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Management in Practice

Where’s the investment opportunity in China?

Liang Meng, who founded a private equity firm after leading D.E. Shaw’s China operations, gives an overview of the fast-developing private equity market in China. He describes how demographic trends inform his investment strategy.

As China’s economy has boomed over the last decade, private equity has grown into an active industry. From 2001 to 2012, there were nearly 10,000 deals worth $230 billion, according to China First Capital (and as reported in the New York Times). Early on, large global firms with dollar-denominated funds dominated, but as the field grew more crowded, fast moving, yuan-denominated funds (whether foreign or locally managed) were increasingly able to execute deals quickly. Local firms also sometimes had advantages negotiating regulatory hurdles, especially when it came to exiting an investment.

Competition isn’t the only challenge for a PE firm in China. A series of accounting fraud scandals led to a halt of IPOs starting in mid-2012, and some 7,500 deals worth more than $100 billion remain un-exited.

Liang Meng ’97 and Kevin Zhang ’94 knew the challenges when they started Ascendent Capital Partners in 2011. Meng had been chief executive for Greater China with the hedge fund D.E. Shaw. Zhang was a Goldman Sachs partner and co-head of Goldman Sachs' Asian special situations group, with responsibility for the firm’s investing activity in China.

We talked to Meng about the opportunities that led him to launch Ascendent. Acknowledging the inevitability of competition and bottlenecks, he sees deep structural trends in China, including urbanization, expanding consumer consumption, and an increasingly sophisticated manufacturing infrastructure, that will drive growth in support industries such as packaging and machine components.


Q: What is the state of private equity in China today?

Liang Meng: We thought a lot about, before we came out, set up Ascendent on our own, my partner and I—my partner, Kevin, is also an SOM alum; class of '94. So, we talked a lot about what's going to happen in Chinese private equity in the next 10, 20 years. We actually thought it was the right time to do it. You know, Blackstone, KKR, Carlyle, maybe TPG—maybe with the exception of KKR—these major names in the U.S., they started somewhere around 20, 30 years ago, and they grew very fast because the country was undertaking that kind of trend, and that was happening.

In China, we thought the same thing is taking place. It used to be dominated by international private equity firms. They have their clear advantages, and we could see some disadvantages as well. We all used to work for those large firms, trained, and having set higher standards for operations. But at the same time, we're more local and we actually truly understand what's happening in China—where China's going. And yes, there's a lot of competition, and there's always competition. But we do view the Chinese private equity is still in a nascent stage of development. It may hit an intermediary bottleneck, but with the country growing, and with more reception for private capital, the pie will become even bigger.

Q: What do your investment choices say about the direction of the Chinese economy?

Meng: We are looking at a lot of the demographics changes and how China's growth—where China's growth is going to come from. Urbanization is a big theme. So, we focus on consumption quite a bit on the food and beverage side. We focus on the urbanization-related themes, like high-speed rail. We focus on upgrading of basic manufacturing; so, we call it advanced manufacturing. We focus a lot on control systems because these are the things that can automate Chinese basic manufacturing. It's no longer going to be the world's biggest factory. Well, we probably will still be the biggest factory; hopefully, they will turn out to be the world's best factories. And that will take 10, 20 years, and that's an ongoing trend. Very important. And so we would invest in those control systems, advanced manufacturing, and then focus on demographic changes—on healthcare, on consumption, and high-speed rail, which is really changing how all the cities interact within China.

When I did investing in Nanjing, a city about 200, 250 kilometers from Shanghai, 10 years ago took me a long time to drive from Shanghai to Nanjing. There were no flights because it's just too short. And you couldn't—you had to stay overnight and come back the next day. Today, from Shanghai to Nanjing, it takes less than an hour, train. So, you can literally have a breakfast meeting in Shanghai, and then you go and take the train to have a lunch meeting in Nanjing; you come back for an afternoon or a dinner meeting in Shanghai again. So that's changing how things are gonna work out in China.

So, we're identifying these trends and looking at ancillary industries. So we're not going to invest in rail, because that's heavy-capital-intensive, really government driven. But the things that support or supply to the rail sector—components, systems—they'll be very interesting, because there's a huge demand for it. And we look at food and beverage. Branded food, branded beverages; high valuation. But then we look at the ancillary industries—the packaging side of it, the bottling side of it—because they're brand agnostic, and demand is huge. And per capita consumption continues to grow. It's still a huge opportunity in the developing world, and in China. Healthcare, pharmaceutical—there are a lot of areas. It's just focusing on the big picture of demographic changes and the policy-driven urbanization theme. There are ample opportunities down the road.