China Money Podcast - Video Episodes

In this episode of China Money Podcast, guest Monte Brem, CEO of private equity firm StepStone Group, shares his firm's investments in China and how offshore investors can protect themselves when investing with local Chinese managers. Q: You have been relocated to China for more than two years, and StepStone’s office in Beijing opened about two years ago. How have your businesses in China grown during this time? A: We’ve increased the amount of capital we invest into China by a huge amount. We used to invest around $25 to $30 million into Chinese managers and deals. Now we are investing around $300 to $500 million a year. So on the investment side, there has been huge growth. Q: So where do you see attractive opportunities right now? A: Almost all the money we invest into China is somehow connected to the consumer market. (Because) a lot of markets like mining and resources are very difficult. Most of them are not accessible to foreign investors anyway. The consumer markets tend to be more open and less politically oriented. We’ve invested in a firm called QiMing Venture Partners, which is a private equity firm that does both consumer and health care investments. The other one is CDH (insert name) that has a focus on consumers. We’ve also done some nontraditional investments as well, such as Citi Capital, which does SOE (State-Owned-Enterprise) buyouts. Q: What kind of return are you targeting? A: Most investments are targeting return of 30 percent IRR as China is such a growth oriented market. Globally, the target is in the range of 20 percent on a growth basis. Q: Do you mostly invest in overseas funds or Chinese locally run USD funds? A: As a firm, we tend to favor local managers, particularly in China, so those managers with local approach and have a local team. When we invest in local managers, one of the challenges we face is that we can’t invest in RMB funds because we are not a local Chinese entity. So today we are investing in offshore USD funds of Chinese managers. Most of these managers manage both a USD fund and a RMB fund. Q: There may be potential conflict of interests when a manager invests both a USD and a RMB fund. What’s your observation on how managers handle this? A: Overall, it has been a major headache. It’s one of the things that makes the Chinese market more complicated and less appealing. But those managers who are committed to their offshore businesses have gotten very good in balancing the conflicts and put together structures that protect the offshore investors. I think the most important thing is that you have to find the managers who really value the offshore part of their strategy. That’s the main protection you have as many managers understand that foreign capital tends to be more institutional and long-term.

In this episode of China Money Podcast, guest Howard Marks reveals his thoughts on China’s economy and its investing environment. He also gives a surprisingly frank evaluation of Oaktree Capital Management’s performance in China. Listen to the full-interview in the audio podcast, watch the shortened video version or read an excerpt. Q: You’ve just completed a trip in China, and Oaktree has had an office in Beijing since 2007. How would you rate China’s investment environment? A: I have a lot of respect for China’s long-run economic outlook. But this is a period when (China’s economy) is slowing. There are some questions about how it will land – whether it’s hard or soft – of course you know I don't claim to know the answers. Also, China’s customers – the U.S. and Europe – have been growing very slowly themselves. So that will have a retardant effect on China’s economy as well. The combination of the two suggests that China is in for a slow period. On the other hand, valuations in China have corrected quite a bit from two or three years ago when everybody assumed China’s outlook was flawless for eternity. Prices have come down considerably both relative to valuations in other countries and in absolute terms. That’s very healthy for the investment outlook. Q: What unique challenges do you face investing in China? A: A controlled economy probably has the ability to do better in the short term. In the long run, there is not much experience with that. Many (such experiments) in the past haven’t lasted. Of course, China is making a compromise between a controlled economy and a less controlled one. The world has yet to see how it is to do business in China dealing with issues such as property rights: whether foreign private investors can do well as owner of businesses. It’s important that people do not assume that business-as-usual in China is the same with business-as-usual elsewhere. So if you don’t know how property rights will be treated, then you should try to avoid situations that pivot on that issue. For example, in our distressed debt investing, we often invest in the debt of the companies that fail to pay for their debts because we have creditor rights that can give us access to the value of the company. We don’t know how creditor rights will be treated in China, so we probably won’t invest in (this method).

In this episode of China Money Network, guest Howard Marks reveals his thoughts on China’s economy and its investing environment. He also gives a surprisingly frank evaluation of Oaktree Capital Management’s performance in China. Listen to the full-interview in the audio podcast, watch the shortened video version or read an excerpt. Q: You’ve just completed a trip in China, and Oaktree has had an office in Beijing since 2007. How would you rate China’s investment environment? A: I have a lot of respect for China’s long-run economic outlook. But this is a period when (China’s economy) is slowing. There are some questions about how it will land – whether it’s hard or soft – of course you know I don't claim to know the answers. Also, China’s customers – the U.S. and Europe – have been growing very slowly themselves. So that will have a retardant effect on China’s economy as well. The combination of the two suggests that China is in for a slow period. On the other hand, valuations in China have corrected quite a bit from two or three years ago when everybody assumed China’s outlook was flawless for eternity. Prices have come down considerably both relative to valuations in other countries and in absolute terms. That’s very healthy for the investment outlook. Q: What unique challenges do you face investing in China? A: A controlled economy probably has the ability to do better in the short term. In the long run, there is not much experience with that. Many (such experiments) in the past haven’t lasted. Of course, China is making a compromise between a controlled economy and a less controlled one. The world has yet to see how it is to do business in China dealing with issues such as property rights: whether foreign private investors can do well as owner of businesses. It’s important that people do not assume that business-as-usual in China is the same with business-as-usual elsewhere. So if you don’t know how property rights will be treated, then you should try to avoid situations that pivot on that issue. For example, in our distressed debt investing, we often invest in the debt of the companies that fail to pay for their debts because we have creditor rights that can give us access to the value of the company. We don’t know how creditor rights will be treated in China, so we probably won’t invest in (this method).

In this episode of China Money Podcast, guest Hellen Song shares her views on where great investment opportunities exist for venture capitalists in China, and what type of entrepreneurs are more likely to survive — and succeed — in the rough markets of China. Q: We are sitting in this beautiful Beijing courtyard hotel, which you have invested in. Tell us how did you find out about this opportunity? A: During Tsinghua University's hundredth anniversary, I (as an alumni) came to Beijing and found it’s hard to find a boutique hotel with an (old) Beijing flavor. I walked into this area and found this hotel, but it's under very poor management. Though they only charged 100RMB, the hotel was still empty. I stayed here for seven days. When I left, I asked the owner if I invest with him and get a good manager to run this hotel, would he work with me. That’s how we started. Q: I’m surprised to hear that you didn’t previously know the hotel owner. We all know how important Guanxi is in China? A: It depends on which industry. If it’s government dominated sectors, then Guanxi is of course very important. For us, we are looking for a person or a team to invest, it’s not really Guanxi that we are looking for. We are looking for a good CEO with good experience and good execution skills. Q: In terms of industry and strategy, where do you see attractive investment opportunities? A: My favorite investor is Peter Lynch. I admire his strategy, which is “follow the consumers' money.” So I focus on three sectors. One is children-related industries, because in China, it’s six people’s salaries (two parents plus four grandparents) raising one child. Also, this sector is not a mature market yet in China. Second, women dominate families’ cash flows in China. So I want to invest into the industries where women are spending money. Third, older population-related industries. In China, there are 115 million people who are over 60 years old. Therefore, bio, medical equipment and health care are all very attractive.

In this episode of China Money Network, guest Hellen Song shares her views on where great investment opportunities exist for venture capitalists in China, and what type of entrepreneurs are more likely to survive — and succeed — in the rough markets of China. Q: We are sitting in this beautiful Beijing courtyard hotel, which you have invested in. Tell us how did you find out about this opportunity? A: During Tsinghua University's hundredth anniversary, I (as an alumni) came to Beijing and found it’s hard to find a boutique hotel with an (old) Beijing flavor. I walked into this area and found this hotel, but it's under very poor management. Though they only charged 100RMB, the hotel was still empty. I stayed here for seven days. When I left, I asked the owner if I invest with him and get a good manager to run this hotel, would he work with me. That’s how we started. Q: I’m surprised to hear that you didn’t previously know the hotel owner. We all know how important Guanxi is in China? A: It depends on which industry. If it’s government dominated sectors, then Guanxi is of course very important. For us, we are looking for a person or a team to invest, it’s not really Guanxi that we are looking for. We are looking for a good CEO with good experience and good execution skills. Q: In terms of industry and strategy, where do you see attractive investment opportunities? A: My favorite investor is Peter Lynch. I admire his strategy, which is “follow the consumers' money.” So I focus on three sectors. One is children-related industries, because in China, it’s six people’s salaries (two parents plus four grandparents) raising one child. Also, this sector is not a mature market yet in China. Second, women dominate families’ cash flows in China. So I want to invest into the industries where women are spending money. Third, older population-related industries. In China, there are 115 million people who are over 60 years old. Therefore, bio, medical equipment and health care are all very attractive.

In this episode of China Money Podcast, guest Jim Rogers shares his bearish views on the Chinese property sector, and explains why those who argue that the RMB is approaching fair value are wrong. Listen to the complete interview in the audio podcast, watch a shortened video version, or read an excerpt below. Q: We are in this high-speed train from Tianjin to Beijing going at 350km per hour. Are you impressed? A: Yes. I am. I came over today and it’s very quiet and very smooth. I couldn’t believe how wonderful it is. It’s better than an airplane. Q: This is a perfect showcase of China’s infrastructure boom during the past few decades. How much longer can this boom go on? A: I’ve driven across China a few times. I know there are a lot of space and a lot infrastructure needed to be done, so there will be more to come. Q: Last time we talked, you said the Chinese property bubble will have an ugly burst. We’ve seen housing prices drop, but by small margins. Will it get much worse? A: It’s actually been dropping a lot in some places. But, what I’m worried about is that the Chinese government is loosening interest rate and bank reserve requirement ratios too soon. If they loosen too soon, as they did once before, the bubble got much worse, and people will lose more money ultimately. Q: You predict that the U.S. economy will go into a downturn next year and 2014. How will that affect the Chinese economy? A: With the largest economy in the world having problems, everybody feels it. If you sell to Wal-Mart, you will feel the pressure. By the way, Europe is slowing down. So you have two of the largest economic blocks slowing down, China's (prospects) will be clouded too. Q: As you know, many economists are calling for the Chinese economy to warm up again, if not during the second half of this year, then early next year. You don’t think it’s the case? A: No, because I expect the U.S. and Europe to slowdown in 2013 and 2014. Sure, some parts of the Chinese economy will be fine, but most of China, especially those dealing with Europe and the U.S. will have problems. China is spending billions of dollars to clean up its air and water, so (environmental technology and) water treatment sectors will do very well. If you are in agriculture, you will not care if America is in trouble. Also, some parts of the Chinese economy will still have a hard landing, such as the property sector. So it’s a mixed bag.

In this episode of China Money Network, guest Jim Rogers shares his bearish views on the Chinese property sector, and explains why those who argue that the RMB is approaching fair value are wrong. Listen to the complete interview in the audio podcast, watch a shortened video version, or read an excerpt below. Q: We are in this high-speed train from Tianjin to Beijing going at 350km per hour. Are you impressed? A: Yes. I am. I came over today and it’s very quiet and very smooth. I couldn’t believe how wonderful it is. It’s better than an airplane. Q: This is a perfect showcase of China’s infrastructure boom during the past few decades. How much longer can this boom go on? A: I’ve driven across China a few times. I know there are a lot of space and a lot infrastructure needed to be done, so there will be more to come. Q: Last time we talked, you said the Chinese property bubble will have an ugly burst. We’ve seen housing prices drop, but by small margins. Will it get much worse? A: It’s actually been dropping a lot in some places. But, what I’m worried about is that the Chinese government is loosening interest rate and bank reserve requirement ratios too soon. If they loosen too soon, as they did once before, the bubble got much worse, and people will lose more money ultimately. Q: You predict that the U.S. economy will go into a downturn next year and 2014. How will that affect the Chinese economy? A: With the largest economy in the world having problems, everybody feels it. If you sell to Wal-Mart, you will feel the pressure. By the way, Europe is slowing down. So you have two of the largest economic blocks slowing down, China's (prospects) will be clouded too. Q: As you know, many economists are calling for the Chinese economy to warm up again, if not during the second half of this year, then early next year. You don’t think it’s the case? A: No, because I expect the U.S. and Europe to slowdown in 2013 and 2014. Sure, some parts of the Chinese economy will be fine, but most of China, especially those dealing with Europe and the U.S. will have problems. China is spending billions of dollars to clean up its air and water, so (environmental technology and) water treatment sectors will do very well. If you are in agriculture, you will not care if America is in trouble. Also, some parts of the Chinese economy will still have a hard landing, such as the property sector. So it’s a mixed bag.

In this episode of China Money Podcast, guest Nick Cao discusses China's commercial property sector, which has gone through an explosive growth phase after early 2010, when home buyer restriction policies dragged down the residential property market. http://www.chinamoneypodcast.com Q: Since the government launched home buyer restrictions, the commercial property sector has been going rapidly. Some are concerned about a bubble. Are you? A: It depends. I would say China's commercial property sector is still less developed than the residential side. We see two different groups in the commercial sector. One is the large developers in China, such as China Resources and China COSCO. They moved into commercial properties before the tightening measure was initiated. But the other group is forced into the commercial sector because their residential sales have stalled. And they operate the commercial sector as if they are still running residential properties. Lots of these (commercial properties) are poorly designed. Some of them are in tier two and tier three cities. Take the city of Shenyang. There are oversupply issues. We see ten large shopping malls within two kilometer distance. So that’s scary and there are a lot of concerns for investors. But, overall I wouldn’t say it’s a bubble because in China, there still lacks good quality shopping malls (in many cities). Q: For the past few years, the transaction volume in commercial property has doubled. Do you see that continue? A: I would say, yes. Because China's economy is moving from manufacturing-based to services-based, so this generates stronger demand for office space. Some international firms are expanding into second tier cities in China, which requires high quality office space. Also, the government is promoting domestic consumption. That’s demanding more retail shopping malls. Moreover, the insurance industry in China is just allowed to invest in commercial real estate so (investment) demand will still be quite high. Q: We have seen residential property prices double in the space of one to two years. Will the same happen in commercial property? A: No, I don’t think it’s going to happen that fast. It’s all case-by-case. For example, if there were two shopping malls next to each other, their prices would move very differently (depending on how well they are managed). Q: But we often read reports on ghost shopping malls across China. It seems as if you still believe that the fundamentals of commercial real estate is strong demand driving up supply? A: When you talk about ghost shopping malls, you still have to look at it case by case. In China's tier two and tier three cities, it’s still very hard to find good quality shopping malls. Yes, there are lots of them that are vacant. But that's because the developers don’t know how to run a successful shopping mall. Our Guest Today: Nick Cao is the China head of investment and capital transaction at global real estate consultancy, Knight Frank. Nick has six years of experience in real estate investment and has advised on six billion RMB real estate investment deals involving office, retail serviced apartments, hotels and joint-ventures. Mr. Cao graduated from the London School of Economics.

In this episode of China Money Network, guest Nick Cao discusses China's commercial property sector, which has gone through an explosive growth phase after early 2010, when home buyer restriction policies dragged down the residential property market. http://www.chinamoneynetwork.com Q: Since the government launched home buyer restrictions, the commercial property sector has been going rapidly. Some are concerned about a bubble. Are you? A: It depends. I would say China's commercial property sector is still less developed than the residential side. We see two different groups in the commercial sector. One is the large developers in China, such as China Resources and China COSCO. They moved into commercial properties before the tightening measure was initiated. But the other group is forced into the commercial sector because their residential sales have stalled. And they operate the commercial sector as if they are still running residential properties. Lots of these (commercial properties) are poorly designed. Some of them are in tier two and tier three cities. Take the city of Shenyang. There are oversupply issues. We see ten large shopping malls within two kilometer distance. So that’s scary and there are a lot of concerns for investors. But, overall I wouldn’t say it’s a bubble because in China, there still lacks good quality shopping malls (in many cities). Q: For the past few years, the transaction volume in commercial property has doubled. Do you see that continue? A: I would say, yes. Because China's economy is moving from manufacturing-based to services-based, so this generates stronger demand for office space. Some international firms are expanding into second tier cities in China, which requires high quality office space. Also, the government is promoting domestic consumption. That’s demanding more retail shopping malls. Moreover, the insurance industry in China is just allowed to invest in commercial real estate so (investment) demand will still be quite high. Q: We have seen residential property prices double in the space of one to two years. Will the same happen in commercial property? A: No, I don’t think it’s going to happen that fast. It’s all case-by-case. For example, if there were two shopping malls next to each other, their prices would move very differently (depending on how well they are managed). Q: But we often read reports on ghost shopping malls across China. It seems as if you still believe that the fundamentals of commercial real estate is strong demand driving up supply? A: When you talk about ghost shopping malls, you still have to look at it case by case. In China's tier two and tier three cities, it’s still very hard to find good quality shopping malls. Yes, there are lots of them that are vacant. But that's because the developers don’t know how to run a successful shopping mall. Our Guest Today: Nick Cao is the China head of investment and capital transaction at global real estate consultancy, Knight Frank. Nick has six years of experience in real estate investment and has advised on six billion RMB real estate investment deals involving office, retail serviced apartments, hotels and joint-ventures. Mr. Cao graduated from the London School of Economics.

In this episode of China Money Podcast, guest Ludvig Nilsson discusses the challenges facing China’s private equity industry and where he sees attractive investment opportunities. Listen to the podcast, watch the shortened video or read an excerpt: Q: Last year, you described China’s private equity industry as a hyped market with strong fundamentals. Have you changed your opinion? A: Not really, I think the hype is still on. The inflows of new capital into China are actually increasing, not just from overseas investors but also from local institutions. Specifically, China’s insurance companies. The insurance industry is only now allowed to allocate significant money into private equity. On an overall basis, the potential is very large. The combined assets of the insurance industry are a few hundred billion dollars. If you apply a percentage of two to three percent that could arguably be invested into private equity, that’s a quiet a large number. Q: You answered the first part of the question, but how about the fundamentals? People are concerned that there is now too much money chasing too few deals? A: Yes, but that’s always been the case for as long as the industry has been around. There are new opportunities right now and they derive from two areas. One, there are a range of newly emerged industries that need capital for consolidation, the consumer industry, for example. On macro basis, China has never seen as tight a credit condition as the present ever. Some six months ago, it was the tightest condition I’ve ever seen since I moved to China 15 years ago. China has always had lots of money sloshing through the system. Now a lot of that money has dried up. What I think we will see is that there are currently two thousand (private equity) funds. They will consolidate into perhaps one thousand or so funds. And, only half of them will make seasonable returns. That sounds like a lot, but (it means) 75 percent of the funds you see in the market will not do well. Q: Is there any particular industry or strategy that you think presents better opportunities at present? A: We are looking at western China regions more. Given the new development phrase that the western China regions are going through, we see a lot of opportunities of investment ahead of the curve. Some of the managers there tend to have strong local connections and very good deal flow and very good understanding of risks at that area. They have been able to do deals at very attractive valuations. There are a large number of fund managers that emerged in Chengdu, Chongqing and Xi’an. Most of them started out as small RMB funds backed by leading industrial families in those regions. Many of them are looking to increase their capital base as the investment opportunities there are huge. Q: But going to a frontier market represents unique risks and challenges. How do you manage that? A: Exactly. The reason we want to work with local funds over there is because they know how to manage that risk. Some of the funds from Shanghai going to China’s western region, they are as foreign as I am. So, many of those local risks can best be managed by those with local connections. Our Guest Today: Ludvig Nilsson is a co-founder and managing director at Jade Invest, a Shanghai-based private equity fund-of-funds manager focused on China. Prior to co-founding Jade Invest in 2005, Ludvig was a consultant at PricewaterhouseCoopers where he focused on commercial due diligence for private equity clients. For more information, go to http://www.ChinaMoneyPodcast.com

In this episode of China Money Network, guest Ludvig Nilsson discusses the challenges facing China’s private equity industry and where he sees attractive investment opportunities. Listen to the podcast, watch the shortened video or read an excerpt: Q: Last year, you described China’s private equity industry as a hyped market with strong fundamentals. Have you changed your opinion? A: Not really, I think the hype is still on. The inflows of new capital into China are actually increasing, not just from overseas investors but also from local institutions. Specifically, China’s insurance companies. The insurance industry is only now allowed to allocate significant money into private equity. On an overall basis, the potential is very large. The combined assets of the insurance industry are a few hundred billion dollars. If you apply a percentage of two to three percent that could arguably be invested into private equity, that’s a quiet a large number. Q: You answered the first part of the question, but how about the fundamentals? People are concerned that there is now too much money chasing too few deals? A: Yes, but that’s always been the case for as long as the industry has been around. There are new opportunities right now and they derive from two areas. One, there are a range of newly emerged industries that need capital for consolidation, the consumer industry, for example. On macro basis, China has never seen as tight a credit condition as the present ever. Some six months ago, it was the tightest condition I’ve ever seen since I moved to China 15 years ago. China has always had lots of money sloshing through the system. Now a lot of that money has dried up. What I think we will see is that there are currently two thousand (private equity) funds. They will consolidate into perhaps one thousand or so funds. And, only half of them will make seasonable returns. That sounds like a lot, but (it means) 75 percent of the funds you see in the market will not do well. Q: Is there any particular industry or strategy that you think presents better opportunities at present? A: We are looking at western China regions more. Given the new development phrase that the western China regions are going through, we see a lot of opportunities of investment ahead of the curve. Some of the managers there tend to have strong local connections and very good deal flow and very good understanding of risks at that area. They have been able to do deals at very attractive valuations. There are a large number of fund managers that emerged in Chengdu, Chongqing and Xi’an. Most of them started out as small RMB funds backed by leading industrial families in those regions. Many of them are looking to increase their capital base as the investment opportunities there are huge. Q: But going to a frontier market represents unique risks and challenges. How do you manage that? A: Exactly. The reason we want to work with local funds over there is because they know how to manage that risk. Some of the funds from Shanghai going to China’s western region, they are as foreign as I am. So, many of those local risks can best be managed by those with local connections. Our Guest Today: Ludvig Nilsson is a co-founder and managing director at Jade Invest, a Shanghai-based private equity fund-of-funds manager focused on China. Prior to co-founding Jade Invest in 2005, Ludvig was a consultant at PricewaterhouseCoopers where he focused on commercial due diligence for private equity clients. For more information, go to http://www.ChinaMoneyNetwork.com

In this episode of China Money Podcast, guest Alberto Forchielli discusses China-Europe cross-border deals, the challenges Chinese companies face when expanding overseas, and the mistakes he has made but never regretted. Q: First, give us a brief introduction of your fund and its strategy? A: Mandarin Capital Partners is set up to encourage Chinese companies to invest in Europe, and European companies to invest in China. It’s a bi-lateral fund, cross-border (focused). We have invested all of 300 million plus euro we had. Plus, we did a number of leveraged buyout. So our overall volume of investment has been one billion euro. Q: For Chinese companies expanding overseas, what are the biggest challenges that they face? A: First one is to find a good deal. To find a good deal, you have to find out (about the deal) early on. Generally, good deals are done by insiders. So the trouble for Chinese companies is to become insiders. Secondly, speed. They are not used to do mergers and acquisitions, particularly overseas deals. And also, there are many permissions they have to go through. So they need to sign a temporary contract with a very heavy break-up fee. That puts them at a disadvantage verses international competitors. [wpvideo JA29GPWp w=640] Q: Your focus is industrial companies. For this sector, how does valuations compare historically? A: With the crisis, the multiples have been coming down. We’ve never bought anything for more than seven times EBITDA. We even went down to buy great companies at 3.2 times (of EBITDA), which is unheard of in China. In China, you pay 20, 30 or even 40 times. (We also buy) companies with technologies, profitable and full of cash. So you can definitely do an incredible multiple arbitrage with those companies. We did an exit yesterday. It was four companies that we bought and merged in the pharma business. We sold one year later at three times of our original investment, only because it was restructuring plus China exposure. Q: That all sounds great. But I’m sure during this process, you face many challenges and risks. Can you tell us about that? A: We got where we are, not because we figured everything out, but because we’ve made every possible mistake that can be possibly made. We’ve made them all. The first mistake is when people want to talk to you just to gain knowledge. They want to use you and make you work like crazy. We went through that, and now we are very quick in trying to do a closing. The second is never co-invest with Chinese companies, because they slow us down. Their process is so slow that what I can discuss with a Swiss lawyer for half an hour takes me two days to explain to my Chinese partner. It’s a big burden. It’s like running a marathon with a 20-kilo bag on my back. The third thing is not to go after a Chinese who comes to you and says, I want to buy something. Never. Whether it’s a European or Chinese, forget about it. It’s a waste of time. You only have an opportunity when you are in China or Italy (where a company needs to expand overseas), but never the other way around.

In this episode of China Money Network, guest Alberto Forchielli discusses China-Europe cross-border deals, the challenges Chinese companies face when expanding overseas, and the mistakes he has made but never regretted. Q: First, give us a brief introduction of your fund and its strategy? A: Mandarin Capital Partners is set up to encourage Chinese companies to invest in Europe, and European companies to invest in China. It’s a bi-lateral fund, cross-border (focused). We have invested all of 300 million plus euro we had. Plus, we did a number of leveraged buyout. So our overall volume of investment has been one billion euro. Q: For Chinese companies expanding overseas, what are the biggest challenges that they face? A: First one is to find a good deal. To find a good deal, you have to find out (about the deal) early on. Generally, good deals are done by insiders. So the trouble for Chinese companies is to become insiders. Secondly, speed. They are not used to do mergers and acquisitions, particularly overseas deals. And also, there are many permissions they have to go through. So they need to sign a temporary contract with a very heavy break-up fee. That puts them at a disadvantage verses international competitors. [wpvideo JA29GPWp w=640] Q: Your focus is industrial companies. For this sector, how does valuations compare historically? A: With the crisis, the multiples have been coming down. We’ve never bought anything for more than seven times EBITDA. We even went down to buy great companies at 3.2 times (of EBITDA), which is unheard of in China. In China, you pay 20, 30 or even 40 times. (We also buy) companies with technologies, profitable and full of cash. So you can definitely do an incredible multiple arbitrage with those companies. We did an exit yesterday. It was four companies that we bought and merged in the pharma business. We sold one year later at three times of our original investment, only because it was restructuring plus China exposure. Q: That all sounds great. But I’m sure during this process, you face many challenges and risks. Can you tell us about that? A: We got where we are, not because we figured everything out, but because we’ve made every possible mistake that can be possibly made. We’ve made them all. The first mistake is when people want to talk to you just to gain knowledge. They want to use you and make you work like crazy. We went through that, and now we are very quick in trying to do a closing. The second is never co-invest with Chinese companies, because they slow us down. Their process is so slow that what I can discuss with a Swiss lawyer for half an hour takes me two days to explain to my Chinese partner. It’s a big burden. It’s like running a marathon with a 20-kilo bag on my back. The third thing is not to go after a Chinese who comes to you and says, I want to buy something. Never. Whether it’s a European or Chinese, forget about it. It’s a waste of time. You only have an opportunity when you are in China or Italy (where a company needs to expand overseas), but never the other way around.

In this episode of China Money Podcast, guest Michael Werner discusses Chinese banking stocks, their exposure to local governments and the property sector, and whether Chinese banks will see their non-performing loan ratios skyrocket. Q: First, let’s look at Chinese banking stocks. In terms of valuation, are they attractive? A: I still think the banks are attractive. We’ve seen a very strong increase in terms of the share prices over the past three to four months. But I still think you will get incremental news that will help the valuations of the banks. As China’s Central Bank eases monetary policy that will help with valuations, thought it might not be the best for earnings. I still think for the next two to three months, we still have some upside for the banks. [wpvideo kSb9Ii6K w=640] Q: Now let’s turn to the fundamentals of the banks. Many people are concerned about the banks’ exposure to the property sector and local governments. How big a risk are these? A: Yes, these are certainly risks to the banks. But I think the market has overstated the risks. We really saw that toward the end of last year. The market was pricing in for some of these loans to go to zero in terms of valuation, which in our view is simply not going to happen. The listed banks that we cover, they had around 11 to 12 percent of their loan book exposed to local government loans. On the property side, you have around 15 percent going into residential mortgages and maybe another 10 to 12 percent going into commercial real estate. In our view, the residential mortgages are very safe with very low loan-to-values. There is a very good track record of people paying off these loans. On the local government financing vehicle side, certainly there will be some problems. But I think the bulk of the loans are going to end up healthy. But there will be a good five to ten percent of the loans that will have trouble repaying. That’s a couple of years out, and the banks will have enough time to earn up enough reserves to provision against that. On the commercial real estate side, the banks have actually reduced their exposure. They do have exposures, but they tend to have exposure to the largest, the best and the most liquid of the property developers. So I don’t think that will be a problem. The largest concern that we have are the LGFV loans. Q: So, where do you think the non-performing loan ratio will peak? A: Our best guess right now is around 2.5 percent. Right now, the NPL ratio for the whole banking system is around one percent. Getting into 2 or 2.5 percent in the next couple of years is actually in line with what we have seen in other countries that experience slowdowns. We think the Chinese economy will slow down to 7 to 8 percent at the end of this year to early 2013. Q: So are you saying there are not as much trouble as people fear? A: That’s absolutely correct. What we have seen in China is relatively good underwriting standards. I think that Chinese banks are going to surprise people on how well they are provisioned and what the ultimate NPL ratio will be. Some people have been forecasting 8 to 12 percent (NPL ratio). That does not seem likely in our viewpoint. The government will definitely help put in place policies that will mitigate these risks. Just like during the past few years, the banks have been earning a lot of money, and the government has put in place very restrictive policies in terms of capital and provisioning. Now on the other end, when economic growth is slower, the regulators will relax some of those restrictive measures. That counter-cyclicality (in policies) is actually positive for the banks.

In this episode of China Money Network, guest Michael Werner discusses Chinese banking stocks, their exposure to local governments and the property sector, and whether Chinese banks will see their non-performing loan ratios skyrocket. Q: First, let’s look at Chinese banking stocks. In terms of valuation, are they attractive? A: I still think the banks are attractive. We’ve seen a very strong increase in terms of the share prices over the past three to four months. But I still think you will get incremental news that will help the valuations of the banks. As China’s Central Bank eases monetary policy that will help with valuations, thought it might not be the best for earnings. I still think for the next two to three months, we still have some upside for the banks. [wpvideo kSb9Ii6K w=640] Q: Now let’s turn to the fundamentals of the banks. Many people are concerned about the banks’ exposure to the property sector and local governments. How big a risk are these? A: Yes, these are certainly risks to the banks. But I think the market has overstated the risks. We really saw that toward the end of last year. The market was pricing in for some of these loans to go to zero in terms of valuation, which in our view is simply not going to happen. The listed banks that we cover, they had around 11 to 12 percent of their loan book exposed to local government loans. On the property side, you have around 15 percent going into residential mortgages and maybe another 10 to 12 percent going into commercial real estate. In our view, the residential mortgages are very safe with very low loan-to-values. There is a very good track record of people paying off these loans. On the local government financing vehicle side, certainly there will be some problems. But I think the bulk of the loans are going to end up healthy. But there will be a good five to ten percent of the loans that will have trouble repaying. That’s a couple of years out, and the banks will have enough time to earn up enough reserves to provision against that. On the commercial real estate side, the banks have actually reduced their exposure. They do have exposures, but they tend to have exposure to the largest, the best and the most liquid of the property developers. So I don’t think that will be a problem. The largest concern that we have are the LGFV loans. Q: So, where do you think the non-performing loan ratio will peak? A: Our best guess right now is around 2.5 percent. Right now, the NPL ratio for the whole banking system is around one percent. Getting into 2 or 2.5 percent in the next couple of years is actually in line with what we have seen in other countries that experience slowdowns. We think the Chinese economy will slow down to 7 to 8 percent at the end of this year to early 2013. Q: So are you saying there are not as much trouble as people fear? A: That’s absolutely correct. What we have seen in China is relatively good underwriting standards. I think that Chinese banks are going to surprise people on how well they are provisioned and what the ultimate NPL ratio will be. Some people have been forecasting 8 to 12 percent (NPL ratio). That does not seem likely in our viewpoint. The government will definitely help put in place policies that will mitigate these risks. Just like during the past few years, the banks have been earning a lot of money, and the government has put in place very restrictive policies in terms of capital and provisioning. Now on the other end, when economic growth is slower, the regulators will relax some of those restrictive measures. That counter-cyclicality (in policies) is actually positive for the banks.