Summary
- Carlyle has only themselves to blame for the troubles they have experienced with the widely-reported Xugong Construction Machinery company acquisition.
- There are a large number of PE firms eagerly eyeing China, and therein lies the source of one big problem: Too many buyers using the exact same strategy and going after the exact same few companies.
- Buying small is a better strategy which delivers two significant benefits.
Analysis
As I have said before, Carlyle has only themselves to blame for the troubles they have experienced with the widely-reported Xugong Construction Machinery company acquisition. There is not need for buy-out firms to "now [be] more cautious about China, given what Carlyle had to go through."
Carlyle made two mistakes: First, they went after a big company involved in a sensitive field, heavy industry. Anyone who knows anything about modern Chinese history knows that these companies were at the forefront of the Chinese government efforts in the 50's and 60's to “surpass the west.” Obviously, this strategy did not quite pan out, but there is still a strong nationalistic connection between these companies and the government and even the ordinary citizens of China. Secondly, Carlyle clearly did not do their pre-acquisition guanxi work. If they had, they would have found out very early (i.e. before this whole mess went public) that the deal was sensitive. What is pre-acquisition guanxi work? It means contacting the relevant government agencies in advance to discuss your ideas and to get their feedback and suggestions. This is a nice way of getting unofficial approval, and getting them involved in the success of the plan. Later, you are much more likely to receive friendly approval from these government departments as they are already aware of the deal and, in fact, tacitly gave their official thumbs-up in advance.
As the article note in the next section, there are a large number of PE firms eagerly eyeing China, and therein lies the source of one big problem: Too many buyers using the exact same strategy and going after the exact same few companies. You don't have to be a PE expert to know what happens as a result. Prices go up. Worse still, there just aren't any companies available to buy. Remember that the massive growth in recent years in China has NOT been driven in any way by large Chinese companies. Or even by the government. In fact, both of those parties often were hindering the growth. No, the growth came from small and medium size Chinese enterprises, mainly focusing on the manufacturing sector and later on consumer products for the hungry local consumers. Throughout this period, the large state owned companies remained relatively stagnant and in many cases saw their sales shrink dramatically. Sure a few large companies experienced growth, but in most cases, it was the opposite.
Buying small is a better strategy which delivers two significant benefits: A) It stays below the regulatory radar and thus avoids the Carlyle-type problems. B) It focuses acquisitions on the many smaller-sized companies that are the true leaders of the Chinese economic miracle, as opposed to the crumbling state-owned mega-companies that the large majority of the western PE's are chasing after now.
OK, I know all the PE experts are sitting back now and groaning about deals being too small to merit the paperwork involved. I guess I have to say first, you should probably consider streamlining your internal processes to reduce the paperwork. Secondly, it is not as bad as it seems if you follow the magic strategy of ROLL-UP, i.e. buy one, then use this company as a vehicle to buy a string of related companies or competitors. In a relatively short period of time, you can roll-up 10 small companies into a nice sized business. If you target the right type of industry, i.e. an industry that has clear benefits from economies of scale in purchasing or production or sales or whatever, you will also reap a double reward when these synergies begin to hit the books.
Of course, the challenge will be management, so that makes your first acquisition important, not so much as a standalone company, but as a central management structure that all of the rolled up companies will merge into. This will very likely require bringing in some talented people that are probably too talented for the small-size of the first company acquired. No problem, just sit down with these candidates and layout your plans for the roll-up. Get them properly motivated of course (performance incentives, shares, etc.), and give them marching orders to develop SYSTEMS of management in each functional area. Once you feel they are ready to roll (pardon the pun), then start your roll up process.
By the way, this also opens up some interesting opportunities for buying out the entrepreneurs of the rolled up companies; you can offer them partial cash and partial shares in the total rolled-up business. If you paint the right picture for him or her, this should be quite attractive to them, i.e. they will eventually own shares in a very large, stable, and professionally-managed company.
