upfront with cdib international (pei asia)

8/18/2019 Upfront with CDIB International (PEI Asia)

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July/August 2009 Issue 32Upfront

“We focus on what weknow and we are therst to confess whatwe don’t know.”


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China Development Industrial Bank is already both an LP anda direct investor in private equity. Now the rm is looking to takeon the role of fund of funds manager and GP too. Paul Yang, thegroup’s CIO, talks to Siddharth Poddar about the rm’s growthambitions, Asia’s need for home-grown LPs, and more.

In the four years that Paul Yang has been executive vice president and chief financial

officer at China Development Financial Holding, the firm’s private equity activities have

expanded from direct investment in Taiwanese venture capital only to plans to launch into

diversified third party fund management businesses.

“I was brought in by the chairman of CDFH to transform the business from a large

venture capital firm to a later stage principal investor and to diversify in terms of both

geography and the type of deals we made to more growth-oriented and expansionary

deals,” says Yang, who is currently responsible for the group’s principal investment

activities and fund investments, which sit under the China Development Industrial

Bank (CDIB) banner.

It would seem he has already far exceeded that remit: due to experiences gained

in the process of diversifying geographically, CDIB is currently mulling plans to launch

itself both as a fund of funds manager for other Asian LPs, and as a GP managing third

party capital in its core investment geography of Greater China.

If all goes to plan, the firm will have three standalone businesses. The fund of funds

and co-investment business will be managed by CDIB International, while another

subsidiary will be set up for the management of the private equity fund. Finally, a third

entity, China Venture Management, another wholly-owned subsidiary of CDIB, will be

more focused on managed accounts or specific project funds.

It’s a heady mix, as Yang agrees. “In terms of the business evolving, we are similar

to investment banks,” he says. “Goldman Sachs started that way – they first invested

their own capital in proprietary deals and then decided to manage others’ capital.”

However, while the firm’s business is very similar to the private equity arms of the

big investment banks, it differs in that the group’s growth has been driven by private equity

being the anchor investment provider. And in terms of the capital structure, Yang says,

“We’re more like private equity firms that have gone on to have a permanent capital base.”

The back story

Once it had decided to diversify its private equity portfolio geographically in 2005,

CDIB began by reaching out to the regions on its doorstep. The first step was to target

Taiwanese companies operating in mainland China, after which the firm realised it could

leverage its experience to invest in non-Taiwanese companies in China. South Korea

– where it saw “a similar industry profile and some levels of compatibility in terms of

corporate culture” – soon followed and then Vietnam.

“Outside Greater China, these are markets we feel we should be able to become

a mainstream player in,” says Yang, though he stresses this is by no means dilutes the CDIB

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belief that China is the best market to invest in for the next

10 years.

When looking further afield – to those markets where it

might not be so easy for CDIB to become a mainstream investor

– the approach became more trial and error.The firm first tried making direct investments in foreign

markets like the US, but while the investments did not book losses,

their performance was not as good as the firm would have liked.

Likewise, Yang says, CDIB realised that in a market like the

US it would be hard pushed to source the best deals as it was

competing with top venture capital firms in a market where they

were already well-established. Ultimately, the firm came to the

conclusion that rather than compete, CDIB should just become

a limited partner in their funds.

That analysis led the firm to “decouple how we manage our

capital” – planting a seed for the third party capital management

business plans that would ultimately follow. In markets where

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The need for an Asian LP base

Paul Yang caught attention in April this

year when he was interviewed onstage

at the Private Equity International Forum:

Asia in Hong Kong by The Carlyle

Group’s David Tung. In a conversation

that encompassed several wide-ranging

topics, the standout moment was Yang’s

impassioned call to the audience to do all

they could to aid the development of an

Asian LP base.

With commitments to more than

25 private equity funds since starting its

fund investment business in 2006, CDIB

is among the more active limited partners

in Asia today. LPs themselves are thin on

the ground in Asia, with the exception of

Australia and Japan, and Yang fervently

hopes to see a change soon in the way

Asian institutions perceive the private

equity asset class.

Asian institutions, both in terms of

government savings institutions and the

private sector, are at a capital surplus,

he says, and other than the oil-producing

countries, Asian governments provide

most of the capital to the world. “We

provide a lot of capital, but we are only

doing it in the form of corporate bonds

or US treasuries,” he says.

Even when Asian institutions do

invest in private equity, “they usually

finance the large US players and not their

own industry,” he says.

It is his belief that Asian private equity

needs a stable base of Asian limited

partners, for without one, the Asian

private equity industry will not grow into

the same size as a percentage of GDP as

it has in the West.

“There’s no way you can have a

$20 billion fund for Asia unless Asian

institutions invest in private equity. Most

Western LPs allocate about 10 percent

of their assets to alternatives and most of

that is at home anyway,” Yang says.

Furthermore, as long as the Asian

industry relies on Western institutions

for most of its capital, it will keep having

a layer of risk premium fees. “If you are

raising domestic capital, there is no risk

premium. If you go the other way around,

of course there will be,” concludes Yang.

Asia should have its own LP base for

two primary reasons, he suggests. The

first is that Asia has sufficient capital.

Secondly, Asian institutions may have

invested in large global funds because

there wasn’t enough talent in Asia, but

now, many Western firms are appointing

local talent to jobs in the region, “so lack

of talent is not an excuse either”.

In his view, the problem in Asia is that

not many institutions have experience

of investing in private equity. Institutions

here are not willing to give up money for

eight to 10 years without having much of

a say in how it is managed. “The cultural

fabric comes in the way,” he argues.

So how can a stable LP base be

achieved? Yang is honest, saying: “I don’t

have an answer yet, but to ask people to

be vulnerable for 10 years is a tall ask in

Asia.” Few would disagree.

He does, however, offer a few

plausible suggestions. Perhaps the LP-GP

relationship could be modified in the

Asian context, he says. “We could see

more LP involvement in decision-making

[or] we could have shorter life spans for

funds.” Another possibility could be that

Asian institutions invest more in private

equity through separately managed

accounts.

The bottom line, in his view, is that

Asian LPs need to feel comfortable

investing in the asset class, because “if

LPs are not comfortable, they will never

open the purse”.

In his four years at the helm of

CDIB’s private equity investment

programme, Yang has succeeded in

opening the purse. Asian GPs will be

hoping other regional institutional

investors will do the same.

Yang onstage with Carlyle’s David Tung at PEI’s Asia Forum in April


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July/August 2009 Issue 32

it had the relevant experience, like China, South Korea and

Vietnam, it carried on as a direct investor. In those where it felt

it did not have the requisite skill set or local knowledge, like India,

Australia, Europe and the US, it decided to commit capital to

proven private equity fund managers investing there.

“Even though we have to pay 2 and 20 to fund managers,

we feel that the net investment return from being an LP in funds

investing in these regions will surpass what we could manage on

our own,” he says candidly, adding: “We focus on what we know

and we are the first to confess what we don’t know.”

CDIB’s third party funds programme began in 2006, when the

firm also began actively co-investing alongside established private

equity managers. About 30 percent of capital from its third party

funds programme has been invested in direct deals alongside its

GPs. For example, the firm committed $20 million to Carlyle Asia

Partners II, and put in another $75 million in co-investments.

Co-investments allow the firm to assume greater exposure to

certain industries and sectors in which it has expertise, says Yang.

As an example, he offers: “We don’t know India, but we do know

the financial services industry, so when Carlyle brings us a financial

services deal in India, we look at it.”

As a result of the changes over the last four years, today CDIB

is 75 percent invested in Taiwan including Taiwanese companies in

China, 20 percent in Europe and the US, and 5 percent in Korea,

India and Australia.

But plans to diversify have not peaked yet: CDIB wants to

diversify its holdings further. Yang says the firm would like to

see no more than 60 percent of its portfolio invested in Greater

China. This would be split equally between investments in Taiwan

and investments in Chinese companies and Taiwanese companies

with business in China. Of the remaining 40 percent, the firm

wants a 60 percent allocation to Europe and the US, and the

remainder allocated to Australia, India, Korea and Vietnam.

Standalone fund of funds business

The firm’s diversification of its investment portfolio through the

backing of external fund managers has led it to consider whether

it could launch an independent fund of funds business.

“We are beginning to draw the programme,” Yang says, adding

the firm is looking at which other Asia-based investors have the

same needs as itself.

As of now, although CDIB has a good diversification globally

in terms of its third party commitments, it does not back managers

with a mandate to invest in Greater China because it makes direct

investments in the region. However, in pushing the fund of funds

programme as a standalone business that will manage others’

capital as well, Yang acknowledges the firm needs to “fill the

Greater China hole because there are likely to be LPs that want

exposure to greater China”. As such, the firm may have to

invest in third party funds focused on Greater China for this

reason alone.

He admits that in doing so the firm is “managing potential

conflicts of interests”, but hedges: “To be frank, when one is in

so many pockets of this business, one can’t say there is no conflict.

However, we have a very clear rule whereby in the case of any

conflict, we will cooperate and not compete.”

The first of the firm’s fund of funds offerings will be launched

within 2009 and more than half the money raised will be

committed by CDIB. The amount invested by the parent in the

fund will be a differentiating factor compared to other fund of

funds managers, according to Yang, who says: “A typical fund of has

less than 10 percent of its own capital in its fund, but we will have

between 50 percent and 60 percent. As a result, there is a greater

alignment of interest.”

He is confident of the success of the firm’s initiative and says:

“We feel that we have the necessary experience and resources

to make third party investments.”

Plans to be a GP too

Yang is also confident of the firm’s ability to take on the role of

GP in its core markets.

“In markets that we have experience, we decided to be a

direct investor and also be a GP for other people’s capital because

we believe that we can provide value,” he says.

The firm is evaluating the possibility of launching its own

Greater China-focused private equity fund which will manage

capital on behalf of third party investors. This does not, however,

imply that CDIB will curtail or cease its direct investment activity.

It will continue making direct investments as either the anchor

investor in the fund or alongside the fund on a pre-agreed basis.

Yang says that this could be done through a parallel scheme,

whereby both the firm’s proprietary capital and the capital from

Upfront

To be frank, when oneis in so many pocketsof this business, one can’tsay there is no conictof interest.”


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July/August 2009 Issue 32

the fund it raises will be invested in the

same deals on a pro-rata basis. “This would

ensure there is no conflict of interest,”he says.

There are, however, going to be

overlaps between the private equity fund

it manages for Greater China and the

Greater China-focused private equity funds

that the firm’s fund of funds product will

invest in. Yang acknowledges this potential

conflict of interests as well, but says thatit is not going to be a big issue if there

is an alignment of interests. He adds:

“Sometimes it is better, as more pairs of

eyes are looking at and evaluating the same

deal, so the outcome may be better.” l

Upfront

CDIB at a glance

uEstablished: 1959

uNumber of investment professionals:

more than 70

uOffices: Taipei, Hong Kong, Seoul and

Menlo Park; Shanghai office due to open

in the second half of 2009

uSize of private equity portfolio (including

direct investments): $2 billion

uAmount committed to private equity

funds: $400 million

uAmount co-invested alongside private

equity funds: $200 million

u21 percent net IRR in the last 12 years

from its direct investments

uNumber of private equity funds backed:

more than 25

uSelected managers CDIB has committed

capital to:

n Western Europe: Apax, Doughty

Hanson, Adams Street Partners, Sun

Capital Partners, Terra Firma, PAI

Partners

n Asia: Carlyle Asia, Carlyle Japan,

AIF Capital, Pacific Equity Partners,

Samara Capital, CX Partners

n North America: Clayton Dubilier &

Rice, Thomas H Lee, Adam Streets

Partners, Platinum Equity, Lehman

Brothers, Sun Capital Partners, Oak

Hill Capital Partners

nGlobal : Clear Channel, Goldman

Sachs, Kohlberg Kravis Roberts,

Silverlake Partners

A brief history

A cursory glance at China Development

Financial Holdings’ business profile will not

reveal the firm’s sophistication as a private

equity investor. What started in 1959 as

the China Development Corporation, as

part of an effort by the World Bank and

the Taiwanese government to promote

private enterprise, has evolved into a large

private equity player, both as a direct

investor as well as a limited partner in

third party-managed private equity funds.

The initial investment company

obtained a bank license in the early

1990s to become an industrial bank. In

the mid-1990s, Taiwan passed a financial

holding companies law and the company

merged with Grand Cathay Securities,

which provides trading, securities

and wealth management services.

The proprietary investment business

of the group is undertaken by China

Development Industrial Bank (CDIB).

Initially, CDIB’s equity investment

activity was restricted to venture capital in

Taiwanese companies. In 2005, when Paul

Yang joined the company, it had $3 billion

in shareholder capital and $10 billion in

assets. Its entire portfolio at the time was

allocated to venture capital and invested

predominantly in Taiwanese companies.

In 2005, following Yang’s arrival at the

firm, it started moving from early stage

venture investing to later stage venture

capital and early stage private equity. The

firm simultaneously sought to expand its

focus beyond Taiwan in order to diversify

its holdings geographically.

upfront with cdib international (pei asia)

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