Is China Private Equity's Next Rock Star?Published: January 12, 2011 in Knowledge@Wharton
The future of private equity is in China, said the leader of one of the world's largest private equity firms. Robust economic growth, abundant opportunities, little competition, and a positive government attitude make China one of the most appealing countries in the world today for private equity investors, David Rubenstein, co-founder and managing director of The Carlyle Group, said at a recent Wharton forum. China is also setting the pace for global private equity by investing large amounts of capital outside of its borders, he added.
"I think for those reasons, China will probably be the trend setter, and really the epicenter of private equity in the next five to 10 years," Rubenstein told the audience at the Seventh Annual Wharton China Business Forum 2010, "Recovering from the Crisis: A Look into China's Future."
China has roughly 20% of the world's population and is now the third-largest economy, said Rubenstein, who served as deputy domestic policy advisor to President Jimmy Carter before starting The Carlyle Group in 1987. Depending on how it is measured, some say China is already the world's second-largest economy, and soon, China will pull into first place, he predicted. "China was the largest economy in the world for 15 of the last 18 centuries, until the 1700s when Europe came along and replaced it," Rubenstein said. "The United States has been the largest economy in the world since the 1870s. We will lose that title in roughly 2035 or 2040, depending on how you measure growth. And then China, for the rest of this century, will be the largest economy in the world."
The numbers are dramatic, although some observers are uncomfortable with the economic statistics that come out of China, Rubenstein said. Actually, there are two schools of thought: One school says that China underplays its economic growth; another said China overplays it. "Nobody really knows exactly what the right numbers are. Sometimes people say the Chinese government officials aren't certain themselves. They tend to look at electricity consumption as the real measurement of economic growth because that's something they know they can really put their fingers on. I would say it's pretty likely that the growth is around the 8% to 10% range."
While the recession has dampened China's growth somewhat, the country has shown "amazing resilience" through the recent economic turmoil, making it the darling of private equity investors. "Even in the last few years, as private equity investment has gone down in other parts of the world, in China it has been going up," Rubenstein noted. The investment has not been concentrated in one region or sector, he pointed out, but over a range of industries in all parts of China. "The money going into China is not just going into the coastal areas," he said. "The government has been very happy with this development."
"What makes the Chinese government encourage companies like The Carlyle Group to come invest there? "It isn't capital," Rubenstein said. "China does not need foreign capital. They have $2.4 trillion in foreign reserves ... It's the management that private equity firms have ... I think the government is trying to get contacts, expertise, technology and skill sets, not capital."
The image of private equity is better in China than probably any country in the world, Rubenstein noted. "When I'm in Washington D.C., people are barraging me, [saying that] I'm not paying enough taxes, I'm not worried enough about labor concerns. I've got labor unions protesting me. I've got everybody telling me that I didn't do something right. In China, people want my autograph. In China, private-equity professionals are like rock stars. Because China has taken the view that private equity is a value-adding technique and a value-added resource, they encourage it."
For Rubenstein, the irony is startling. "If Richard Nixon and Mao Zedong came back, they wouldn't know which country was which. Honestly, I tell people --- though I don't like to get quoted saying it because I get in trouble -- the center of capitalism is Beijing, the center of non-capitalism is Washington, D.C. Now obviously, that's an exaggeration to make a point, but there's no doubt that in China, what private equity people do is very much welcomed and not criticized," Rubenstein asserted. "Right now you see more intervention in the economy in the United States than you do in China. It's an incredible role-reversal. I never thought it would happen."
Looking back, it took a while for private equity to reach China, said Rubenstein, who offered a synopsis of private equity's history there. While the world generally considers the term "private equity" to mean buyouts, the U.S. uses the term to refer to both buyouts and venture capital, he said. The venture capital business in the U.S. started on a small scale in the 1960s, usually with investors putting down 20%. It expanded in the 1970s with what was known as "bootstrap deals" -- when investors put down 5% and borrowed the rest. Private equity first entered Asia around that time, Rubenstein noted, but most deals were small, based in Hong Kong, and controlled by banks or insurance companies. Private equity investment in Asia took off in the 1990s, when the 1997 Asian Financial Crisis left many Asian companies in need of capital. But it was not until the turn of the century that private equity investors began to show a real interest in China as the government warmed to more foreign investment.
Opportunities Are Growing
Despite the increased interest in China, especially in the past five years, there is still a relative lack of private equity competition there, Rubenstein said. "In the United States, private equity as a percentage of GDP is 3.4%. In China it's 0.2%. As a result, you can say there's enormous opportunity there because it's still a very small percentage of the economy."
China's burgeoning army of new entrepreneurs are opening doors to new investments, Rubenstein pointed out. And China's creaky, state-owned enterprises (SOEs) "are ripe for private equity privatization," he said. There are about 143,000 SOEs in China today and the government probably wants about 500 of them to remain state-owned, he estimated. "That means there are over 100,000 state-owned enterprises that are going to be privatized, and that's a very good opportunity for private equity."
Opportunities will also grow as China shifts the focus of its economy away from exports and more towards its domestic market. "I do think as China produces more products for its domestic market, it will transform its economy a bit and probably produce more so-called value-added products," Rubenstein said. "In the United States, right now, 75% of our GDP is consumer spending. In China, that percentage is roughly 30%. So the Chinese government is trying to get that percentage up and trying to have more domestic consumption. And as it does so, the Chinese economy will grow differently and provide a lot of opportunities to invest in [companies] that will make things for Chinese consumers."
Going forward, Rubenstein sees China playing an even larger role in the private equity world as it increases its investments abroad. "China is going to set the tone for private equity because a large number of their sovereign wealth funds are going to be investing large amounts of money outside of China, and they're going to be setting the rules and the patterns for what some of those investments are going to be." To take just one example, China's national investment fund -- China Investment Corp. (CIC) -- revealed in a filing with the U.S. Securities and Exchange Commission early this year that it owned $9.63 billion in equity stakes at more than 60 U.S. companies, including American International Group Inc., Apple Inc., News Corp. and others.
"The United States has been the dominant player in private equity for the last 30 or 40 years," Rubenstein said. "China will soon be almost as important as the United States in the world of private equity, and may replace the United States at some point because of the enormous amount of money that's being invested -- not only in China but the amount of money China is investing through CIC and other organizations outside of China."
China is "the great economic story of the 21st century," Rubenstein concluded. "Nobody would have predicted at the beginning of the 20th century that the United States would become as dominant as it did, and even today we probably can't predict how dominant China will be in terms of its economy throughout the 21st century. But given its population, its entrepreneur culture, and capital, it's going to dominate the global economy for most of this century."