It used to be that Western private equity firms wrestled with the decision of whether or not to set up shop in the large and growing markets of Asia. No longer – Western private equity investors across the size gamut, from small venture firms to middle market buyout shops to global mega-firms are expanding to Asia after recognizing that they need to in order to stay competitive.
There are two reasons to expand to Asia – investing and supporting. For some firms, the primary motivation for opening up an office in China or elsewhere in Asia is the facilitation of investment activities – either through making a regional allocation from a global fund, or through raising a separate dedicated Asia fund. Particularly large private equity firms with well known brands have the opportunity to expand those brands to the world's most rapidly expanding economy in search of Asia-based portfolio companies.
Other firms have little interest in pursuing Asia-based businesses but rather seek to improve the operation of US or European portfolio companies through adding an Asian affiliation. In this article we profile the Asian operations of three US private equity firms currently adding value to portfolio companies through Asian affiliates. You won't find these firms looking for primarily Asian investment opportunities. But all of them have enjoyed success in making the operations of primarily middle-market, US companies more global. The firms profiled are Sun Capital (headquartered in Boca Raton, Florida), Lincolnshire Management (based out of New York) and Blue Point Capital (headquartered in Cleveland, Ohio).
Far East functions
The forms of support lent to portfolio companies, as well as how the GP goes about providing this support, are numerous. Since the 1990s, China and India have grown to become the outsourcing destinations of choice for many multinational corporations. Now companies in the middle market are expressing interest in tapping the supply chains and cost efficiencies to be derived from outsourcing to Asia. However, many mid-cap companies lack the scale and resources necessary to make such an endeavor cost-effective and manageable on their own. That's where some private equity firms have begun to step in and lend a helping hand.
Lincolnshire Management. Lincolnshire has been operating in China for the past year, bringing on board a Shanghai-based managing director, Richard Huo in 2005. Huo has since provided China expertise for the firm's US portfolio companies, including setting up a factory in Shanghai for Visual Products, a Lincolnshire-backed signmaking business based in the US.
From his post in China, Huo has also evaluated potential local competitors, as well as identified and qualified prospective buyers for Lincolnshire's portfolio companies. After all, the fates of countless US middle market companies – and therefore the fates of their private equity backers – have become inextricably intertwined with the markets of China, India, Indonesia and elsewhere in Asia. Companies in Asia can present themselves as either friend or foe to North American and European companies in a wide range of industries, including IT, apparel, furniture, manufacturing and food products. Having someone on your side focused up close and personal on these markets can provide invaluable insight on competitive threats for one's existing and potential US-based investees.
?Fifteen years ago, a US company that had sales of between $15 million and $100 million could pretty much make their products [in the US] and sell their products [in the US],? TJ Maloney, president of Lincolnshire, recently told sister publication Private Equity International. ?As a general proposition, that's no longer true. Whether you're looking to improve the operations of your existing US-based portfolio companies or you're looking for new investment opportunities, you really have to have a handle on the worldwide competition.?
Sun Capital. Operations-intensive Sun Capital, which specializes in turnaround and distressed investing, has also opened up a representative office in Shenzhen, China, to help its US portfolio companies design, develop and implement their sourcing programs.
In 2004, Sun Capital began thinking about opening up a sourcing office in China, and it hired David Stokoe in 2005, bestowing upon him the title of ?VP, Operations – Sourcing.? Stokoe's assignment was to head up Sun's outsourcing support efforts, based on the experience he had reaped as chief executive of Sun portfolio company JTECH Communications, a restaurant paging device manufacturer. ?When I started at JTECH as CEO in 2001, we were 100 percent manufacturing in South Florida,? recalls Stokoe. ?When [Sun] sold the company five years later, our costs had been reduced by 70 percent through outsourcing and the use of improved technology.?
?Once we opened the office [in Shenzhen], it was a question of then working with the portfolio companies to see how we could make their sourcing more cost effective,? notes Stokoe. ?We felt, as a general rule of thumb, that by outsourcing to Asia, we could save 20 to 30 percent of manufacturing costs on a landed basis (net of transportation costs). We never had a predetermined number of affiliates necessary for the program, but we knew the majority would be able to use the service to save on manufacturing costs.?
Like some other private equity firms that have opened affiliates in China, Sun Capital will not pursue portfolio investments in the country. ?We have no intentions of doing deals in China,? says Stokoe.
Blue Point Capital. Another firm that engages in such sourcing support activities is Blue Point Partners which, in addition to its Cleveland headquarters, also operates out of its offices in Charlotte, North Carolina and Seattle, Washington. Two years ago, Blue Point opened up its first international office – a ?Shanghai liaison office? in China to support existing and future Blue Point portfolio companies.
?Our dollars are no greener than any other private equity group's,? noted David Given, managing director of Blue Point Capital, recently to PEI. ?So what value can we bring to a company that offers something additional to management teams, in helping them optimize their business models??
As an example, Given cited one of Blue Point's portfolio companies that wanted to build a greenfield manufacturing plant in China, and needed assistance in securing a site. Blue Point helped the company weigh the many different financial incentives offered by local municipalities, as well as assisted the management with navigating the regulatory waters of China. ?We helped them work through the red tape, the bureaucracy of getting the permits and everything else to establish the facility,? says Given. ?And we're assisting in all the decisions about construction and everything else.?
Bluepoint has also assisted companies in establishing sales channels for products made in China to be sold in China, in addition to North America. More often, it works the other way: companies require some components that can be sourced in China at a lower cost than in North America today. ?So it's establishing direct production presence in China, it's sourcing in China, it's selling finished product in China – it runs the whole gamut,? says Given. ?All of these advisory roles serve the purpose of optimizing portfolio companies' performance.?
?What our China presence does is it helps us more effectively evaluate new investment opportunities in North America, because we are more aware of any imminence or substance of any kind of a threat to the North American business – or opportunity for the North American business model,? Given says.
Picking a starting point
Not too surprisingly, Sun Capital, Lincolnshire and Blue Point have all chosen to set up their portfolio support of-fices in China.
?China is certainly dominant, and specific provinces are a key consideration,? says Larry Harding, president of High Street Partners, a Boston-based consulting boutique aimed at facilitating the overseas expansion of US-based corporations and private equity firms. ?Most typically, we are helping our clients set up a rep office, or RO, in Beijing, Shanghai or Shenzhen.?
?RO's are often the entity of choice to facilitate new employees coming over in a private equity deal, especially when it involves a handful of employees focused on providing local support for the activities of the US parent. If it's a more extensive manufacturing or other profit-making operation, however, then a WFOE (wholly foreignowned enterprise) subsidiary is required,? says Harding. ?The right entity structure really depends on the type of activity that needs to be supported.?
Regarding Sun Capital's decision to base its rep office in Shenzhen, Stokoe notes that the city of the flourishing southern Chinese province of Guangdong has reached critical mass. Referred by some as a ?mecca of foreign investment,? the city has within a several hundred mile radius a wide range of manufacturing factories that have been set up for export purposes. ?It just reduces the travel you have to do, and it's a great base to start from,? says Stokoe. ?It may be that we expand from Shenzhen to other places in China.?
While China is still the predominant pick for many private equity firms choosing to set up a presence for investment or operational support activities in Asia, the entire region – from top to bottom – is exploding, says Harding. ?Japan has really taken off in the last six months and we're seeing quite a bit of activity in Korea, Hong Kong and Singapore as well. Taiwan is also still strong. I would say those are the biggest markets.?
?It took Sun Capital about six months to organize the setting up of an office in Shenzhen, including obtaining the necessary permits and letters of registration from the province,? recalls Stokoe.
?It's not always easy. In terms of actually setting up an office in China, for instance, there are many registration requirements to fulfill,? says Harding, who notes that the process can tend to get bogged down in red tape – and not necessarily just at the level of the local bureaucracy in China.
?It can be as quick as 30 to 60 days, but quite often, it depends on all of the different parties doing what they're supposed to do quickly,? says Harding. ?It's not at all unusual for a form that needs to be signed at headquarters to languish in somebody's inbox for a week or even a month, so what should take less than two months can take quite a bit longer without the right level of focus.?
However, the process is improving, particularly as local authorities accumulate greater experience, undergoing numerous iterations of working with overseas-based companies seeking to set up a local presence.
?We've seen a growing capability in Asia's high-growth countries to be more streamlined and supportive of US and European companies coming in and making investments locally,? says Harding. ?Singapore and Hong Kong are, by far, the most developed with working in a streamlined way with Western companies,? Harding adds.
?China is still one of the more challenging locations, but while it's not yet Hong Kong or Singapore, it really isn't at all the nightmare that it was a few years ago,? notes Harding. Meanwhile, Korea and Taiwan fall toward the middle of the efficiency spectrum. Japan is also reasonably straightforward, given the decades of experience local authorities have had in working with multinationals.
?We're starting to see a lot more back-office outsourcing work in the Philippines too,? says Harding. ?India has obviously been the highest profile player in this space, but the Philippines is really closing the gap in that sector of the market.?
Once the office has been set up and cleared with the proper authorities, then begins the process of hiring onthe-ground expertise that can work with portfolio companies and teach them how to design and implement sourcing programs. ?[The portfolio companies] are the ones actually doing it, but we're working with them to facilitate it,? says Stokoe, who travels often to China, often staying for a week to 10 days at a time working with the three Chinese nationals that the firm has hired for the Shenzhen office. ?By doing so, we can accelerate the timeline to implementation – typically we can reduce the time involved to implement by 50 percent.?
To date, 19 of Sun Capital's 56 portfolio companies have taken advantage of the proffered outsourcing support. All 19 participants are US-based companies, although Sun's program is open to its Europe- and Canada-based companies as well.
So far, the practice of setting up overseas offices dedicated to supporting a US- or Europe-based portfolio company is still predominantly a strategy engaged by middle market private equity firms seeking to differentiate their strategies – and returns – from their competitors. According to one source at a mega-fund, his firm hasn't yet set up any oversight team dedicated to foreign outsourcing operations as of yet. US portfolio companies are supervised by the US investment team, so any outsourcing issues, local or global, still fall under their jurisdiction, despite the frequent flier miles that demands.