Funding pro specializes in SOEs

Zhao Linghuan, CEO of Hony Capital, said that other than in a few sectors of State monopoly and defense, State-owned companies are expected to be more market-oriented and to prove their efficiency through competition with other companies, both domestic and overseas. [Photo/Provided to China Daily]

Few people compare doing business with reading a book. But Zhao Linghuan does. The 50-year-old chief executive officer of Hony Capital said conducting private equity investment in China is just like that.

In the beginning you read a book introduced from the West and take down the main points one by one. But you keep adding the points when you go back to your daily work. Eventually, you have collected enough points to integrate them into your own book - on PE investment operations in China, he said.

Hony is Zhao's own book on China operations. It has now grown into a manager of seven funds, looking after a total of more than $6.8 billion in assets, in industries ranging from engineering equipment, pharmaceutics, retail, energy conservation to environment protection and culture.

The company was launched in 2003 by Legend Holdings, a Chinese investment house in IT, investment and real estate formed by the Chinese Academy of Sciences.

It has signed up limited partners including China's National Council for Social Security Fund, China Life Insurance Co, Goldman Sachs and Temasek Holdings.

What is unique about Zhao's book is the expertise in generating new market value in State-owned enterprises. In fact, half of the 70-plus investment deals it has made are State-owned enterprises. "Back in 2003 and 2004, most other PE and venture capital firms tended to shun the old, if not debt-ridden, SOEs and to work with privately owned companies," Zhao said.

That was the time when Hony Capital started to pay attention to SOE reform, Zhao said, "because some of them were really eager to make changes and reform themselves. And we thought change was doable because many of them took up lots of resources.

"They had been shielded from competition for so long that they weren't quite sure about how to compete in the market," Zhao said. But they would learn and learn quickly because they were given some help.

Key SOE deals were Zoomlion Heavy Industry Science & Technology Development Co, China International Marine Containers (Group) Ltd and CSPC Pharmaceutical Group Ltd.

Zoomlion was founded in 1992 by seven staff members from the former Changsha Construction Machinery Research Institute. It was listed on the Shenzhen Stock Exchange in 2000.

In 2005, problems arose over the proportion of State-owned equity being too large, becoming a hindrance to the company's attempted business expansion at home and abroad.

Hony Capital offered to play a role in the restructuring of the company, to take over part of the equity from the old majority shareholder. After the company's restructuring, State-sector shareholders retained 25.95 percent of Zoomlion's shares. Hony Capital and its partners owned 14.5 percent by investing 322 million yuan ($52.1 million), of which 222 million yuan was paid by Hony Capital itself.

The management team owned another 12.56 percent. China Economic Weekly quoted an agreement between Zoomlion and Hony Capital in 2006 and an announcement on logoff approval of Changsha Construction Machinery Research Institute in 2008. The rest of the shares are publicly owned.

But Hony Capital is not content with being a passive investor. "We influence our investment company's strategy and profit model, even though it is an SOE," said Zhao. "We make additional contributions to the company's development and make sure its strategy does not run counter to the nation's policy direction."

In the Zoomlion case, Hony Capital also worked with other investors to help boost Zoomlion's globalization effort, including the latter's 271 million euro ($360 million) acquisition of Italy's concrete machinery manufacturer Compagnia Italiana Forme Acciaio SpA in 2008.

Thanks to its new connection with the Chinese market, CIFA's profit increased in 2012 by 80 percent compared with 2008, according to Gao Zhen, a managing director at global equity private firm Mandarin Capital Partners that joined Hony in Zoomlion's takeover of CIFA.

In 2012, Zoomlion saw its total asset value rise to 88.97 billion yuan from only 4.2 billion yuan in 2005.

During the same period, the company's operating revenue rose from 3.28 billion yuan to 48.1 billion yuan.

The country's unprecedented urbanization drive, actively promoted by the government, continues to generate new opportunities for Zoomlion, Zhao noted. The company is supplying construction machinery to building projects across China in the areas of new cities, new expressways and railways and public infrastructure and utilities.

"Other than in a few sectors of State monopoly and defense, SOEs are expected to be more market-oriented and to prove their efficiency through competition against other companies, both domestic and overseas. "We've done the right thing. Our experimentation in the last decade or so has successfully created such market-savvy SOEs," Zhao said.

Not many financial participants in SOE restructuring have been so content with their results. In 2005, the global PE firm Carlyle Group planned to invest $375 million in State-owned machinery maker Xugong Group for an 85 percent stake. But doubts immediately spread throughout China that the deal was too cheap and public assets shouldn't be sold like that. The deal collapsed.

Another foreign PE firm, Newbridge Capital Investments Ltd, offered 1.24 billion yuan in 2004 for a 17.89 percent of the stake in Ping An Bank, then known as Shenzhen Development Bank, to become the first Chinese-foreign joint venture in the banking industry. This joint venture also experienced conflicts and complaints from both sides.

Hony sees itself as a different story in which it is more flexible by acting more willingly to adapt to Chinese business culture. "Any investor would like to have the controlling power. But Chinese companies don't want to be controlled," Zhao noted.

"But to control doesn't mean you must be the majority shareholder. We are the second largest shareholder of Zoomlion but still have a strong influence," he said.

Hony Capital chooses its deals by examining the people it wants to work with and undertakes careful evaluations. It usually takes as long as three months and many internal debates before an investment decision is finalized. But "choosing the right people, or those you have confidence in, is vital", Zhao said, adding that otherwise the investor could end up in trouble even though the valuation figures reveal no flaws.

If a SOE management team is competent and possesses a good incentive structure it can make a great contribution to the firm's development, said Zhao.

Once a company is considered to be trustworthy, Hony Capital is not only generous in acting as an investor but also goes out of its way to help it in many other ways.

Looking ahead to the next stage of China's economic reform, Zhao said the newly elected leadership in China makes him feel confident, especially in that the SOE reform will enter a new phase. From what he can tell, "Many SOEs are keen to learn new skills, to expand into new markets and to make new changes."

Hony Capital will continue to leverage its past experience in SOE reform, he said.