inception. In this context, venture capital firms, with their domain expertise and networks in multiple markets, are well positioned to offer early-stage guidance.
“Over the next 10 years, the distinction between a company based in the US or China will become secondary. The focus will be on building global brands and user bases that cut across multiple geographies and leverage skills and resources in those locations,” says Steamboat’ Ball.
China hits the accelerator When 500 Startups chose Rui Ma as its first Beijing-based venture partner early last year, it was
a sign that the US accelerator was getting a serious about China. Ma is one of three partners in Asia and one of 10 around the globe sourcing deals.
500 Startups has already launched seed funds targeting Southeast Asia and India, with the potential of follow-on investments from the US-based master fund. Although 500 Startups is one of the better well-known Silicon Valley seed-stage investors in China, its accelerator program has yet to gain traction in the country. Ma says the company faces two main obstacles.
“Firstly, most angel investors have cropped up in last three years and are still in the low thousands so investors don’t really understand risks yet and terms are only just becoming standardized,” she says. “Secondly, is the lack of sharing culture and a mentoring ecosystem; successes generally happen behind closed doors right now. There are starting to be more exits but it’s still relatively concentrated.”
Though US accelerators and pure seed-stage investors have a limited presence in China, the investment models they have established in Silicon Valley have been adopted locally. Beijing-based Innovation Works, for example, was set up in 2009 by the former Google China head Kai-Fu Lee to combine early-stage investment with the operational services typically associated with most Silicon Valley accelerators. Meanwhile, Chinaccelerator is one or four Asian programs to be part of US-based TechStars’ Global Accelerator Network (GAN).
US seed-stage investors’ access to Chinese start-ups has so far been dependent on these kinds of networks and by hiring local talent – as in the case of 500 Startups. However, it is early days.
“There is no reason why more structured programs cannot be setup in China,” says Chris Evdemon, a partner with Innovation Works. “The challenges will be adapting them to the realities of the Chinese early stage ecosystem and being honest in terms of the type of entrepreneur and project that you are targeting.”
500 Startups’ Ma stresses that is if any US seed stage investor is to build a significant presence in China, it must differentiate itself from local players. “Local players in the seed space tend to focus solely on products addressing the domestic market whereas we are a lot more flexible,” she says. “We have still need to educate our target audience as to our value-add but I’m glad to report that it’s really starting to stick and people are really seeing us as value-added partners.”
20042005200620072008200920102011201220132014
avcj.com | July 01 2014 | Volume 27 | Number 2412
DATA [email protected]
A tech odysseyThe US accounts for a relatively small proportion of Chinese outbound M&A, and the US tech sector for a small proportion even of that. It is a story of fits and starts, but finally the trend might be gaining traction
China outbound M&A: US vs. non-US
Source: AVCJ Research
80,000
60,000
40,000
20,000
0
50
40
30
20
10
0
US$
mill
ion
Dea
ls
No. of deals - Non-USNo. of deals - US
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014YTD
Value (US$m) - Non-US Value (US$m) - US
China outbound tech M&A: US vs. non-US
Source: AVCJ Research
80,000
60,000
40,000
20,000
0
50
40
30
20
10
0
US$
mill
ion
Dea
ls
No. of deals - Non-USNo. of deals - US
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014YTD
Value (US$m) - Non-US Value (US$m) - US
$152.3mLenovo Group buys Lenovo Group (HK)
$300mSuntech Power buys MSK Corp (Japan)
$80mShanda Games buys Mochi Media
$280mAlibaba Group features in consortium that buys TangoMe
$1.75bLenovo Group buys IBM’s PC division
$146mChina Great Wall Computer buys TPV Tech (HK)
$43.4mSungy Mobile buys GetJar
$50mIDG-Accel China Capital buys Razer USA
$76mSpreadtrum Communications buys Quorum Systems
$115.5mTing Hua Invest buys Data Systems Consulting (Taiwan)
$50mShenzhen O-film Tech buys DigitalOptics Corp assets
$152.3mLenovo Group buys Lenovo Group (HK)
$150.7mHanergy Holding buys Apollo Solar Energy Tech (HK)
$235.8mZoomlion Overseas Invest buys ZoomlionCifa (HK)
$309.5mCension Semiconductor buys Hiroshima Elpida (HK)
$213.2mCRH Microelectronics buys China Resources Microelectn (HK)
$500mTencent Holdings buys CJ Games Corp (Korea)
$175.1mChina Great Wall Computer buys TPV Technology (HK)
$50.4mPerfect World buys Cryptic Studios
$41mChinaSoft International buys Catapult Systems
$95mJiangxi Greatsource Display buys I/OMagic Corp
China tech deals - Non-US China tech deals - US
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avcj.com | July 01 2014 | Volume 27 | Number 2414
OF THE NEARLY 88,000 ENTITIES IN THE US Internal Revenue Service’s (IRS) list of foreign financial institutions that have registered for tax disclosures, more than 17,000 hail from the Cayman Islands, jurisdiction of choice for many in the private equity industry. Search any of the leading names in Asia – from The Carlyle Group to Affinity Equity Partners to Hony Capital – and you find entries for one or more of their vehicles.
These firms that have taken the first step towards complying with the US Foreign Account Tax Compliance Act (FATCA), a piece of legislation designed to help America root out taxpayers with assets secreted offshore. Compliance came into force on July 1 but the transition to full reporting will not happen until 2015. It is hoped the next 12 months will see various regulatory wrinkles ironed out and then a frenzy of activity as PE firms rush to meet the looming deadline.
“Some clients are proactive but most are not,” says Alexander Traub, head of Asia at fund administrator Augentius. “We will see over the coming year how seriously they take it and there will probably be a mad scramble at the end to put something in place.”
The penalty for failing to declare US investors to the IRS is well known: private equity firms and other foreign financial institutions (FFIs) will be subject to a 30% withholding tax on any US source payments. Less clear are the guidelines for individual jurisdictions and the additional costs in terms of due diligence and reporting that will be incurred by PE firms in the name of compliance.
The unknown burdenChina-focused Lunar Capital Partners is among those on the IRS’ initial FFI list, published on June 2. The firm had to complete some one-off preparation work to meet the deadline – establishing which investors fall under FATCA’s jurisdiction and filing documents with the IRS – but this is merely a taste of what is to come.
Stephen Tang, Lunar’s CFO, simply echoes what he said to AVCJ in February: “The full compliance burden hasn’t hit us yet – no one
knows how much extra work will be required.”FATCA compliance should be easier for PE
managers than those in other asset classes. GPs have comparatively small investor bases and they usually know each LP. The IRS said that onboarding documentation for new investors should be finalized by May 5 for registration and inclusion on the June 2 list. While many PE firms didn’t start asking for assistance on the process until around April, some funds with retail investors have been preparing for two years.
Those with neither US operations nor US investors might be under the impression that they don’t have to comply at all, but in the vast majority of cases they are mistaken. First, it is difficult to transact business in Asia without coming into contact with a financial institution that is compliant and won’t work with a counterparty that is not. Second, many jurisdictions have signed intergovernmental agreements (IGAs) with the US, making FATCA compliance a local issue.
“A lot of Asian PE funds say, ‘I don’t target the US as an investment jurisdiction and I don’t look for US investors so therefore the impact on
me is non-existent.’ But under the Model 1 IGA framework there will be a local legal requirement to comply,” says Charles Kinsley, tax principal at KPMG China. “They will also find that more of the banks and custodians they use in the region start asking more questions about FATCA status. Some won’t do business with you if you’re not compliant.”
IGAs are the more complex factor and their impact could be wide-ranging. As of mid-June, the US had signed 24 intergovernmental agreements (IGAs) and reached “an agreement in substance” with another 51 jurisdictions. The majority are Model 1 agreements, which means compliance with FATCA is a local tax requirement, with local authorities collecting the relevant information and passing it on to the IRS. Cayman signed a Model 1 IGA last November while Singapore and China are among those to have reached agreements in substance. Hong
Kong follows Model 2 so there is no automatic disclosure.
Regional variationsEach Model 1 jurisdiction will have its own guidelines that to a certain extent dictate how FATCA will be interpreted, with various local carve-outs and nuances intended to accommodate existing local disclosure requirements. Areas of uncertainty have already emerged. Augentius’ Traub notes that lawyers in Singapore are advising managers to do nothing until the IGA with the US is actually signed. However, if a Singapore fund sits underneath a Cayman master structure, the fund must be FATCA compliant under Cayman law.
Jurisdictional variations also come into play when establishing the FATCA status of special purpose vehicles (SPVs) used by a fund for investment purposes. A private equity firm that invests throughout the Asia Pacific region may use SPVs based in a range jurisdictions to take advantage of tax breaks offered under different double tax treaties. For example, Hong Kong might be used as a conduit for China and Mauritius for India. More SPVs might exist for particular deals if LP co-investors require it.
“All the way down the chain, entities that hold bank accounts will generally be requested to confirm their FATCA status. Moreover, for non-financial foreign entities that derive mainly passive income, they will also have to disclose if they have a greater than 10% US ownership, directly or indirectly, and then provide the details of such persons,” says KPMG’s Kinsley.
It leaves managers with plenty of food for thought as they either play catch up on registration or press ahead with the next stage, putting in place the infrastructure that will facilitate recurring monitoring and reporting.
The IRS has said many requirements won’t be rigorously enforced in the first couple of years provided firms make good-faith efforts to comply – shorthand for having the correct policies and procedures in place and updating onboarding documentation. But appearing on the FFI list is a reputational issue as much as anything else.
“It is in your best interests to register because if you have US investors or counterparties they will look on the IRS website to see if you are registered,” says Augentius’ Traub.
A ticking clockAs of July 1, PE firms were supposed to have taken the first step towards compliance with the US Foreign Account Tax Compliance Act (FATCA). Few in Asia can exist beyond the regulatory web
“There will probably be a mad scramble at the end to put something in place” – Alexander Traub
Number 24 | Volume 27 | July 01 2014 | avcj.com 15
Q: Institutional investors withdrew from venture capital after the dotcom bubble. Are they now returning?
A: They are coming back, but in interesting ways. The guys who invested in venture all along are reducing the number of names they back. They are increasing the amount committed to each fund, so the total dollars invested is roughly the same. Then you have institutional investors that are getting into venture for the first time because they have seen the model working. On a relative basis, venture performance is good and it’s an asset class they want to commit to. The other consideration is how institutional investors are going to invest in the latest technology or healthcare trends. During the dotcom bubble you could invest in a company when it went public and get a sizeable increase in valuation; you didn’t have to invest in that company when it was private to get good returns. Now you see the increase in valuation happening as a private company; if you wait until the company goes public you might lose money.
Q: Concerns have been expressed
about the size of valuations. Is this another another bubble?
A: I don’t think there is a bubble but we can’t turn our backs either. We look at it on a relative basis. Compared to 10 years ago, the revenues of these companies are a lot larger at IPO. So valuations are high but I don’t think it is a bubble because the quality of these businesses going public.
Q: How does this work on a sector basis? If Uber has a high valuation, does that mean
online taxi services as a whole is too hot?
A: It is more nuanced than that. Uber might have a high valuation but there are about five other companies with a similar business model that don’t have high valuations. The situation is in part driven by potential acquirers. Maybe Facebook and Google want to buy messaging apps. The last remaining pretty good private messaging app is going to look very attractive because the next large company that feels it needs a messaging app is going to acquire it.
Q: Which sectors do you find interesting right now?
A: We like healthcare a lot. We find it very attractive from an exit standpoint in that there have been a lot of IPOs in the last 12 months and big pharma companies in the US and Europe is trying to fill their pipelines. There also aren’t many VCs investing in healthcare so the valuations tend to a bit more favorable. Security on the technology side is also of interest. It covers everything we do, whether it’s mobile phones, online payment, storing documents in the cloud or online education and wanting to protect your information.
Q: In a more globalized VC world, is it important for managers to have competency in multiple markets?
A: It depends on the strategy. If you are investing in companies in different geographical markets then you have to understand what is going on in those markets. If the strategy is to find the best entrepreneurs and bring them to Silicon Valley then
there is less need to understand the market dynamic where that entrepreneur is from. What we have seen with globalization is it’s not so much a case of where entrepreneurs are going to set up companies as who are they selling to. If you have an entrepreneur in Eastern Europe who is selling to global customers the VC doesn’t need to have intimate knowledge of Eastern Europe. They need to understand what is going on in the global economy and then the culture of the buyer, rather than the culture of the creator.
Q: How is Top Tier’s allocation to
Asia changing?A: We are reducing our exposure
to Asia. Our offices are only in the US. We are not there on the ground so we don’t understand the nuances between some of
the more local GPs. The first time we invested in a China-focused fund was 2005-2006 and we did it through a well-known US manager with a dedicated China fund. When we became more comfortable with the market we committed to Orchid Asia, a China-focused fund that isn’t run by a US manager. Six months ago we did a research trip in Asia and decided the expectations for US venture capital had increased to the point where they are about the same as China. On a risk-adjusted basis the projected returns for the US were higher than for Asia, so we have shifted more of our focus to the US.
Q: A number of entrepreneurs in China have entered the VC space and are raising funds. How important is the emergence of this second generation of managers?
A: We have seen this happen in the US – someone creates a successful company and then turns around and becomes a VC investor, putting money back into the market. It is a good thing because a lot of entrepreneurs are going to be attracted to these people. As a venture capitalist with a successful company under your belt, you understand what newer entrepreneurs are going through, what it’s like to run a business. It’s an important milestone for venture capital in any emerging market. When you have entrepreneurs raising funds or groups spinning out of mature venture capital firms, it shows a level of maturity that – from a VC standpoint – almost moves you from the emerging markets category to the established market category.
JESSICA ARCHIBALD | INDUSTRY Q&A [email protected]
Global optionsJessica Archibald, managing director at VC-focused fund-of-funds Top Tier Capital Partners, on mounting valuations in the US venture capital market and Asia losing some of its shine on a risk-adjusted basist
“Valuations are high but I don’t think it is a bubble because the quality of these businesses going public”
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