Some Practical Issues in Private Equity Investment

Author: [Site Administrator]
Source: [Fund Analysis]
Article type: Regular article
Published: 2007-12-7 20:32:38
Column: Expert Perspectives

The Partnership Enterprise Law of the People's Republic of China came into effect on June 1. Since then, a new type of entity — limited partnerships related to private equity investment — has appeared across the country. To date, approximately a dozen or so such entities have been established nationwide. The Qingdao Mu Zi Venture Capital Center, which shares its name with this column, was among the earliest, and has since achieved significant business progress. Here I share some practical reflections from the experience, for investors interested in equity investment.

The Qingdao Mu Zi Venture Capital Center was established strictly under the newly implemented Partnership Enterprise Law in August 2007. It is one of China's first entities to be strictly organized and operated according to international private partnership conventions. Several of the limited partners are chairmen of large private enterprises, each holding leading positions in their respective industries. The two general partners each have over a decade of practical experience in capital markets, having completed numerous primary and secondary market projects. The entity's primary business directions are: investing in pre-IPO companies that meet listing conditions; investing in listed companies' private placements; strategic investment in IPO companies; taking equity stakes in government-guided funds and management companies engaged in equity investment.

For the entity's steady development and sustained long-term growth, we designed the following business model: using government-guided funds as the primary investment platform to make controlled equity investments in outstanding local enterprises. The advantage of this business model is that all the best local enterprises can become our investment targets, and with local government support, we can steadily cultivate large numbers of outstanding enterprises meeting listing conditions based on market and economic development needs.

In equity investment, the investment itself is only the simplest, most elementary step. The key is whether sufficient support can be provided post-investment, offering comprehensive services to prepare companies for listing conditions. For a company to go public, profitability and other operating metrics are just basic requirements. The more difficult and more significant challenges are complex soft obstacles. These difficulties, without local government support, are very hard to resolve. Our business model resolves these difficulties in one stroke. Many companies undergo share reform quickly, but encounter numerous problems on the path to listing — often stuck on soft issues that cannot get local government support. Investing in such companies carries significant investment risk.

More critically, equity investment cannot be conducted through a slash-and-burn, predatory development model. Currently, the vast majority of equity investment firms do not put effort into cultivating listing resources. All effort goes into competing for existing listing resources. This predatory development model is unsustainable and is something we disdain.

Currently, we have completed all matters related to the joint establishment of the Pingxiang Innovation Capital Venture Investment Co., Ltd. together with China's largest venture capital and private equity firm, Shenzhen Innovation Investment Group, and the Pingxiang Municipal Government. Pingxiang Innovation Capital's first phase is 100 million yuan, with our share at 30%, Shenzhen Innovation Investment at 40%, and Pingxiang Municipal Government at 30%, expanding to 300 million yuan within three years.

Since the guided fund only plays a guiding role in actual investments, our actual investment in specific companies will far exceed our share in the guided fund.

Pingxiang Innovation Capital has signed investment letters of intent with Jiangxi Yongte Alloy Co., Ltd., Jiangxi Qianglian Electric Porcelain Co., Ltd., and Jiangxi Yongtai Chemical Co., Ltd. Intermediary teams including Shenyin Wanguo have also entered to begin preliminary work. Additionally, Pingxiang Innovation Capital has reached basic investment intentions with Jiangxi Hillkon Pharmaceutical Co., Ltd., Jiangxi Anyuan Chemical Fillers Co., Ltd., Pingxiang Xinan Industrial Co., Ltd., and Jiangxi Lianda Metallurgy Co., Ltd.

The local companies are all highly distinctive in their industries, providing the most basic assurance for the eventual success of these projects. Our goal is not merely to shepherd these few companies to listing, but to have far longer-term plans. There are many more distinctive local industries available for cultivation. Therefore, this can become a highly promising reserve source for listing resources, enabling sustainable development.

Our next investment priority will be to replicate the Pingxiang model. Government-guided funds in several cities are already under discussion and advancement. We believe this model will provide the most solid guarantee for our entity's long-term, sustainable development.

The biggest problem currently in the private equity space is the short-sighted rush for quick results. Many people don't want to do the real work of cultivating companies. They're all rushing into the resale of supposedly sure-to-list stocks. Many unlisted stocks have been speculated to astronomical levels. Stocks originally acquired at 1 yuan per share have in some cases been flipped 10, 15, or 20 times. Investing in such companies turns equity investment into pure speculation, harboring enormous risk.

From the standpoint of market construction, entities specializing in equity investment should be committed to growing alongside their portfolio companies, leveraging their own advantages in capital, resources, and other areas to jointly cultivate truly excellent enterprises. That way, listing becomes a natural outcome rather than a process of exhaustive scheming.

China's capital market needs good companies. Entities specializing in equity investment should be committed to discovering and cultivating truly outstanding companies for the capital market. The more good companies there are, the healthier the capital market's development and the more promising its future — and the greater the returns from equity investment. Only this kind of virtuous cycle between equity investment and capital market development is truly sustainable.