Opening the gate

As Washington DC-based private equity giant The Carlyle Group noted unabashedly in a press announcement, its recent tie-up with Beijing Municipal Government afforded the prospect of “preferential treatment”. Until recently, such treatment has been the preserve of local groups able to easily establish RMB funds, which benefit from certain advantages – such as faster government approval times for deals – that other fund types do not. These days, foreign-owned RMB vehicles such as the Carlyle Asia Partners RMB Fund are increasingly common – and often come in the form of joint ventures with local governments. The playing field, it appears, has been levelled.

Andy Thomson

The reasons for the apparent embrace of foreign capital are not entirely clear. In recent years, the Chinese authorities have demonstrated something of an ambivalent attitude towards non-domestic funds. They have not wanted to court the kind of controversy seen in other Asian markets (such as South Korea, for example) where some highly lucrative “flipping” of assets has inflamed public opinion. On the other hand, foreign capital has not been actively discouraged – notwithstanding the bureaucratic maze that has often challenged those looking to raise funds and complete deals.

The answer, in all likelihood, is a prosaic one; China knows private equity firms can bring expertise as well as capital to the table in helping its companies to grow and prosper. Private equity is, therefore, acknowledged as a potentially beneficial market force, but is also considered controversial and to be handled with care. Having taken baby steps with the asset class in the past, China is now somewhat more emboldened and has decided to open the gates to new participants a little wider.

As a consequence, there is much for the limited partner community in the West to celebrate. For many years, a larger allocation to Asia – and especially China – has been high on priority lists. If anything, the global financial and economic crisis made this geographic diversification even more urgent given the way in which it has thrown a spotlight on the relative outperformance of Eastern markets. The ongoing structural problems in many Western economies have also given pause for thought.    

A persistent problem, however, has been how to achieve the desired risk/return profile. Even with the help of the most expensive consultants – and even when hedging your bets through pan-Asian funds of funds – backing local GPs is often perceived to be a thorny challenge for Western LPs. Although they know such groups have traditionally had access to the best deal flow, they are also often characterised by disconcertingly brief track records and by cultural and procedural nuances that may be difficult to get comfortable with. Plus, for the larger LP groups, there is the problem of putting big-ticket commitments to work in typically modestly sized local funds.

Make no mistake: sophisticated LPs, wherever they are based, will continue to search for local specialists – with their thick contact books and good friends in the corridors of power – in any market around the world.

But if sizable allocations can be put to work with tried and trusted US-based heavyweights like The Carlyle Group and The Blackstone Group – the latter of which has also assiduously cultivated high-level contacts in the region and recently launched an RMB fund in concert with the Pudong Government – it should substantially assist the process of portfolio realignment from West to East. With the outsiders now having effectively become insiders there appears little obvious disadvantage to investing via the Blackstones and Carlyles of this world.

For Carlyle, becoming an insider has been a long and painful journey. Back in 2007 the attempted buyout of state-owned Xugong, a construction machinery firm Carlyle had been negotiating to buy for three years, finally fell through. Cynics saw it as symbolising the futility of Western LBO shops trying to export their practices to China.

Carlyle’s subsequent success in its latest partnership lends weight, however, to an alternative view: that in three years of negotiations over Xugong, Carlyle and the local officials developed a healthy respect for one another that laid the foundation for future engagement. It also reinforces the old adage that persistence pays – as Western GPs now busily launching RMB funds are no doubt inclined to acknowledge.