In the wake of the Asian financial crisis in the late 1990s, which saw asset prices tumble across the region, China was untouched by the economic contagion due to its restrictions on capital outflow.
That made investing in China a relatively unattractive proposition for Shan Weijian, who was then managing a US$100 million China-focused fund at Texas Pacific Group (TPG), a major American private equity firm.
In South Korea however, an opportunity would soon present itself: the country, which was hit by a severe liquidity crisis, accepted a US$58 billion bailout from global financial institutions led by the International Monetary Fund (IMF).
As a condition of the deal the government accepted the IMF’s demand that at least one failed bank would be sold to foreign investors by the end of 1998.
Seoul subsequently placed two nationalised lenders, Korea First Bank (KFB) and Seoul Bank, up for auction. The collapse of the two banks was emblematic of the prevalent practice of government-directed lending that favoured conglomerates over small- and mid-sized firms, and relationship-based lending that lacked proper checks on borrowers’ credit-worthiness.
Of 40 prospective bidders, only Newbridge Capital, a TPG affiliate, and HSBC were interested buyers. And of the two Korean banks, Newbridge and HSBC concluded that KFB was more attractive, given its better business fundamentals, skilled workforce, longer history and stronger brand.
Despite HSBC’s higher price offer, Newbridge won the government over with its bid of 500 billion won (then US$417 million) for a 51 per cent stake and total management control, said Shan, who was instrumental in negotiating the deal.
Shan, dubbed one of the most successful dealmakers in Asia by the Financial Times, was speaking at a recent private equity workshop at NUS Business School organised by Veronica Eng, Partner and Chairman – Asia at Permira Advisers.
Commenting on the negotiation process, Shan said HSBC’s offer of a full takeover of KFB would only have reduced the government’s loss by 10 per cent but without offering any future gains. Newbridge’s offer of warrants, however, would entitle the government to acquire over three years an additional five per cent equity stake in the bank.
“They thought it was a good idea … because they can tell (angry) taxpayers that we have done this deal with Newbridge and we will stand to gain better upside than Newbridge, because not only do we have about half of the ownership, we have five per cent warrants which Newbridge (does not) have,” said Shan, who also led TPG’s successful acquisition of Shenzhen Development Bank.
‘Fair and logical’
In doing deals, Shan says he adheres to a principle of being “fair, reasonable and logical”.
“You have to be able to explain logically to the other side why it’s fair,” he said. “Because you have to look at the same deal … from the perspective of the other side, and then you can possibly figure out the deal that meets the requirements of both sides.”
In 2005, Newbridge sold KFB to Standard Chartered for US$3.3 billion, a more than threefold return on its investment.
Today, Shan is chairman and chief executive of Pacific Alliance Group (PAG), one of Asia’s largest investment firms with assets of about US$9 billion under management.
PAG takes a thematic investment approach, developing expertise in sectors such as consumer retail, food and beverage, healthcare, logistics and industrials. Most of its deals are from China.
Acknowledging that China is among the most challenging markets in terms of commercial fraud and conducting due diligence, Shan said investors have to be sceptical in all situations and warns of the need to examine everything.
Using its fraud detection guidelines, PAG is able to verify, for instance, a company’s reported steel production by checking their electricity bill, he explained.
However, what worries Shan about China’s market is the issue of overcapacity.
In the past two decades, the country’s economy has grown by about 15 times in nominal terms, faster than any other country in history, he said. That translates to an annual gross domestic product growth rate of 14 to 15 per cent in nominal terms, or 10 per cent annually in real terms.
Yet an investor in the Morgan Stanley China Enterprise Index since that period up till today would have lost a significant amount of capital. “In no other country will you see this phenomenon,” Shan said. “The reason is whereas earnings have been increasing, the capital base with which you produced the earnings has been increasing faster, and therefore your ROE (return on equity) has been declining. So a major problem for China is too much investment and therefore overcapacity.”
‘Many roads lead to China’
For Omar Lodhi, Dubai-based chief executive of Abraaj Capital Asia, the key to exploiting China’s economic boom is to tap into the growing capital and trade flows between China and emerging markets in Southeast Asia, the Middle East, Africa, Indonesia and India.
“Our niche strategy … is predicated (on the idea that) many roads lead to China,” said Lodhi, another speaker at the NUS private equity workshop.
Abraaj, which has assets of US$7.5 billion under management, is focused on what it calls growth markets, aiming to use economic expansion instead of financial leverage to drive returns.
One recently emerging market which Abraaj said offers “very exciting” opportunities is Myanmar, which is undergoing political reforms and opening up to foreign investment.
Lodhi said Abraaj could be investing in the country in the next two to three years, although many of its portfolio companies are already looking to expand their businesses there.
During his talk, Lodhi discussed stakeholder engagement, corporate governance and environmental issues in relation to private equity – as well as tackling the commonly held perception of the industry as asset strippers.
Addressing this, Lodhi said his firm was focused on helping businesses in emerging markets grow organically or expand through mergers and acquisitions. While it is mindful of exiting investments after a period of five years, it is also aware that its portfolio companies must stay viable in the long term.
“You’re not just a PE firm focusing on that fifth year because any buyer who’s going to come in and buy from you needs to take a very positive forward five to 10-year view,” Lodhi said.
“And therefore to attract an interested buyer, you must ensure he or she is able to see that positive trajectory … so you must therefore always have a long-run view for any business. It’s part and parcel of your business model. You won’t succeed without it.”