FountainVest optimistic about China private equity

Frank Tang, CEO of FountainVest Partners, is confident that now is the time to invest the $950 million his fund recently raised.

What are your assets under management and who did you raise this from?
We set out to raise $750 million with a 10-year term, but upsized the amount to $950 million due to the solid demand. We closed our fundraising in November. Our anchor investors include the Canadian Pension Plan Investment Board, Ontario Teachers' Pension Plan and Temasek Holdings. We also attracted investments from a number of other investors from Asia, Europe and North America. For many of our investors, FountainVest was the first China private equity fund they committed money to.

What kind of investments will you be targeting?
We have a focus on China and will seek to invest between $50 million and $150 million per deal. We anticipate closing between 15 and 20 investments over a four- to five-year period. We will seek minority stakes in high-growth companies and anticipate holding at least 10% in our investee companies, with one board seat.

What is your strategy to differentiate yourself among the large number of private equity firms scouting for investment opportunities in China?
We are entirely locally managed and all decisions for FountainVest are made at the local level. That sets us apart from a number of the global funds with just a representative office in the region. Origination is one of our strengths; the four partners who came together to found FountainVest all have a strong background covering China. I was most recently head of China investment for Temasek, after an 11-year career at Goldman Sachs. My co-founders also bring extensive local experience. Terry Hu has covered the China technology, media and telecommunications sectors as well as had a stint investing in real estate globally. George Chuang was based in Shanghai both for Temasek and earlier for Goldman Sachs focusing on China. Chenning Zhao has prior experience in private equity investments with a focus on China.

Do you have a sector bias in your investments?
We will identify mid-market capitalisation firms and have a bias towards privately-owned firms which aspire to become emerging champions. We like the themes of domestic consumption and urbanisation and anticipate that firms in businesses like retail, lifestyle and healthcare will benefit from these themes.

Due diligence on investee companies has historically been challenging. How will you ensure you have covered every aspect?
It is true that the increasing number of frauds is making due diligence difficult. In an environment where people are short of cash, there is an obvious incentive to do "creative" accounting and this is no doubt true of the current situation. We use multiple sources to check on background and attach a great deal of importance to using both formal and informal channels for due diligence. The collective experience of our local management team when evaluating China investments should also be useful.

It is now clear that China will not escape unscathed from the recession impacting markets the world over. How will this impact your plans?
The impact of the global slowdown is having a spillover effect on China and we foresee difficult times for companies focused on exports. There have been layoffs in China in the export sector and things look severe. But domestic demand is still strong, as is the drive to create infrastructure, so we feel the themes we have identified should hold up.

Will domestic consumption pick up enough to offset the export slowdown?
The government is taking steps such as reducing taxes and establishing a safety net of social security. Savings rates in China are high because there is a poor social safety net. People need to be encouraged to spend. The government can use fiscal surpluses to alleviate people's worries about the future. One segment which will be insulated is the youth area - areas like online gaming and entertainment will continue to do well.

In a more difficult credit environment, leverage has dried up. How will this affect your plans?
This plays to our strengths. We are betting on companies which need equity more than they need debt. We do however agree there is a need to keep a close tab on the working capital situation for companies. I'd also note that the ability of firms to raise debt is somewhat sector specific. So, infrastructure companies for example are not facing the same issues getting loans as companies in the retail sector. Chinese banks will continue to lend as they are well capitalised and have quite a low loan-to-deposit ratio compared to their international peers.

How long do you think a down cycle could last in China?
I'd hazard a guess things will continue to be difficult for at least two years, but I would also note that this is working to our advantage as a private equity investor. As time goes by and owners realise they are unable to raise equity capital for their companies via an initial public offering because markets are closed and other sources of capital are also not readily available, they will be forced to become more realistic about valuations. And lower traded multiples result in lower comparables for benchmarking.

This story was initially published in the December/January issue of FinanceAsia magazine.

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