Cai Lei from JD Capital: Chinese PE at a Historical Turning Point


Speech delivered by Cai Lei, partner of JD Capital, at China’s Wealth Forum in Hangzhou on March 28, 2015

From a professional perspective, finance involves two ends: the source end and operating end. PE is the combination of “P+E”, or private + equity. All of the functions and various stories of PE are the interactions between P and E in the end.

The “source end” of PE is “private”. PE has a high threshold and more flexibility in operation, which increases the possibility of making long-term investment. The “operating end” of private equity is “equity” rather than listed company. A variety of financial products can be combined into different portfolios, which makes PE more flexible than most of other asset management institutions. Both valuation adjustment mechanism (VAM) and repurchase can be adopted when making investment, so the return on investment should be rather high in PE. We only invest in projects with internal rate of return (IRR) no lower than 30%. 

Given the characteristics of its “source” end and “operating” end, I think in nature, PE has dual attributes. “Crossover” is a heatedly discussed topic recently and PE is a typical product of crossover. For one thing, it is financial capital with decent risk-benefit ratio; for another, it belongs to active investment with a long cycle, deep involvement and the attribute of industrial capital. Therefore, PE is a typical product of the crossover of finance and industry, and the legendary stories of PE are originated from these two characteristics. If I had not read a book titled Barbarians at the Gate 20 years ago, I would not have joined this profession. Venture capital (VC) is a special form of PE despite its longer investment cycle, deeper involvement and requirements for greater specialty.

Having understanding this background, let’s now review the development of PE in China over the past decade. Starting from CDH Capital and Shenzhen Capital Group, various PE repurchases have been exploring plenty of investment opportunities considering the conditions of their respective times. Different PE institutions have developed their own specialties after making attempts in growth fund, VC, M&A, cross-border investment and investment in SOEs. 

Currently China’s PE is standing at a historical turning point facing tremendous opportunities. Firstly, PE is financial capital. At present, China is conducting its financial reform covering interest rate, foreign exchange rate, and the access of financial institutions to the market, which, together with the impact of Internet finance, will transform the landscape of the traditional financial sector. Secondly, since almost all of the traditional industries will be fundamentally restructured and upgraded, PE institutions have huge opportunities in industry investment. Thirdly, China is conducting the property right reform. Under the mixed-ownership reform, the property right of tens of trillions worth of the net asset in the SOEs is to be reformed. Meanwhile, the handover of management in many private enterprises in Zhejiang Province is, in essence, a reform on property right. In addition, such issues as the overseas investment of Chinese capital and highly information-based economy are all opportunities as well as challenges for investment institutions. In the competitions with other institutions, PE institutions that cannot grasp the opportunities might fail and fade.

If we look at China’s PE at this historical turning point, we will find that the challenge is greater than the opportunity. Here I am going to analyze from the “P+E” mode. 

First, the “source” or “fund” end. The biggest challenge facing China’s PE is the lack of funds. China’s PE is still too weak in terms of the amount of capital to take part in large-scale transactions, which constitutes the biggest challenge. 

Second, the “investment” or “asset” end. To be objective, the majority of China’s PEs is not capable enough in this respect. Few of PE institutions in China has got involved into the mainstream economic and industrial activities. Rather, the majority are outsiders of the mainstream economic activities in China. Warren Buffett showed his ambition at the age of 84 in his latest letter to his shareholders that he has invested in nine and a half companies out of the Fortune 500 Companies with the rest 490 and a half to be invested in. In contrast, Chinese PE institutions lack such strong capacity.

Third, the incompetency of both “P” and “E” ends. On the whole, China’s PE institutions have not lived up to its due role in the allocation of resources in society. They should have been very flexible with various tools at disposal and contributed hugely in the resource allocation as a product of the crossover of finance and industry. The proportion of Chinese enterprises’ participation in global competition does not match the share of the Chinese economy in the world’s total. The dominant PE players such as KKR and Blackstone split the then large groups during the fourth wave of M&A in the US. Over the past one or two decades, the innovations in the US have been mainly concentrated in emerging areas like the Internet and new energy. These innovations are all catalyzed by VC and generalized PE institutions. On the contrary, China’s PE institutions have not yet participated much in activities that have driven historical process. While our PE institutions are related to both finance and industry sectors, they are not financial institutions or industry investors. They belong to the middle zone, which poses a challenge.

Now I am going to share with you how we can make some breakthroughs against such a backdrop. 

First, breakthroughs at the “P/Source of Funds” end.

The top priority for both investment institutions and asset management funds is to find capital; since without money, they can make nothing done. The nature, cycle and requirement of the source of funds determine the requirement for the use of such funds. JD Capital’s strict requirement on the return of investment has been determined by our clients at the source end. Currently, the biggest problem facing PE institutions is the lack of money, so breakthrough should be made at the source end so as to attract more long-term money in large sum.

At present, there are many discussions in this profession. For example, the supervisor has suggested that conventional or small-scale PE be transformed to large-scale PE or even small-scale public funds. The investment means that the threshold and method by limited partners (LPs) have to be improved in an innovative manner. The latest revised act by the SEC in America has clarified the requirement of supervision and regulation on the equity-based crowd-funding, which means that breakthroughs can be made in the financing mode of PE investment.

The financing mode of PE investment will approach to the mode of public funding. In effect, this has been put into practice, such as the listed funds of KKR on overseas market and the public funding-based Harvest Fund launched during the reform of mixed ownership by Sinopec last year at home. Each institution can make its own exploration in this regard.

Another important point to make is the liquidity of PE funds. If the liquidity problem remains unsolved, it will be very difficult to increase the scale of financing. The liquidity problem of PE funds can be addressed from different perspectives such as the secondary market and the inter-institution market of PE funds, the Internet finance, and the online and non-online transaction of financial assets. 

Second, breakthroughs at the “E/investment” end. 

I always believe that funds are of great importance for the survival of investment institutions or asset management funds, but it is the operating end that determines their value in the long run. What determine the competitiveness and value of a PE institution are its capacity of fund management, effect of the use of funds, ability to allocate assets of different categories with different cycles, or to be more practical, the long-term return on the funds.

How to make this breakthrough, then? From my point of view, the answer lies first, in the thinking, insight and manner of the institution and second, in its specialty, capacity and method. Of course, the team, mechanism and system serve as the very basis. Making larger breakthroughs requires that it spots the systemic opportunity, grasps the opportunity that can bring about large amount of return, and lays out its business in all kinds of assets, at both ends of the industry chain and across the world.

Third, the overall updating and progress of the PE institution.

The real breakthrough does not merely refer to the breakthrough at the specific source end or investment end. The overall upgrade of the institution plays a bigger role.

To begin with, the supervision and regulation should take into consideration specific conditions. Today’s conference is hosted by our association, which means we have a PE organization now. I think, in China, supervision is conducive to the healthy development of an industry. While the bigger industries have been put under supervision, the industry that lacks supervision is like a child without parents. Supervision is important since it can help grasp the opportunity for the industry on the whole. People are discussing about the mixed-ownership reform of the SOEs and various development modes. In my opinion, the PE mode can be applied to the management of both state assets and state-owned enterprises and the problems can thus be properly addressed.

Second, the listing of GP, or whether have PE institutions become listed companies. Last year, JD Capital was listed on the National Equities Exchange and Quotations (NEEQ). People were confused by such practice at the beginning, but they have understood it now since the NEEQ has begun to rise rapidly. The Initial Public Offering (IPO) of Blackstone in 2007 transformed it from an asset management fund for LPs to an investment institution with its own money, which has profound influence on the market. Similarly, the listing of JD Capital last year has driven the explorations in PE industry. 

Third, the integration of the PE industry. Chinese PE institutions are dispersed in many categories. Like any other industry, the PE industry is going to undergo an integration and M&As. We have some plans in JD Capital. We can cooperate with competent institutions and teams that are good at managing sub-category assets; at the same time, we have a “Little Giant” plan to cooperate with talents from various fields to roll out joint venture GP to compete with other asset management funds from both home and abroad.

Fourth, the development of information-based PE. At first sight, the development of information technology is not closely relevant to PE institutions, but the core of investment lies in information. Against the background of the rapid development of information technology, it is one of the important measures for PE institutions to get updated by making breakthroughs in information-based and Internet-based development and improving their capacity and efficiency in resource allocation so as to strengthen their competitiveness.

The above are what we think and what we practice. Thank you.