By Zhang Ran (China Daily)
Updated: 2007-09-06 10:53

"PE funds not only generate returns for investors, but also significantly enhance the value (for the company) through their portfolio companies," the AT Kearney report points out, based on analysis of data from 30,900 PE-financed firms in Europe and the US.

"The results are reflected in rapid sales growth, healthy margins, larger investment budgets and accelerated expansion into new markets."

According to Zhang Qi, an analyst with Haitong Securities, the average return on equity in Chinese listed companies is about 10 percent. That figure is 21 percent for American listed companies.

This indicates a wide gap between the two countries in terms of management ability to create value. For Chinese companies dissatisfied with their current performance level and seeking to fill the efficiency gap, PE is often the perfect fix.

To increase management efficiency, direct investment from a foreign competitor isn't always the best option for a Chinese company. The ongoing Danone-Wahaha saga is a pretty good example of the kind of tensions such marriages can generate, with the underlying fear of the foreign partner cannibalizing the home market. PE poses no such threat as it seeks no market, all it wants is profit.

Given the difficulty of securing a controlling stake in State-owned enterprises in China, investing in high-growth private companies even with minority stakes makes perfect business sense for many PE firms.

"Unlike American or European owners, who often encounter difficulties in finding successors when their children refuse to take over the family business and thus sell their companies to PE, Chinese corporate leaders, most of whom are first-generation entrepreneurs, won't part with their controlling stake," says Lily Jin, chief representative of 3i's Beijing office.

China focus

London-listed 3i has been focusing its investments in China as minority stakeholders since its entry in 2001.

The average amount of PE invested in a company in the second quarter is estimated at only US$54 million over US$113 million in the same period last year, according to the Zero2IPO report.

More PE investors are clearly settling for minority stakes in their Chinese portfolio companies to avoid risks, as evidenced from the fact that their average amount invested in targeted companies is on the decline.

The continuous inflow of new money definitely reflects the pull of the "China story". A handful of pioneers have indeed made it big by listing their portfolio companies on overseas stock exchanges such as the NASDAQ. But the new M&A rule issued by the Ministry of Commerce in September has set up new hurdles for the traditional overseas listing model of red chips that most foreign-invested PE investors followed.

"The alternative is to set up a joint venture in China and to prepare for a domestic listing. We have tried that in some cases, but I have to say there are great potential risks," says Shen Nanpeng, founder and partner of Sequoia Capital China.

Unlike the sophisticated NASDAQ, with which PE is familiar, the A-share listing is a totally different ball game. The lock-in period for foreign strategic investors to sell shares on the A-share market after an IPO is three years, much longer than the six-month lock-in period on the NASDAQ or the New York Stock Exchange.

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