Investor finds exit blocked
Foreign investors often say that doing deals on the mainland is hard, but some are finding that cashing out of them can be even harder.
In April, the South China Morning Post broke the news that British private equity house Actis wanted to sell its majority stake in Xiabu Xiabu Catering Management, a popular hotpot chain restaurant on the mainland.
More than two months later, the proposed sale has stalled.
The stumbling blocks are several internal issues, including who should have the final say on any potential acquirer of the stake.
Actis, a spin-off of the British government's investment agency Commonwealth Development Corporation, made a high-profile announcement in 2008 when it invested US$50 million in Xiabu Xiabu. But it didn't disclose how big a stake it bought.
People with knowledge of the matter said Actis owned a 51 per cent stake in Xiabu Xiabu, making it the company's indisputable controlling shareholder. The rest is held by the founding family of the restaurant chain. Legally speaking, Actis should have the right to sell its stake to anybody it chooses.
But sometimes, making deals on the mainland, in particular for foreign private equity investors, is not just about the contract signed but also about the personal relationship between the investors and the local management or individual business owner.
'When Actis decided to sell its stake in Xiabu Xiabu, a lot of international private equity firms showed their interest quickly, but the whole thing turned out to be more complicated than we thought,' a senior executive at a private equity firm who reviewed the deal said.
Industry insiders say Actis's exit problem is common in the private equity business in China, which has a much shorter history compared with the US but has attracted such big global investors as the Carlyle Group, KKR and Blackstone.
In the West, private equity fund investors often clearly divide themselves into two groups - the buyout fund, which typically wants a majority stake in any deal target, and growth-capital fund investors, who take relatively small stakes during the growth stage of a company's development with a view to eventually selling out. But, in China the two groups are often mixed, given the limited supply of buyout deals that enable a private equity investor to obtain a controlling stake in a Chinese company.
Some industry veterans say that because of stiff competition for deals in China, if a buyout fund gets control of a company, it will tacitly agree to leave the business and its local management untouched just to secure the deal.
'It's pretty amazing, isn't it? Although you own 51 per cent of the company, you are not really the big boss who can make a decision on whom you want to sell your stake to,' a Hong Kong-based private equity dealmaker said.
Xiabu Xiabu was founded in Beijing in 1998 by a low-profile Taiwanese business family named He. The chain has expanded aggressively in the past few years. The company runs a chain of more than 240 restaurants around the country, according to its corporate website, which also says it aims to open outlets abroad.
A typical meal at Xiabu Xiabu costs about 30 yuan (HK$37), similar to McDonald's.
The sources said Actis was trying to sell its stake in Xiabu Xiabu for more than US$150 million, at least three times the amount it paid for its original investment. It introduced some potential buyers to Xiabu Xiabu's founding family, who own the rest of the company, and the local management, which is backed by the founder. They all rebuffed the overtures from Actis' preferred buyers.
Xiabu Xiabu didn't return phone calls seeking comment.
The senior officials responsible for the company's daily operations were reluctant to open the restaurant chain's financial books to potential investors to allow them do the required due diligence, the sources said.
Instead, the founding family and their supporters preferred to introduce a potential buyer to Actis - and that buyer might not be willing to pay as high a price for the stake.
'Despite having majority control on paper, private equity firms should still adopt a partnership approach with Chinese entrepreneurs, as enforceability of the terms in China is sometimes questionable,' said Joe Chang, head of the Hong Kong office for Swiss institutional investment adviser SCM Strategic Capital Management.
Chang suggested private equity investors should negotiate hard for the right to appoint an external and credible person to be chief finance officer at the companies they invest in so they can safeguard their rights and capital.
One of Xiabu Xiabu's main competitors on the mainland is Hong Kong-listed Little Sheep, which was taken over this year by US fast-food restaurant giant Yum! Brands, the owner of Pizza Hut and KFC. Little Sheep's early investors included two private equity funds: British investor 3i Group and Shanghai-based Prax Capital.
They were apparently luckier than Actis. Both 3i and Prax made more than three times their original investment in Little Sheep when they cashed out, and the sale went smoothly.
'Exit structures needs to be carefully thought out at entry. For example, the place of company incorporation can determine the exit route, whether offshore or onshore structure,' Chang said.
He added that some Chinese entrepreneurs did not really understand what rights they were signing away at the point of entry; therefore the founding entrepreneurs might refuse to stick to the terms when disputes arose later on.
And unlike in many other countries where private equity firms operate, the legal enforceability of a shareholders' agreement has long been problematic on the mainland.
Xiabu Xiabu said last year that it planned to have more than this number of outlets in China in the next three to five years