Privately Speaking with CDH’s Wu Shangzhi

Every so often, a firm pitches itself – or its PRs do – as a mini-Blackstone. The idea is that from the ‘next tier’ of GPs a new dominant multi-asset manager will emerge with many hundreds of billions under management and products to satisfy demanding institutional investors. In Europe, EQT Partners makes a strong case for itself. Bahrain-based Investcorp has grand designs.

Given the way things are going, however, Asia is the place to look. A new round of big fundraises is underway, with Asia-Pacific-focused managers targeting $104.7 billion as of October 2017, PEI data show. In the last year, KKR has opened an office in Shanghai – its eighth office in the region – amassed $9.3 billion for the biggest-ever Asia fund and anointed Asia head Joseph Bae as one of two heirs apparent to founders Henry Kravis and George Roberts.

With $17 billion in assets under management, business lines that span most of the alternatives space and a roster of blue-chip international investors, Beijing-headquartered CDH Investments certainly fits the mini-Blackstone bill.

The firm was an early mover in Chinese private equity, having spun out from investment bank China International Capital Corporation in 2002. Chairman and founder Wu Shangzhi set it up along with five other founding partners, all of whom had worked together in CICC’s direct investment department since 1995.

Over the years CDH made its name by restructuring a number of mainland Chinese companies and making them attractive to overseas investors by listing them in either Hong Kong or another global financial centre. The firm has more than 60 China brands in consumer retail, healthcare, industrial and energy to its name. And from its roots in private equity, it has expanded into venture capital, real estate, credit, public equities and wealth management.

WU-ING THE INVESTORS

The firm’s 67-year old chairman Wu, known for his down-to-earth demeanour and formidable work ethic, is still very much involved on the deal level and in fundraising, he tells Private Equity International.

When we meet at CDH’s office at the International Commerce Centre in Kowloon, Wu has just arrived in Hong Kong from a week-long trip to the US for investor meetings. The firm is likely to start formally marketing its sixth flagship fund, targeting $2.5 billion, in the new year. He declined to provide details on the fundraise, but was happy to talk up its latest deal, SharkNinja, a small home appliances company in Massachusetts which it hopes to integrate into Asian markets.

Differentiation is another topic Wu is happy to talk about.

“We were asked by one of the limited partners: ‘What does CDH do to differentiate itself from other general partners?’” Wu responded by talking about the firm’s recent deal with shoe retailer Belle International, the result of its more than 10-year relationship with the company. Its network, built on years of finding the right partners to do deals together, is CDH’s ‘edge’, Wu tells PEI.

CDH first invested in Belle in 2005 and took it public two years later. The pair acquired apparel business Baroque Japan in 2013 and listed the company on the Tokyo Stock Exchange in November 2016. In July CDH teamed up with Hillhouse Capital for Belle’s privatisation, the first and largest take-private transaction of a blue-chip stock on the Hong Kong Stock Exchange, in a deal valuing the retailer at $6.8 billion.

Nanfu Battery is a similar case. The firm’s 18-year relationship with the company spans its first investment in 1999, a trade sale to Duracell in 2003, and a management buyout in 2014.

For Wu, it’s all about relationship building. “Each deal is driven by a different value proposition but if you look closely, it’s about building long-term relationships, waiting for the opportune time and discussing the next investment opportunity.”

Marc Lau, managing partner at Axiom Asia which has backed the firm’s earlier funds, agrees: “CDH’s key success factors are its relationships with entrepreneurs, the strong reputation built by the firm’s many successful exits, and its ability to help companies navigate the market. These are fundamental skillsets, which the firm has built up in its private equity business over the last 20 years starting from the founding partners’ roots at CICC until today.”

Lau adds the team has one of the longest histories in the China market and was a key player in its evolution. “It has been through cycles such as the turbulence of the Chinese stock market, the global financial crisis as well as the early days of state-owned privatisation. You’re hard pressed to find a team that’s as large and with as much experience and history as CDH.”

The performance of its latest private equity funds, however, has been mixed: the 2010-vintage $1.5 billion Fund IV is showing a 9.37 percent net IRR and a 1.4x money multiple, according to June 2017 documents from Washington State Investment Board. Meanwhile the $2.6 billion Fund V, a 2013-vintage still in the initial stage of its investment life cycle, is delivering a 6.2 percent net IRR and 1.1x multiple, data from CalPERS show.

Wu would not be drawn on fund performance and CDH declined to provide any information. But he did point out the firm returned $4 billion to its investors in the last 18 months and Fund V sits in the top quartile. The firm is also in the process of deploying its $800 million mid-market fund.

LONG-TERM TRENDS

Historically the China market has been predominantly growth capital-oriented, which means not all firms are truly experienced in control deals. But as companies get larger and sectors become ripe for consolidation, the industry will see stronger momentum in control transactions.

CDH has China buyout firmly in its sights. The firm has already executed a few buyout and control transactions but the market is still at an early stage of maturity, Wu says. This is why while he expects more than half of the capital raised for Fund VI to be in these deals, the firm will continue to make minority growth investments.

Industry insiders tell PEI buyouts in China are not necessarily the same as the West where financial engineering plays a major role. In China (as in the rest of Asia), private equity firms work alongside the manager or entrepreneur to grow the business, which plays very well to the growth capital mindset and the importance of building relationships.

When asked how CDH’s team has responded to this new norm, Wu says the firm has begun the transition internally over the past five years by adapting the skillsets needed to handle large complex transactions that involve control, financing, leverage and re-listing and/or other exits, as seen in the Nanfu Battery transaction, for example.

“China buyouts are evolving – how they will take their final shape has yet to be seen. But we are all on the learning curve and climbing that learning curve fast,” Wu says.

Along with the growth in buyouts, Wu has a clear sense cross-border deals will continue to be an important part of the landscape. China’s fast-growing consumer market will only get more dynamic as it seeks high-quality brands, technologies and services to serve domestic demand.

All CDH’s cross-border deals are focused on driving value in China and are often generated from the relationships and long-standing partnerships it has built, Wu says. An example is its longstanding portfolio company Shuanghui – now named WH Group – which it bought in 2007. Five years later Shuanghui bought Smithfield, the largest pork company in the US, for a reported $7.1 billion including debt, one of the largest US acquisitions made by a Chinese firm at that time. It effectively catapulted a former state-owned company into a global Fortune 500 company.

The cross-border deals CDH pursues all have a unique China angle, Wu points out.

“We seek to leverage our extensive experience investing and helping Chinese companies become leaders in China’s fast growing domestic consumption sectors. These deals provide our investors exposure to opportunities that they will not get from their global buyout funds and we believe CDH is well-positioned to continue to capitalise on these opportunities in the future.”

Despite its illustrious history, China’s ‘safe pair of hands’ – as the firm is often regarded by its peers – doesn’t have an unblemished record. Wu tells PEI investing in South-East Asia has not developed as expected. “Indonesia in particular, has not delivered as we thought it would. Our experience hasn’t been easy because the market was quite different from China, opportunities are relatively small, and we were not ‘in the circle’.”

Wu adds the firm had better results in Vietnam with some deals generating “very attractive returns”. Based on this experience, its Singapore team now focuses on cross-border deals that leverage CDH’s China experience and only looks for deals in the region on an opportunistic basis.

CDH also has its work cut out for it with Belle, which experienced “unprecedented challenges” because of rapidly growing e-commerce platforms in China. Belle has seen 13 quarters of negative same-store sales growth since the fourth quarter of financial year ended February 2014.

NO SURPRISES

Wu emphasises the Chinese economy and its growth potential have never been more important and the firm continues to be excited to invest in China on behalf of its international and domestic LPs.

CDH has been run since inception by its six founders and is still on its first generation of leadership. Wu says the group is fortunate to have a “naturally hedged” generational waterfall. Wu is close to 70 and the firm’s chief executive Jiao Shuge is 51, which ensures a smooth changing of the guard when the time comes.

“If you look at the other partners and key leaders, most are in their late 40s or 50s, and their responsibilities and expectations are quite clear.”

The six founders have worked to cultivate a firm with strong leadership and partnership, where succession is not a worry, Wu says.

“Besides, I’m still young, right?”