Domestic bliss

Non-Chinese private equity firms investing in China have long been frustrated by what they perceive to be an unlevel playing field that favours domestic investors. Their sense of injustice is heightened further when a firm like Chery Automotive sells a stake to a local consortium at least in part because that course of action is the swiftest and most hasslefree option.

The background: Chery Automotive, launched in 1997 in Anhui province and now one of China's leading car makers, has found itself buffeted by a global economic slowdown which has hit the automotive industry particularly hard. Last year, Chery sold 356,000 vehicles – well short of its target of 480,000. The firm, needing some kind of fundraising in order to mitigate the effects of the sales shortfall, initially targeted an IPO. But, amid a meltdown on the IPO market, the firm has not yet heard back from the China Securities Regulatory Commission on its IPO application.

As an alternative – while still apparently keen on an IPO at some point in the future – Chery began entertaining the idea of selling a stake to private investors. Despite the difficulties of the global automotive industry as well as those specific to the firm, Chery was always likely to be seen as an attractive target. China's domestic car market has seen sales surge recently as the government has implemented tax incentives for compact cars and rebates to rural buyers in order to bolster domestic demand. It appears to have worked, with the evidence of recent months being that sales are rebounding.

Unsurprising, then, that Chery's offer of a 20 percent stake was duly taken up. The stake was sold (for a price variously reported to be anything from $293 million to $425 million) in early June to a consortium including Bohai Industrial Investment Fund (53 percent owned by the Bank of China), CDH Investments, China Huarong Asset Management and a Shenzhen-based investment fund.

The common thread binding all four investors is that they were local firms investing through yuan-denominated funds. Chery wanted its money quickly and without complications. Yuan-denominated funds are able to deliver on this, mainly because they need few government approvals and do not require currency conversions involving large sums of money – which in China can be lengthy and problematic.

While foreign investors are able to set up yuan-denominated funds, they are only able to do so through foreign-invested enterprise rules. Local funds, meanwhile, are able to launch domestic yuan funds, governed by rules which appear much more favourable. While yuan funds were ostensibly launched to give a boost to the entire Chinese private equity and venture capital industry, there is a widespread belief that they were also seen by the Chinese government as a way to adjust the balance of a market dominated by funds raising money outside the Chinese mainland. Critics have voiced the opinion that some poor quality investors are able to compete effectively only because of this alleged favouritism.

Other recent developments have added to the suspicion that the Chinese government has been pandering to protectionist and nationalist sentiment. Some market observers felt this was implied in the decision in March this year to block a bid by Coca Cola Company for China Huiyuan Juice, the country's largest juice manufacturer.

For all this, there are still reasons for all investors to feel buoyant about prospects in China. For one thing, against the backdrop of an economy picking up steam, the view from the private equity market is bullish. In Deloitte's newly published Private Equity Confidence Survey for emerging markets (see also right), 50 percent of respondents expressed the view that the level of private equity investment in China would increase in the period ahead, while 37 percent felt it would stay the same and only 13 percent forecast a decline.

In the same survey, a market source expressed the view: “There are more domestic players but they are managing smaller amounts of money. The foreign players will have the most significance.” The report also noted: “It is recognised that foreign investors have a pivotal role to play in both the Indian and Chinese markets”. Maybe the respondents are not aware that the goalposts have been moved. Or perhaps they are, but do not think it will make a material difference. Time will tell.