CHINESE WALL

Amid much fanfare in October last year, The Carlyle Group proudly announced that it had agreed to acquire an 85 percent stake in construction firm Xugong Group for $375 million (€292 million). The hubbub surrounding the deal appeared to be well justified: as the first acquisition of a controlling stake in a Chinese state-owned company by a foreign private equity firm, this seemed a seminal moment in the flowering of the world's most populous nation's buyout industry.

It wasn't long before the champagne went flat. Five months after the agreement, the deal was blocked pending a government enquiry. A subsequent report in the UK's Financial Times newspaper was quick to identify the root of the problem: “The Carlyle offer has become one of a series of takeover bids by overseas companies that appear to have been held up by a nationalist backlash against foreign investment”, it claimed.

Given that such economic nationalism has regularly flared up elsewhere in Asia in recent times – notably in South Korea – the FT's suggestion certainly has the ring of truth. It was given added weight when Xiang Wenbo, chief executive of Chinese industrial group Sany, expressed the following view on a personal weblog: “The most important message I want to make is that Xugong should not be acquired by foreign companies.”

There again, Wenbo has something of a vested interest given that Sany has emerged as a bid rival to Carlyle in what has now become a battle for ownership of Xugong. In theory, it should be a relatively easy battle for Sany to win. Surely, if nationalism is their guiding motivation, the Chinese authorities would be only too happy to hand Xugong over to a nice cosy domestic merger arrangement?

But this is where the picture becomes a little confusing. Far from grasping Sany by the hand, Xugong appears to have slapped it in the face. The firm issued a statement berating Wenbo for his “irresponsible” weblog remarks and has bluntly stated that it won't hold talks with other parties while the bid from Carlyle is still pending. Banking sources, meanwhile, have questioned whether Sany has the financial clout to carry out its proposed deal given that Xugong's annual sales are three times larger than its own.

In what would surely be an ironic denouement, Sany has responded by hinting that it may go hostile and make an offer for Xugong even if its overtures are rejected. In the process, it would run the risk of painting itself as the bad guy. Contrasting with its Chinese rival's aggression, Carlyle has sought to assuage concerns by saying that it will be cautious on the application of leverage and will not take a hatchet to the target's workforce. In addition, it is offering what many commentators see as a generous offer price of two times Xugong's book value.

Despite Xugong's apparent willingness to deal fairly with Carlyle and its stand-off with Sany, nationalist motivations behind the intervention of the regulators cannot be entirely ruled out. A recent Chinese State Council document called for special government protection and support for machinery and equipment industries that affect economic security and national defence. Given that Xugong's major product line is mobile cranes, it seems unlikely to be thus categorised. But you never know.

Maybe there's an altogether more prosaic explanation lying behind developments in the form of China's age-old reputation for stifling bureaucracy. Foreign companies operating in the country have long complained about the tortoise-like speed with which the authorities arrive at their decisions. And let's not forget, of course, that this is the first deal of its kind. Every excuse, in other words, for a little prolonged rumination.

Not that this somewhat more benign explanation would provide any comfort to Carlyle executives as they sit twiddling their fingers in the hope of an eventual verdict. Reports at the time suggested the firm had spent as much as two years courting Xugong before its deal agreement was finally reached. Rival private equity firms observing from the sidelines may seriously question whether sourcing deals in China is really worth the time, effort and cost in light of Carlyle's experiences. And that's surely bad news for the fledgling Chinese buyout market.