Private equity (PE) majors are increasingly subscribing to the popular view that China’s growing integration with the rest of the world and vice versa creates interesting opportunities.
This reflects in firms investing in Chinese enterprises that want to expand globally, or infuse capital into companies that are targeting the Middle Kingdom, says Hamilton Tang, Managing Director of CDIB Capital International Co, the PE arm of Taiwan-based China Development Financial Holding Co., in an interaction.
Speaking to this portal on the sidelines of HKVCA China Private Equity Summit 2017, Tang said CDIB Capital had a China-plus strategy, which covered companies in countries such as Taiwan that are setting up advanced manufacturing facilities in China. He added that the fund liked deals in the consumer segment, which covered everything from education to healthcare and retail.
Can you explain to us your company structure? Are you an LP as well as the GP who manages the investment?
Yes – I am still new with CDIB Capital. For the past 17 years until about two weeks ago, I was (managing partner) with SMC Capital that was started by Simon Murray, the former managing director of Hutchison Whampoa. Basically, to answer your question – off the balance sheet we have made investments in other funds, and we are obviously the GPLP business. So we have made investments of our own, and on behalf of our LPs.
In terms of your own fund, what is your investment strategy and thesis? Would you say that you are sector agnostic?
There are a few preferred sectors. The strategy is probably defined as the China-plus strategy. So, while we are China-centric, we are not exclusively focused on China. And I think it subscribes to the view increasingly popular with other GPs that China’s growing integration with the rest of the world and vice versa creates some interesting opportunities. Some specific examples would be around China-Taiwan quarter. CDIB’s parent is a Taiwanese group ultimately. There are interesting opportunities arising from the Taiwan-China quarter. Despite what you read about in the papers and the politics of it, there is actually quite a healthy entrepreneurial ecosystem that co-exists between Taiwan and China for a lot of different reasons.
So going back to your question about sector focus, there are really three areas, one of which I think plays quite exclusively on China-Taiwan, which is what we call value-add or advanced manufacturing, typically expressing itself as an import substitution play.
An example would be a capable Taiwanese entrepreneur relocating to China and tackling niche areas with growth potential that are currently challenging but it manages to muscle its way in maybe because of the China home base, and hopefully because of the professional management skills of the Taiwanese founders. So value-added advanced manufacturing is one.
The others probably include consumer – okay, consumer is very broad and includes so many different things – so I would say, if we look at the portfolio of our current fund, which we had closed in the summer of 2015 – there are a number of companies that we have invested from this vehicle, including furniture, or for the lack of a better word – the home sector.
Obviously, there are certain themes that we pursue, although ostensibly consumer covers everything from education to healthcare to retail, etc.
So those two pockets represent ideally about 80 per cent of how we think about constructing the portfolio, and the balance is left for sort of new services, which means companies that don’t fit into either of these other two, or sorts of new age companies.
When you say ‘China plus’, do you mean Southeast Asia too?
Actually, it is Taiwan and Korea, but there’s no real limit. We would like to do something with ASEAN if there is a China twist to it. We’ve done deals in the US, China, Taiwan and Korea – we have invested in companies such as Coffee Bean & Tea Leaf. And then obviously we’ve done deals in Europe that have a China connect – there are also a lot of synergies. It’s fairly loosely defined by design. It’s intended as much not only because of the opportunity set, but also there’s a certain element of defence as well in that. We know how volatile China can be, so we have to have balance in terms of geography, revenue streams, customer base. That’s also a hedge against China.
How many companies have you invested in so far from your latest $405 million fund? How much of this capital has been deployed?
Just in the last few months, the fund has made two investments. (CDIB Capital, together with its co-investors, had recently acquired a minority interest in World Fitness Services Ltd – World Gym Taiwan – the owner and operator of the largest fitness centre chain in Taiwan with 46 locations and over 250,000 members. In April, CDIB also invested an undisclosed amount in L&P Cosmetic Co Ltd, a South Korea-based facial skincare firm). So taking into account those, we have invested in total 10 companies, so there’s room for more. The typical bite size for this fund is about $40-50 million plus or minus. Some deals are a bit smaller. So there’s enough dry powder for at least one middle of the large investment opportunity and possibly two smaller ones. And the rest being sort of reserved, top ups, fees, etc.
Does that mean that you have started thinking about the next vehicle? When do you see CDIB Capital beginning work towards raising the next fund?
In our business, to some degree, one has to think about the path forward. No specific plans certainly for the next fund, but it’s fair to say that perhaps sometime in the second half of next year or the following year, something like this would be appropriate. The group is quite large, so we are not like smaller GPs who need to be at market pretty much once the dry powder is fully utilised, and if nothing else they need to be in the market because the management fee flows change as you transition. CDIB is fortunately not in that position. We can go when we’re ready and with the prior funds we can responsibly go for it.
The group is quite large, so we are not like smaller GPs who need to be at market pretty much once the dry powder is fully utilised, and if nothing else they need to be in the market because the management fee flows change as you transition. CDIB is fortunately not in that position. We can go when we’re ready and with the prior funds, we can responsibly go for it.
Data shows there is a quite a bit of dry powder that is available in the PE firm industry – not just in Asia but globally too. Is that because of lack of deals, delayed deployment, high valuations or because of the environment where PE firms want to raise bigger funds and look at deployment later?
There are a couple of things. The dry powder figure has to be understood in the context of co-investment and that’s a popular theme these days. Everyone’s a deal junkie, and some view funds as a necessary vehicle to get to the co-investment flow. On top of whatever GPs have raised and haven’t used, you have actually this other pocket which is not hard to define, but often it at least mirrors, or exceeds, the underlying amount of capital that has been raised.
An example was the investment we made in Taiwan’s number one fitness chain – World Gym – and while that was quite a large transaction, roughly half was funded by our fund, and the rest was funded by other co-investors we invited in, including some of our LPs. So there was a one to one ratio between captive capital and invited capital in this deal.
Going back to your question, I think the seeming oversupply of capital is reflective of a couple of things – first, the stars have to align to pull the trigger on a deal, and every GP track you go from here on down, you are ultimately pulling the trigger on just a few, and sometimes because of valuation that’s probably one of the biggest drivers.
I would say, in terms of our portfolio – but for a few exceptions – most investments have been highly structured. Essentially that means different types of downside protections, ratchets, redemption rates, collateralization, founder shares, etc. Those are not necessarily everyone’s cup of tea especially in the context of a competitive environment. So, by the time you have to go through everything, and hopefully get some of the downsides addressed, your actual hit rate is quite low and that’s generally true across the whole industry.
Again, perhaps because we are a larger platform, although not necessarily a huge one like the KKRs of the world, (it doesn’t happen at CDIB Capital) but sometimes in smaller firms, it does happen. Not to say that this is not our motivation but one has to be realistic about sustaining the GP and that also dictates fundraising cycles and things like that.
Major global private equity firms are starting to come up with China-specific funds. Is it because China can no longer be part of 20-30% allocation of the global funds? What’s driving the need for China funds?
To some degree it is demand-driven. From what I can see from the LP side, particularly what sophisticated investors – those who have had experience in this part of the world – there is an increasing need for a vertical rather than horizontal approach. I’ve been in the industry for 17 years and have seen the swing. By that, I would say when it relates to China, it was early days, having an allocation as part of the global fund was being opportunistic, and by design it was probably the way to go. Being a horizontal guy, and I think some of our earlier investment track records from our prior firms reflects that.
Over time the market develops the view that you have to have very specific focus and expertise, and that you should provide a foundation for superior returns in terms of having domain, knowledge, and reputation for getting the best deals.
In part, it is demand-driven. The other reality which I can speak specifically from experience is that China requires a deep knowledge of China. I personally view even firms that attempt to do China from Hong Kong or Taipei – which is not our model – it is terribly difficult.
To some degree, it is dictated by the realities of the market and the complexities driven by what investors want.
We’re seeing a lot more of Asian LPs or homegrown LPs nowadays. What is your perception on this? How important are local LPs to the PE ecosystem?
For sure there’s been an evolution. When we first started in the PE business in China — and we were one of the early goers, this was in 2003 — even then CDH had a fund of $70 million, so it was pretty early days.
There were fewer GPs to choose from. Now I think whether you’re talking about significant family offices let’s say based in Europe, which were the LPs earlier and they were the source of a lot of support over the years in my prior firm – all these firms they have certainly scaled the learning curve, many of them have people on the ground here or they’ve hired local resources – so it’s quite different than the old days where it was about going to Zurich and London and explaining the big picture of what China is all about.
On the institutional side, the US or European-centric entities also certainly have not the only outpost here, but also people in positions of senior authority from China or from Asia, who can really cut through it all and really understand very well the layers of the issues. For GPs to go abroad, there’s a tonne of back-channelling because there’s now an infrastructure ecosystem here of Asi-based fairly savvy institutional investors that can be reference points.
There are a lot of GPs starting out today – how is the competition?
Competition is fierce. You take a place like China where you not only have dollar funds but also RMB funds, you have hybrid international guys, domestic guys – it’s all in the fold. One of the things that LPs are looking for is consistently sticking to the strategy or style drift. But the other thing is DPI – that’s one of the holy grails.
There is plenty of data on this, but you have this very robust forecast either an IR or money-on-money basis. When you look at the realised versus unrealised – in total over 20 year period of time, overall China’s DPI is quite low so that’s really one of the specific metrics that LPs are increasingly looking at.
What is your take on today’s valuations?
Obviously in this situation there’s plenty of capital, so demand-supply is a little askew. I think competing just based on capital does not get you much far as there’s simply too much choice. We have specific examples where we prevailed despite having a lower offer than a competitor simply because of what the CDIB platform can bring.