FRIEND NOT FOE

The Carlyle Group, the Washington DC-based private equity firm, has not had an easy time of it in China. That much is common knowledge. The most highly publicised example of its travails in the country has been the protracted – and still ongoing – acquisition of a stake in construction machinery firm Xugong. It was over three years ago that Carlyle first sought a controlling interest in the business. Having since settled for a minority stake, it is still awaiting final confirmation that even this watered-down ambition will be realised. Carlyle was also foiled in its attempt to buy an 8 percent stake in Chongqing City Commercial Bank. The bank bluntly stated in its annual report that Carlyle “didn't meet existing regulations”.

There's a third example. Around the middle of last year, Bloomberg reported that talks between Carlyle and Shandong Haihua, a maker of soda ash and other chemicals, had been called off as the two firms had failed to reach agreement. It meant that the province of Shandong became the scene of one of Carlyle's biggest disappointments in China. But – as anyone familiar with Carlyle's remarkable story of global expansion will know – it is not the sort of firm to let the odd setback get in the way of its relentless long-term progress. So it should not be considered entirely surprising that, last month, the firm was able to tout a transformation in its fortunes – the signing of a “memorandum of understanding” with the Shandong Provincial Government.

According to a press release issued by Carlyle, it will designate Shandong as a key investment area and will “dedicate resources, capital and expertise to the region to promote and develop sustainable, long-term commercial enterprises”. In return, the Shandong authorities “will assist Carlyle by proactively recommending opportunities in Shandong for strategic co-operation and investment”.

Providing it delivers what it promises, the agreement is of the type that other foreign private equity professionals wrestling with China's seemingly intransigent bureaucracy would give their right arms for. It's also an indication that Carlyle plays the relationship game very well. Consider, for example, its experiences in Japan – a country where private equity (never mind foreign private equity) has an unenviable PR job on its hands. And yet Carlyle has forged a reputation in that country as a friend of management.

It may be worth considering also whether the pain inflicted on Carlyle by Chinese regulators has been entirely a bad thing. Take the Xugong saga, for example. On one level, Carlyle has been banging its head against a brick wall for the last three years. But an alternative interpretation of events is that the firm has built invaluable insights into the way in which processes operate and decisions are made within high-ranking Chinese officialdom – while, at the same time, forging some key personal relationships. A painful initiation, it might be argued. But at least it's an initiation.

For sure: Carlyle is now far from an unknown quantity in China. While the firm's uncompleted deals have tended to make the headlines, it has been on the ground a long time. And, in this time, it has, according to a report in the UK's Financial Times, built up a portfolio of some 20 investments in companies operating on the Chinese mainland. These include a stake in China Pacific Insurance, the country's third-largest insurer, as well as a couple in Shandong (a conveyer belt joint venture and a real estate investment in Qingdao Capland Centre).

Of course, there is an aspect to the agreement that this column has not yet dwelt on, but which is vital: Carlyle will provide a “window on the world” by steering Shandong companies into overseas markets “through investments and partnerships”. Thus, while the relationship does imply trust in Carlyle on the part of the Chinese authorities, it should not be seen as altruistic. It is, in essence, a reciprocal relationship of the kind that Carlyle has become a master at forming wherever it chooses to plant its flagpole.

Media reports have also hinted that Carlyle may view the agreement as a stepping stone towards securing an investment in its management company by a Chinese sovereign wealth fund (a Carlyle spokesperson declined to comment to PEI on this). The firm has already lured capital injections from Abu Dhabi's Mubadala investment arm and CalPERS, the Californian pension giant. Something similar in China would be further evidence of its relationship-building prowess.