Saturday, August 15, 2009

The Debts of the Lenders: China Attracts Private Equity Deal Flow In Yuan

Are things really that bad in China? Many bears have been writing off China as an overleveraged bubble - including me. After all, lending has exploded this summer among Chinese banks w/private analysts estimating that M2 increased 27-30% in June alone. But even as macro conditions continue to deteriorate, investment continues to flow into China.

The key difference though is in the MANNER and TYPE of foreign investment.

1) Manner - Private equity by definition sidesteps the equity markets and focuses on project finance and other types of deal placements. While the export sector will certainly continue to suffer based on weaker Western factory orders (especially critical in the upcoming holiday retail season), there are many areas in the Chinese economy that will continue to do just fine . . . if not grow outright. Examples include - water treatment, agriculture, internal infrastructure, health care, IT, and energy exploration.

China is like an adoloscent child recovering from a steroid binge. Investment in the aforementioned sectors makes sense as they are basically disease treatment - meant to fix or moderate the worst excesses of 9-14% annual growth (even higher in the eastern seaboard cities). Industrial pollution, poorly constructed roads and buildings, the removal of an iron rice bowl (the Maoist era state security system), and depleted oil wells are all signs that Beijing has to address. . . and soon.

The business partners in private deals will likely be state actors such as local governments or federal agencies. Private equity is taking a longer term perspective here that effectively sidesteps the dislocations and volatility of the equity markets.

2) Type - The headline says it all. China is growing impatient w/dollar hegemony and is keen to bring its own currency out onto the world stage. All year long, Chinese diplomats have continued to publicly question the safety of their dollar, agency debt, and treasury investments. This nervousness has been reflected in the efforts of US diplomats to re-assure their trade partners in a hyper-active game of shuttle diplomacy w/Geither, Clinton, and other senior officials jetting off on a moment's notice to Beijing and Shanghai. While Chinese officials have been acquiesced to such efforts (for now), efforts are still being made to stimulate their own currency.

The article points out that Chinese authorities are keen to maintain investment funds within the country through exchange controls. This will limit the return on joint ventures initially but fund managers are apparently taking a longer view. Bond offerings and other less public instruments will continue to be offered in placements to foreign investors.

Conclusion - China is currently in the midst of an internally created debt fueled bubble as of early June. Sooner or later, there will be a correction in their equity markets (Shanghai or Hang Seng).

Anyone who thinks China can lift the world out of the recession needs a reality check. For all its advancement, the Chinese economy remains smaller than the US, EU, or even Japanese markets. The Chinese might be able to save themselves but not the whole world. But for those investors willing to take a longer term view and also be comfortable w/a return several years down the line. . . then China remains a sound investment.

Private equity drive to raise renminbi funds

By Henny Sender in New York

Published: August 14 2009 03:00 | Last updated: August 14 2009 03:00

US firms, such as Blackstone and the private equity arm of Goldman Sachs, are establishing investment companies in China to raise renminbi funds from local investors and take stakes in local companies with Chinese partners, according to people familiar with the matter.

The move is another step towards making the Chinese currency more widely available, and a further signal that Beijing is determined to improve the standard of corporate management in China.

The two private equity firms join banks such as Citibank, Bank of East Asia and HSBC in their ability to offer renminbi products.

By tying up with Chinese partners, Blackstone and Goldman hope to gain an advantage in securing deals in China. So far, foreign private equity firms have been frustrated by the relative lack of deal flow in a country where economic prospects are so seductive.
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