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Valuation Methodologies for Chinese Companies -China Mergers and Acquisitions

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China M&A

Best Practices regarding Valuation Methodologies for Chinese Companies

Valuing an enterprise is never an easy task as there are various ways to value a private company and there is often a major difference between financial theory and market reality in China: Multiply this many times in the case of Chinese domestic firms. This leads to a stark contrast in valuation between seller and buyer. As business value, brand value and needs of each counterpart vary widely, we recommend you use many different analytical tools, many different sets of data from both private and public sources in order to give your firm a starting point for determining value prior to negotiations.

Using Comparable Company Analysis to value a company you use multiples by comparing multiples to similarly valued listed firms in the US, Hong Kong or on a tier 1 city, like Shanghai. To calculate Enterprise Value-EV, use EV/Sales, EV/ABITDA (Earnings Before Interest, Taxes, Depreciation, Amortization. One major drawback to this valuation method is ignoring profits) or EV/EBIT almost same as ABITDA. Alternatively you can use equity multiples like Price to Earnings.

Post Merger (Successful Chinese M&A) do a Precedent Transaction Analysis in order to estimate the proper valuation of similar Chinese M&A deals in the same industry of your previous target. Precedent Transaction Analysis deals utilize data from successful transactions within China rather than data submitted to the SEC from publicly traded firms. Getting actual data from outside firms regarding previous China M&A deals is not an easy thing, however.

Lastly definitely try a good old fashioned DCF (Discounted Cash Flow) Analysis. This valuation methodology differs from multiples approach that derives the valuation from the present value of forecast free cash flows and accounts for the time value of money. It works backwards: Future cash flows are estimated then discounted to their present value. Efficient Equity does a thorough DCF Valuation on every Asian company. The risk with DCF’s is that they tend to estimate future cash flows in straight lines not taking into account the wide fluctuations in the Chinese market, government restrictions which cause most local firms to have huge fluctuations from year to year.

Morgan Stanley divests minority share in China International Capital Corporation

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Morgan Stanley’s sale of its minority share in China International Capital Corporation (CICC) might have caused ripples in the water. In December, Morgan Stanley China sold its stake in CICC to TPG Capital and KKR Private Equity. Now, a few weeks later, Ding Wei the leader of CICC’s investment department is leaving his post. I’m sure Mr Wei will land on his feet and he has already made it public that he is considering setting up his own private equity firm.

Tudou (土豆网) Prepares for Nasdaq Public Offering

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Paul Salo
October 25th, 2010
Shanghai

Dutch born Tudou Founder Marc van der Chijs is on top of the world in Shanghai as his creation moves ever closer to a US IPO. Gary Wang, current CEO, said that Tudou has appointed a syndicate of Credit Suisse and Deutsche Bank to float the stock.

Tudou’s success comes with an asteric due to the fact that it’s main rival, Youtube, is blocked in mainland China and most of its market growth came after the block. However, Gary Wang points out correctly that, in fact, Tudou was founded approximately one month before Youtube. Regardless, Tudou now is China’s largest video sharing site with over 400 million users who spend an average of 30 minutes per day watching videos. It’s a very sticky site for local users and has monetized its users with advertising more effectively than Youtube according to internet guru, Mike Chen.

Temasek, who invested $300 Million in the Agricultural Bank of China pre IPO, also participated in Tudou’s first round investment of $35 million USD in August. Tudou is expecting to raise approximately $150 million in their US debut.

CHINA IPO: Innovative exit strategy for WOFE’s in China

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October 22, 2010
Hangzhou, China

If Dick Kramlich’s move in Hangzhou’s pays off, it might have just gotten a lot easier for foreign venture capital firms to capitalize on the value of wholly owned foreign firms in China and give many foreign investors an improved exit strategy to their Chinese investments. Until now, foreign investors have been unable to maintain ownership without forming precarious partnerships with local firms and thus most choose to a WOFE structure in China. However, in addition to increased regulatory scrutiny, wholly-owned foreign entities are not able to list inside China and thus take advantage of the relatively high PE multiples common (95+ P/E ratio) on the mainland.

Kramlich’s firm, New Enterprise Associates, is investing in promising microfinance service UPG which is a wholly owned foreign enterprise. As a WOFE it is currently unable to list on China’s equity markets. However, he will transform the WOFE back to a Chinese firm through a stock swap thus allowing him to invest directly and, eventually, exit through a local IPO on the Shanghai Stock Exchange for example. If NEA successfully exits in this manner, expect many to follow as there are numerous firms with promising technologies starved of capital on the Chinese mainland.

From what we have heard so far, it seems this has the blessings of local officials who are intent on bringing Silicon Valley venture capital style investing to China. Perhaps this is the opening salvo in Mr. Kramlich’s attempts to create worthy exit strategies to satisfy his partners and investors who entrusted him with the largest pool of capital created since the financial crisis and tops out at $2.49 billion USD.

China’s real estate market (CHINA’S WEALTH MARKET Part III)

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China’s private banking industry 中国私人银行业 Part III

Real estate prices continue to rise in Tier 1 cities like Shanghai.  It was estimated this week that prices rose to 22,376 yuan ($3,366) per square meter in October, 2010.  It is expected that the Chinese government will continue with measures meant to curb real estate prices and avoid a painful deflation of Chinese asset values such as is happening across the globe with few exceptions.

The commercial market has also defied dire predictions as increased retail demand has taken much of the excess space resulting from the large increase in business districts and opening of massive new commercial structures.  Demand is simply eating up space in Shanghai and many other Tier 1 and 2 cities.  This is mainly due to the extremely hot retail sector as shown by the new Barbie flagship store in Shanghai and numerous other successful launches this year.

Cash deposits are expected to top their 2009 10% growth in 2010 fiscal year and remain the fastest growing asset class.  Regional distribution of wealth is expected largely remain the same with Guangdong, Shanghai, Beijing, Jiangsu and Zhejiang leading the field and Shandong, Liaoning, Hebei, Fujian, Sichuan and Henan provinces following. In total, these 11 provinces make up over 80% of China’s wealth.

Recommended Read: Condos for Sale in Bangkok

The ebb and flow of China’s Wealth Market (Part II)

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China’s private banking industry 中国私人银行业 Part II

As of 2008, it is estimated there were about 300,000 high net worth individuals in China with liquid of over USD $1.5 million and a total wealth of about $4.3 million.  In total, wealthy individuals assets reached about $1.5 trillion.  In 2009, their total wealth reached $1.4 trillion and lived mainly in 5 provinces:  Shanghai, Beijing, Guangzhou, Jiangsu (near Shanghai) and Zhejjiang. (also near Shanghai)  In 2010, despite the global slowdown, it is currently being estimated to reach over $1.8 trillion due to the ever advancing real estate market.  This growth comes despite a 50% equities market value drop and the almost complete halt of real estate transactions due to intense government intervention and new regulations.  So despite real estate transactions dropping over 90% in 2010, prices rose 13 percent.  Meanwhile cash and cash deposits gained 25% in 2010.  It is becoming ever more clear that China’s wealth market is an almost unstoppable force and continues to have enormous potential for the foreseeable future.

Naturally the number of wealthy Chinese has continued to increase.  As we said in the first part, in 2008, China had about 300,000 wealth individuals with 10,000 ultra wealthy and total wealth stood at $1.3 trillion.  Efficient Equity predicts those numbers will all rise in 2010 with wealthy individuals amounting to about 350,000 and total wealth at $1.8 Trillion.  All this despite a miserable export market, a lack of willingness among Chinese exporters to invest in new facilities and tanking share values worldwide.

New figures suggest that Chinese growth has dropped to 9% from October 2010 and near the governments 8% floor macroeconomic, stability benchmark.  It is expected that China will continue to grow at near the 9% figure despite serious challenges such as FDI decline, continued global weakness, export slump and general overall turbulence. However, most analysists are predicting China’s wealth market to continue setting new highs in 2010.

The fall in equity prices has taken much risk out of investing in China’s domestic stock markets.  In other words, the global slowdown is priced in to current valuations.  And the end of the governments stimulus measures has also not led to the slowdown that many expected.  So much in fact that the Chinese government has been raising interest rates to head off inflation.

China’s private banking industry: Introduction

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China’s private banking industry 中国私人银行业 Part I

The opening of China’s economy and subsequent financial deregulation has given rise to a whole generation of wealthy individuals.  In many ways, these investors differ from in the West.  Average age of mid-thirties and their confidence in their own judgement while considering investment decisions.  As oppossed to the Japanese and Western private wealth market, they tend to be first generation wealth and to trust their friends and own gut instincts as opposed to using professional wealth advisors.  They also are more heavily weighted in the domestic stock market and real estate market.

Although foreign banks launched private banking services as early as 2007, they have failed to gain significant market share as they focused on old money and subsequent generations of wealth.  In 2008, Chinese equities took a major hit along with the global market and the real estate market temporarily declined from the early boom.  However, the crisis has proved to be an amazing opportunity as it gave Chinese newly wealthy individuals a clear view of market volatility and forced them to rethink investing without the help of professionals.  Most have become significantly more risk averse and, intent on maintaining family wealth, have looked outside their group of friends and families to professional portfolio managers.

OKBUY China Secures 2nd Round Sequoia Venture Capital Funding

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October 21, 2010
Shanghai

Popular Beijing based online shoe retalier OKBUY (dotcom) raises $17 million in their 2nd round of funding from Sequoia Capital China VC. OKBUY’s founder Lu Ming said that the funding was necessary in order to increase variety of products offered as it directly influences profitability in the online shoe space in China. OKBUY has 3 large warehouse/storage facilities and will build 2 more by year end. OKBUY is often called the “Zappos of China”. OKBUY also carries clothing, bags and camping/outdoor assessories

Not surprisingly Sequoia Capital was an early ($10M first round funding) investor in Zappos and indespensible in their successful M&A exit strategy. Amazon was the acquirer and Sequoia heavily engineered the M&A outcome according to Zappos founder, Tony Hsieh.

China Asset Management grows 60%+ annually

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China’s asset management industry has grown over 60% annually for the last three years and is expected to grow at least 24% for the next ten years. Factors influencing growth include increased investment market in general, the very beginings of a retirement industry and rapidly growing needs in insurance.

In the past 5 years, foreign asset managers have pored into China but are limited to joint ventures and minority shareholdings and a 49% limitation on foreign ownership of a Chinese/foreign partnership. In addition, Chinese investors move money around at a much quicker pace and long term ownership is practically unheard of. In fact, most asset management firms see ownership 100% churn every two years leading to endless need for sales and new investors. Also, due to intense competition, fees are so low that it is difficult to turn a profit much less match Western standards for returns.

However, for the strongest players, 2007 saw some of the largest returns in the history of the industry: 100%+ New asset management firms have heeded the siren call and, despite the high churn and low fees, are in China to stay. The key is to create a structure that allows for high churn while creating value for clients on both sides of the equation. Branding is also a major factor in longevity and sustainability.

Currently Chinese investors are limited to real estate, equities and simply depositing money in the bank. However asset managers hope that China follows Japan’s path and that mutual funds will eventually take hold in the market. The rapid greying of Chinese society is forcing investors hand according to Bungo Ishizaki of Efficient Equity. “Reduced government pensions, runaway inflation, sky high real estate prices and the lure of Shanghai’s sometimes high flying equities have increased pressure on the financial market to supply consumers with new financial instruments to choose from”.

In an effort to place Shanghai in a world leading role by 2020 the government is rapidly removing barriers to yuan convertability, deregulate the corporate-bond market, raising corporate governance standards and increasing transparency. Currently Chinese companies control approximately 70% of the market. Many experts see investment advice as an area that foreign firms have an edge over Chinese rivals. Giving good advice on market direction, providing critical risk analysis and openly answering investors questions in education seminars. Many unusual practices remain in the market such as the practice of splitting shares in an effort to be the cheapest on the market due to the lingering belief that a mutual fund whose price is low is “cheap”.

Due to the near monopoly of China’s 4 largest banks, many foreign asset management firms have partnered with China Merchants Bank which has shown the ability to sell out subscriptions in the first day of offering. The key is to train the sales force to sell your products over another foreign invested asset management firms. Another avenue to sales in China is to create a sales channel with their own asset management arms and avoid the risk of losing favor with China Merchants Bank. Having a sales channel also creates brand loyalty and gives a foreign firm greater local knowledge of buyers tastes and preferences. For example, Fidelity Investments has coupled a strong sales channel with a robust online sales ability. Creating a proprietary sales channel and building a unique wealth management clientele is the key to differentiation of services and will help a foreign asset management firm to create a niche with staying power in the Chinese market.

Venture Capital and Private Equity Opportunities in China

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By Paul Salo
Shanghai

It is a common misconception that excess liquidity in the Chinese market as a whole eliminates opportunities for private equity investors in China.   The liquidity that exists in china due to the massive government stimulus package and forced bank lending of 2009 and 2010 simply does not reach the small and medium private enterprises.  In fact, less than 15% of recent bank lending has been to private enterprises in china.  These successful and profitable winners in the market are dying to see an infusion of capital and are now willing to look at foreign investment.  Some private firms are allowing themselves to be absorbed by money-losing state owned enterprises in order to meet short-term financial obligations. This has been the case in several industries such as steel and cement. In the PRC, the need for capital in private enterprises is real.

The intense focus of the Chinese government on supporting state owned enterprises alerted me to an opportunity in the market.  In my view, there are many opportunities to invest in China than existed prior to today.  In my view, China, as a market, is becoming more efficient on a daily basis. That said, it is not to say it’s easy for private equity or venture capital firms to differentiate management teams and likely winners among the many “me too” software and Internet firms, for example.   In green energy, we have seen some extraordinarily high (unrealistic) valuations.

Efficient Equity sees opportunity in basic industries and everyday consumer necessities like food and beverage, toiletries and even agriculture.  On top of the opportunity caused by inefficient lending policies, we feel that foreign investors, private equity firms and venture capital will also profit from investing in Renminbi (Yuan) assets and see substantial capital appreciation.   It doesn’t take a crystal ball to see that investing in profitable small and medium enterprises in China earning Renminbi — companies that are not leveraged — puts private foreign capital in an advantageous situation as the Renminbi rises over time.