Barings founding partner discusses private equity and China

On the closing of its third Asia-focused fund, with $490 million of commitments, Jean Eric Salata, chairman and CEO talks about the deployment strategy and why he remains bullish on China opportunities despite the risks keeping him awake at nights.

What are key terms of this fund?
We raised $490 million û the fund was oversubscribed. It is a 10+2 year fund. We invest in companies which require between $20-100 million of equity investment. Our sweet spot is $20-50 million per deal. One of our primary criterion is that companies we invest in must be profitable. We are willing to take majority or minority stakes and typically hold for 3-5 years.

Who are the investors in the fund?
We raised money across geographies û about 50% from north America, 25% from the Middle East and Europe and 25% from Asia. IÆd note that this was the first private equity allocation for some of our investors, which I believe corroborates that more people are looking at this asset class then ever before.

What type of investments will you seek?
We have offices in Hong Kong, Singapore, Shanghai, Tokyo and San Francisco. Our focus will be on China, Hong Kong,Taiwan, Singapore, Japan and India. Specifically, I predict that more then 50% of this fund will be invested in China. There are more then 10 million privately held mid-sized companies in China - they are our focus.

What sectors in China do you anticipate opportunities will arise in?
I am bullish on automotive and automobile components, consumer spending (food, retail), education and the natural resources sector.

Why is Japan a focus for this fund?
If I had to predict which Asian economy is going to do very well going forward it would be Japan. There is increasing evidence that the concept of private equity is gaining acceptance in Japan. We feel there is a strong link between what we are doing in China and what we aim to do in Japan. Also, we found the right team and this was part of our decisionmaking to focus on the country.

How have your last two funds performed?
Our first $305 million fund which closed in October 1999 is in divestment mode now and actually is almost fully divested. Our second $257 million fund which closed in September, 2002 is fully invested and is in harvesting stage. We do not disclose returns, but we were able to raise a fund twice as large as our previous fund, so that is some indication.

Does your focus on only profitable companies contradict your stated emphasis on restructuring opportunities? Do you think you pay a premium for companies doing well rather then say turnarounds?
I agree that in some cases profitmaking situations can lead to premium valuations. But we also seek instances where we can help to effect operational improvements or where the parent or holding company is seeking an exit for a profitable division or company.

We bring more to the table then just capital, which we believe enhances our value proposition. In China an investment from a fund such as ours is a step towards helping our investee company globalise. We help investee companies grow organically or through acquisitions. We help find the right people. Ultimately, we could help the company IPO.

You mentioned helping find people. Is it a challenge finding people in China when there is so much competition to attract talent?
Our philosophy is to back strong management but, yes, this can ultimately be backing one good person and we may have to help our investee companies find the right people. In some cases we do this by using our name to attract high calibre people - for example our investee company, Minth. We issued an advertisement bearing our name to assist them to attract a CFO.

Do you see hedge funds eating into your market?
Hedge funds are competition for only a certain kind of deals for example pre IPO deals where the exit is round the corner. Hedge funds report returns monthly which makes their business more cyclical. We report annually but investors understand that in the first couple of years we are in investment mode. IÆd say for 80% of our deals there is no overlap. Further, in contrast to a fund such as ours, hedge funds have limited resources on the ground in Asia. We commit resources to restructuring and enhancing value in our investee companies. I actually think hedge funds are providing alternative exit options.

Will you pursue MBO opportunities?
The MBO market is growing but as yet there may not be a huge MBO opportunity in China. This is because of the nature of ownership û companies are either owned by their entrepreneur founders or are state owned enterprises (SOEs). In Singapore, Hong Kong, Japan, maybe even Australia we may see MBO opportunities.

What are the risk factors you see in China?
The single biggest thing that keeps me awake at night is regulatory change. I believe the shifting nature of regulation translates into higher discounting. The political and regulatory risk to my mind hampers valuations. I am aware that evidence corroborates that over the last 20 years regulators are moving towards a more open economy. But itsÆ like a pendulum. It does not move in only one direction. For every two steps forward there is a step back. In the larger framework this does not impact our investment strategy but it certainly affects our perceived risk of investing in this market.

How do you source your deals?
Primarily through proprietary origination sources. We use very few of the large investment banks for deal sourcing though obviously we do use them for exits. We sometimes use boutique firms. I think this also reflects the nature of the deals we do and the reality in China today. There is not that much intermediation in the market in which we operate. Our last few deals were referrals - from a former employee, another from a company we had looked at which subsequently got acquired, the next from the CFO of a company we had funded.

Stock market valuations in parts of the region are quite high. How do you keep owners expectations reasonable?
This is a challenge but also an area where being a regional fund covering different geographies helps. Different markets go through different cycles. So, for example, India may currently be very high but Taiwan is quite low. In China there are no capital market benchmarks right now û this is one of the reasons we like China!