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Brutal reminder of the risks faced by foreign equity firms that invest in China

Posted by Author on May 12, 2010

By Sundeep Tucker in Hong Kong, The Financial Times, May 12 2010 –

Foreign private equity firms
salivate at the prospects offered by the Chinese growth story. But restrictive regulations and unwilling sellers mean the country has largely resisted the buy-out kings, forcing them to focus on minority investments instead.

However, the disclosure on Wednesday of another corporate spat within Gome, the country’s biggest electrical appliances retailer, will serve as a brutal reminder of the risks faced by foreign groups that invest in China.

Gome was founded by Huang Guangyu, once China’s richest man, who was arrested and detained in 2008 for alleged corporate crimes and has been held incommunicado ever since.

Mr Huang remains its largest shareholder with a 34 per cent stake and his disappearance rocked the company, sending its Hong Kong-listed shares tumbling. Gome searched for an outside investor to help steady the ship, and last summer Bain Capital agreed a $418m strategic investment, in the form of convertible bonds, which gave it three board seats.

The US private equity firm was convinced it could turn round sales and saw it as a rare opportunity to buy an attractive strategic stake in one of China’s leading consumer companies.

The investment was fraught with risk, given that nobody could ascertain whether Mr Huang was happy with Bain’s involvement. Jonathan Zhu, head of China for Bain, brushed aside fears. “There are always risks in investing, and we are reasonably satisfied that the risk/reward outlook in the current scenario justifies this investment,” he said.

Mr Zhu has this week seen Mr Huang, seemingly through affiliates, use his shareholding to vote against the re-election of Bain’s three board directors. But the company re-appointed them immediately.

“This is exactly why several other private equity firms walked away from this [Gome] deal,” said one Hong Kong investment banker familiar with the sale discussions.

“How can you commit to a company where the major shareholder might be against you?”

Many of China’s fastest-growing companies are privately-owned, and founder entrepreneurs are often reluctant to share power with overseas investors. The ability of foreign private equity to exert influence on corporate strategy can be severely limited……. (more details from The Financial Times)

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