A: Like Ronnie, we think there will be a lot of distressed situations in China. The challenge is always the fear of “catching the falling knife.”
We are less afraid of that because of our business model. We don’t have to wait for the bottom. We want to find good assets and good management team.
We think a number of sources of capital for Chinese developers, such as bank debt, shadow banking, RMB-denominated private equity funds and dim sum bonds (or domestic and foreign equity markets), are drying up at the same time. As a contrarian investor, China is interesting to us again.
Q: Are there any geographic locations or types of real estate that you are interested in?
A: We are agnostic toward (those factors). We are looking for value and great management teams.
Q: You also invested in a Vietnamese property company called Son Kim Land last year. How did that deal work?
A: We started looking at Vietnam in 2011 and 2012. Vietnam was in the middle of a financial and banking crisis. Inflation was out of the control, the government had slammed on the brakes and interest rates went up to 26%.
We interviewed 27 groups, did extensive due diligence on six of them, and we picked one called Son Kim Land. We structured a deal that’s good for investors but also worked to further the development of the company.
Q: Did you take equity of the company?
A: It was a mezzanine structure, which is a debt-like instrument with asset backing that provided downside protection for us. We charged 10% interest rate. If the company could not provide a listing or some other type of exit, they will have to pay a premium redemption.
But if Son Kum Land can develop its business and potentially list the company on Vietnamese domestic markets, then we can convert to equity to share the upside, and their cost of capital will also be reduced.
Q: Back to China, what are some other opportunities that you think are interesting now?
A: A lot of people are coming to the conclusion that China has a two-speed economy now. Things like e-commerce and healthcare are growing very fast. Another realm such as steel, manufacturing and construction are growing very slowly. As a contrarian investor, we are seeing good value in those slow-growing sectors.
Q: How do you invest in those sectors that are usually dodged by overcapacity?
A: We have been in industries where the government has been pushing for consolidation before. Back in 1997, I (when working at a previous company) got involved in Harbin Brewery Group. At the time, there were 600 breweries in China. Harbin Brewery was a small brewery in Northern China worth around US$8 million. The government was trying to consolidate the industry.
We funded Harbin Brewery to acquire other breweries and grew stronger. Later, it was sold to Anheuser-Busch Companies for US$800 million. At that time, we were not involved any more, of course.
But that was a consolidation play that worked along with what the government wanted.
Q: Which specific sector in China are you looking at deals right now?
A: Now, we are looking at the steel industry, which is tremendously distressed with lots of overcapacity. The government desperately wants to consolidate this. I think there will be quite a lot of pain, a lot of bankruptcies and non-performing loans (from this sector).
But ultimately, China will continue to be one of the most powerful and competitive steel producers in the world. China’s domestic steel consumption will still be huge. If you can find the potential winners and give them the capital resources, help formulate good strategy and management teams, you can get into the sector at such great valuation today because nobody wants it.
Q: What are the biggest risks?
A: The biggest risk for a foreign group like us is trying to understand local politics. Trying to figure out who the Chinese government wants to be the winners or the losers can be challenging. So, we try to partner with local groups who have a good understanding of what’s going on.
Q: Do you consider your firm as having good connections in China?
A: I wouldn’t claim that we have good “guanxi” (relations) with any particular entities in China or anywhere else. We know how to structure good transactions, and we know how to work with local groups who have those connections.
My personal belief is that some private equity firms have raised a lot of money by telling investors that they have great connections. The problem is that if you are doing the deals on connections, it’s hard to do good due diligence or to negotiate hard. Like we say, you can’t look into the mouth of a gift horse.
We have not been impressed by the performance of those firms who promoted themselves on the basis of “guanxi”. We look at fundamentals. In addition, we generally look at places where not a lot of money is competing, so “guanxi” doesn’t matter anyway.
Q: So you are not interested in the fast-track new economy of China?
A: I think e-commerce is the future direction of the whole world. But globally and especially in China, I believe investors are overpaying and overvaluing those businesses right now. Are those business real? Yes. Is the growth real? Yes. Am I going to pay 100 times EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization)? No.
About Eric Solberg:
Eric Solberg is the founder and CEO of Asia-focused private equity and wealth management firm EXS Capital. Before founding EXC Capital in 2007, he was managing director and partner of Citigroup Venture Capital International Asia, Citigroup’s proprietary private equity group for Asia.