The Blackstone Group’s recent joint venture with the Shanghai government may well mark another important turning point in the domestic private equity (PE) landscape.

Blackstone, which with $93.5bn of assets under management is among the world’s largest PE firms, has signed a memorandum of understanding with the government of the Pudong New Area. The global PE powerhouse, one of several to now have a presence here, will set up its first regional renminbidenominated PE fund in Shanghai, called the Blackstone Zhonghua Development Investment Fund. It will raise RMB5bn (US$732m) for investments in Shanghai and neighbouring areas.

The indicative significance of this joint venture has many PE lawyers excited about the market’s prospects. “This groundbreaking development sees a major global PE firm showing serious commitment to the market. It will help grow the PE industry in
China and has the potential to even change the landscape of this industry,” says Richard Xu, founding and managing partner of Shanghai-based HanYi, a law firm that has a primary focus on PE transactions.

Allowing a top-tier global PE house to form and manage an RMB investment fund will also set a good example and model for the domestic players and other local governments in different cities. In the view of domestic lawyers, this JV will help raise the bar for the entire industry.

“Opening the domestic market to quality global players will help China build an orderly private equity industry, as well as foster corporate governance and strengthen capital markets,” says Jeremy Dai, a partner of Zhong Lun. “It’s a good chance for domestic PE managers to gain the institutional know-how and technical skills from their international counterparts on PE practices.”

Similar to Blackstone, many other leading foreign PE companies – which are usually ahead of the curve in spotting developing business trends – are refocusing on or expanding their presence in this market. International law firms are also seizing the opportunities by simply following their clients’ footprints.

US PE heavyweight Kirkland & Ellis (K&E) has recently opened an office in Shanghai, its second one in Asia after Hong Kong. The Shanghai office, co-managed by senior partners Li Xiaoyang and Li Chuan, focuses on complex transactions involving China for international PE firms and corporations and will represent Chinese entities active abroad.

“For a very large number of PE clients, particularly those in Asia, China is increasingly their core focus, and they are making long-term investments here. So our China strategy isn’t creative at all; we are simply doing what they are doing,” says
David Eich, senior partner in K&E’s Hong Kong office and the head of the global PE practice in Asia.

“The opening of our Shanghai office allows us to be closer to a larger set of managing directors in the Greater China market. It’s amortising our existing assets and resources across a large pool of potential clients,” Eich says.

Recovery on the horizon
While the PE scene in other parts of the world is still relatively quiet, there is no doubt that the worst of the GFC is over for PE in China. Funds managers and lawyers have all sensed that the market is recovering, as deal flow has started to gradually pick up from the second quarter of 2009. Domestic PE houses such as Hopu, Hony Capital and CDH are leading the recovery. “Many dominant international PE funds have been very quiet in the past 18 months. This has provided good opportunities for the domestic PE firms to thrive. Some of the domestic players have been very active in the market during a period when deal activity witnessed a significant downturn,” says David Blumental, partner of Vinson & Elkins in Beijing.

The strong performance of the PE practices of domestic firms has breathed life into law firms. “We’ve experienced an increase in work load starting from the end of the second quarter. Prior to that, most of the mandates were for restructuring and exit strategies, but now we’re involved in more new deals, due diligence and deal executions,” says Xu.

Deal activity slowed down dramatically in about September 2008, and until the second quarter of 2009 many PE firms were largely reviewing existing projects; only a few new investment deals were closed.

To some, K&E’s expansion in the supposedly uncertain present may look risky, but the firm’s China business has turned out to be “surprisingly” encouraging. “We are in the right place, even at the wrong time. We are increasingly busy here. The view is clear – at least in Asia, especially China that the market has turned and some kind of bottom has been reached. It seems the disability in financial markets has ended and people are now investing again,” says Eich.

Although things are looking up, challenges remain. One of the main issues that stop transactions being closed is valuation. “We are at a time where some level of uncertainty is still swirling around the market and global economy. In many cases, it’s difficult for the founder and the investor to reach an agreement on valuations,” says Blumental.

An advancing and more sophisticated legal framework, meanwhile, has slowed down the pace of deal making. “In the more developed and regulated legal environment, PE investors are more careful and are spending more time and energy on making sure they don’t overlook any major PRC compliance issues, and are paying more attention to evaluating investment risks,” says Xu. Many PE managers reportedly now engage many specialists in different fields to examine target companies more thoroughly.

“PE clients now demand an increased level of skills and attention from more experience lawyers. Lawyers have to be more careful when they advise
on transactions, and need to be more updated on regulatory changes and how these changes are practised in China,” he says.

NEXT: Positive regulatory changes

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