Chinese private equity keeps on rocking the world

ZZ Capital moves into ZZ Top territory, setting up an $812 million deal for a Texas-based index provider, continuing a trend of Chinese PE funds sealing deals as corporates stay home.

Texas has long been synonymous with one of its most famous musical products: ZZ Top, a Houston band that's been rocking the world since 1969.

Now there's a new ZZ in town: private equity fund Zhongzhi Capital, better known as ZZ Capital, is planting its flag in the Lone Star State with the purchase of Alerian, a provider of market intelligence services and indices in the energy and master limited partnership (MLP) sector.

The deal, being handled by ZZ's Hong Kong-based platform ZZ Capital International, underlines a growing trend in Chinese outbound M&A: while corporate giants are reined in by regulators or financial difficulties, private equity funds are still tying up deals around the world. The funds are fuelled by growing wealth and ample liquidity in the country, as well as rising investor sophistication and their eye for international assets.

The value of outbound deals by Chinese PE firms and strategic investors doubled last year to $185 billion, according to Mergermarket. A survey by MVision Private Equity Advisers and London Business School, cited by Private Equity International in March, found more than a quarter of general partners said they lost out to a Chinese bidder in an auction during 2016.

The trend was further underlined last week, when a Chinese consortium backed by PE firms including HOPU and Hillhouse Capital and Bank of China Group Investment won the bid for Singapore-listed Global Logistic Properties (GLP), in what was Asia’s largest private equity buyout deal to date ($11.6 billion). The consortium fought off another group led by Warburg Pincus in the final stage of the auction, while squeezing out the likes of Blackstone, Temasek, RRJ Capital and Prologis earlier on.

What's more, at a time of regulatory curbs on Chinese companies’ outbound investment and a tougher foreign exchange policy environment since November, market participants say private equity funds that have dollars, or platforms to raise financing, offshore will be better placed to do deals. In the GLP deal, for example, a source said one key consideration for GLP was making sure all of the Chinese consortium’s money was offshore so it would be more likely to complete the deal within a defined timeframe.

This reflects the views consultancy PwC expressed in a February report. It said that this year: “In outbound activities, the market will favour financial investors with access to capital denominated in US dollar”.

Everything's bigger in Texas

ZZCI would not be drawn on how it intended to get its hands on the funding for the deal. Its market cap on Hong Kong's Growth Enterprise Market is more than $200 million, yet concluding the deal will cost an initial $582 million in cash and the issue of rollover units, with up to $230 million in further earnout payments if Alerian meets certain revenue targets for each of the next four years, according to a July 14 filing to the exchange.

A spokesman for ZZCI would say only that “we are confident that we will have access to the required debt and equity capital, offshore and in compliance with policies and procedures, to consummate the transaction”.

ZZCI said in the announcement that the transaction was expected to close prior to the end of its 2018 fiscal year, subject to receipt of required regulatory approvals and customary closing conditions. That suggests it is confident it will not hit any hurdles with the Committee on Foreign Investment in the United States (Cfius).

“We do not expect any US government intervention in the transaction. Alerian will continue to be run by its current management team and operate on that basis,” the spokesperson for ZZCI said.

ZZ who?

Unlike the likes of CDH Investments and Hony Capital, ZZ Capital has attracted little attention outside the domestic market – although it was among the top 10 best-return private equity investment institutions, as ranked by consultant ChinaVenture Group in 2016.

A member of the Zhongzhi Enterprise Group founded by Chinese billionaire Xie Zhikun, ZZ Capital was founded in 2011 with registered capital of Rmb1billion ($148 million).

In 2016, ZZ Capital acquired a controlling stake in Asia Capital Holdings, established in 1998 and listed on the Hong Kong Stock Exchange in 2010, and renamed it ZZCI. It has since been the private equity firm’s flagship international alternative investment platform, with cross-border activities in China, North America, Europe and Israel.

For now, ZZCI remains relatively small, reporting pre-tax profit for the year to March 31 of approximately HK$67.87 million ($8.7 million), according to its annual report.

Yet the impressive line-up of veteran M&A bankers it has recruited suggests ZZCI is going places as it shifts its focus from corporate advisory to alternative investments and overseas M&A.

ZZCI’s CEO is Michael Min Cho, previously head of Mergers and Acquisitions at Qatar Investment Authority and before that, co-head of M&A for Asia at Bank of America Merrill Lynch. In June last year, it poached Jung Suh, M&A director at Bank of America Merrill Lynch in Hong Kong for its PE team. Some of JP Morgan and Morgan Stanley’s junior bankers also left for the firm. Its CFO, Peter Chen, was previously with CPPIB and Bain Capital.

The Alerian deal compliments an earlier investment in July into Italy-headquartered renewable energy producer Building Energy 1 Holdings, giving ZZ Capital a foothold in the growing market for US energy industry investment products.

There will be “further growth in capital invested in passive strategies (such as exchange traded products), the development of asset management platforms in emerging markets, and an increasing demand for investment in global energy infrastructure,” said the ZZCI spokesperson. “Alerian is at the intersection of the three, making it an attractive opportunity.”

In announcing the deal, Cho said: “This investment is an important milestone for ZZCI, demonstrating our global execution capability. Our acquisition of Alerian is consistent with our strategy to target selected sectors that exhibit sustained growth and support market-leading businesses and proven management teams.”

In the year ended December 31, 2016, Alerian made net profit before extraordinary items and before and after taxation of $58.6 million, ZZCI said. As of May 31, 2017, more than $17 billion is directly tied to the Alerian index series.

Deal terms

This initial consideration will comprise a cash component of approximately $506 million and the issue of rollover units in a vehicle set up by ZZ to buy Alerian with an expected value of approximately $64 million. And another $12 million of the cash consideration payable on closing will be deposited as escrow funds, according to the filing.

ZZCI plans to raise $286 million in a rights offering by issuing new shares, with an undisclosed amount from debt financing and operating cash to make the initial payment.

It also plans to raise another $230 million with a second rights offering to meet its earnout commitments, depending on Alerian’s ability to meet revenue targets.

Barclays Capital and Haitong International are serving as financial advisers to ZZCI. Ropes & Gray LLP is acting as US legal counsel to ZZCI on the transaction and Linklaters is providing legal advice to ZZCI in respect of Hong Kong corporate and securities law matters.

Evercore Partners is serving as exclusive financial advisor to Alerian and Kirkland & Ellis LLP is acting as legal counsel to Alerian on the transaction.

¬ Haymarket Media Limited. All rights reserved.

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