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- Herausgeber: John Wiley & Sons
- Kategorie: Fachliteratur
- Sprache: Englisch
An extraordinary tale of an American firm's astounding success in China In Money Machine: A Trailblazing American Venture in China, Weijian Shan delivers a compelling account of one of the most significant deals in private equity history: the first and only foreign acquisition of control of a Chinese national bank. Money Machine is the fascinating inside story of the transaction as told by the man who led it, from the intrigues of dealmaking to the complex and uncharted process of securing control by a foreign investor of a Chinese nationwide financial institution, a feat that had never before been attempted, nor has it been repeated. Shan also describes the astonishingly successful turnaround of the institution under the control of the American firm: the clash of cultures, the growth to strength and profitability, and ultimately, the extraordinarily profitable exit from the investment. In the process, he reveals new insights into how finance operates in China's capital system and how private equity firms can add real value to companies. Readers will also find: * A peek behind the curtain of a process usually shrouded in secrecy: private equity dealmaking and moneymaking * The complex negotiations between American private equity executives and Chinese regulators to implement a series of unprecedented changes * The riveting details of the challenges that had to be overcome to return the bank to growth and profitability An exceptional firsthand account of truly singular deal-making and money-making, Money Machine will be of interest to investment bankers, investors, financial analysts and anyone who appreciates a suspenseful, true-life story.
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Veröffentlichungsjahr: 2023
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Table of Contents
Cover
Title Page
Copyright
Dedication
Foreword
A Note from the Author
Part I: Courtship
Chapter 1: An Unexpected Question
Chapter 2: A License to Print Money
Chapter 3: The Craft of Private Equity
Chapter 4: A Special Time and Place
Chapter 5: Dancing with the Wolves
Chapter 6: Rolling Faster
Part II: Fight
Chapter 7: Tug of War
Chapter 8: Behind the Scenes
Chapter 9: Roller Coaster
Chapter 10: Transition to Nowhere
Chapter 11: “Nut Case”
Chapter 12: Untying the Knot
Part III: Transformation
Chapter 13: Making History
Chapter 14: Righting the Ship
Chapter 15: Bank Repairman
Chapter 16: Game of Chicken
Chapter 17: Window of Opportunity
Chapter 18: Mariana Trench to Mount Everest
Part IV: Exit
Chapter 19: Coveted Prize
Chapter 20: Flavor of the Day
Chapter 21: Financial Tsunami
Chapter 22: Stars Align
Chapter 23: Turning Point
Chapter 24: A Deal That Shakes
Epilogue
Acknowledgments
About the Author
Index
End User License Agreement
Guide
Cover
Table of Contents
Title Page
Copyright
Dedication
Foreword
A Note from the Author
Begin Reading
Epilogue
Acknowledgments
About the Author
Index
End User License Agreement
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Praise for Money Machine
“Weijian Shan has been at the top of the Asian private equity game for decades. But this is much more than just a gripping account of the vicissitudes of one deal. It is the story of the only foreign investor to take control of a major Chinese bank and throws light on China's gigantic life‐or‐death struggle to rescue its banking sector as it stood teetering on the edge of the abyss.”
—Tim Clissold,Author of Mr. China
“Shan Weijian is a master dealmaker who takes the reader on a white‐knuckled ride on the roller coaster of China's reform era. It should be required reading in business schools and by anybody who enjoys an intriguing story of money making.”
—James McGregor,30 years in China as a journalist, businessman, investor, consultant, and author of No Ancient Wisdom, No Followers, and One Billion Customers
“The book shows private equity at its very best … taking a perilously close to insolvent institution with bad loans, cleaning it up through write downs and write offs, and powering it forward with good governance and innovative new products on the back of a booming Chinese economy. It's a great case study of how private equity can transform underperforming enterprises even in China… but it took many false starts by Shan to achieve the control necessary for the American firm to administer the medicine needed to transform the business into the trophy asset it became. The storied turnaround, orchestrated by Shan and his partners, was a tour de force that has helped burnish Shan's reputation as an imaginative and capable titan of private equity in Asia.”
—David J. Teece,Professor of The Graduate School at the University of California, Berkeley, the faculty director of the school's Tusher Initiative for the Management of Intellectual Capital and a prolific author of books and scholarly papers
Money Machine
A Trailblazing American Venture in China
Weijian Shan
Copyright © 2023 by Weijian Shan. All rights reserved.
Published by John Wiley & Sons, Inc., Hoboken, New Jersey.Published simultaneously in Canada.
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Library of Congress Cataloging‐in‐Publication Data
Names: Shan, Weijian, 1953‐ author.Title: Money machine : a trailblazing American venture in China / Weijian Shan.Description: Hoboken, New Jersey : John Wiley & Sons, Inc., [2023] | Includes index.Identifiers: LCCN 2022049588 (print) | LCCN 2022049589 (ebook) | ISBN 9781394161201 (hardback) | ISBN 9781394161225 (adobe pdf) | ISBN 9781394161218 (epub)Subjects: LCSH: Shenzhen fa zhan yin hang. | Banks and banking—China—Case studies. | Banks and banking—Foreign ownership—Case studies. | Bank management—China—Case studies. | Private equity—United States. | Global Financial crisis, 2008–2009.Classification: LCC HG3338.S54 S53 2023 (print) | LCC HG3338.S54 (ebook) | DDC 332.10951—dc23/eng/20221019LC record available at https://lccn.loc.gov/2022049588LC ebook record available at https://lccn.loc.gov/2022049589
Cover Design: WileyCover Image: © Koiyip Lam/Getty Images
To our investors, to whom we owe our gratitude for their partnership and trust over the years.
Foreword
An Extraordinary Journey
During the Global Financial Crisis (GFC), banks around the world, including in America, Britain, and Europe, were supported by government cash injections and guarantees.
But there was one significant bank, deeply troubled before then, that worked through that time to strength and success, without any government funding or financial guarantees.
Where was this bank? In China! And who controlled the bank and guided it during this extraordinary recovery? A U.S.‐based private equity firm!
How was all this possible? How was it possible that a U.S. firm took on leadership of a Chinese bank? How did a good‐sized national bank, troubled and weak before the GFC, become strong, healthy, and successful, without a single dollar of government support? How did the team work with Chinese regulators to implement a series of unprecedented steps? How did the private‐equity process proceed, in China, once the bank was so successful, to realize very substantial benefits for its investors, in U.S. dollars?
And there's more—all true, amazingly. A high‐profile lawsuit filed in the United States, involving a Chinese bank and a Taiwanese‐listed company, and of interest to the Chinese government at high levels. A board composed largely of Chinese businesspeople, with a U.S.‐based major shareholder and an American chairman, making rapid change.
Weijian Shan tells this extraordinary success story, based on his own leadership role, in a fascinating insider's chronicle, including insights into the many challenges of business in China.
Shan led the complex process of establishing an American private equity firm as the lead shareholder. He led the bank through a uniquely challenging process of raising capital. And, once the bank was fully recovered to strength and profitability, Shan led another complex but highly successful process of the sale of the bank, finding a good home for its future, and rewarding investors handsomely.
I had the privilege of leading the management of the bank during most of that time, as its chairman and CEO. I was the only Western employee in the bank, the only one who did not speak Chinese. It was a very special experience. I am proud of my Chinese colleagues who worked diligently with me to take the strategic and tactical steps to turn the bank around, from weak and troubled to strong and successful. I still have many friends there.
Shan tells this extraordinary story from deep inside knowledge, with fascinating insights and perspectives. It's a great story for readers who want to understand more of how things can really work inside China's capital system, and for those who want to see how a private equity firm can add real value to a company, even in the face of exceptional challenges.
Frank Newman
Chairman and CEO, Shenzhen Development Bank (2005–2010)
Chairman and CEO, Bankers Trust (1996–1999)
Undersecretary/Deputy Secretary, United States Department of the Treasury (1993–1995)
October 31, 2021
A Note from the Author
This story involves several Chinese customs and systems that may not be familiar to Western readers. These involve names, Chinese currency, and the organization of the Chinese government. Here, I outline some important facts to help readers best understand the details of the story.
People in China present their names in the proper Chinese order: family name first, followed by their given name. For example, Mao, Zhou, and Chiang are surnames of, respectively, Mao Zedong, Zhou Enlai (China's former prime minister), and Chiang Kai‐shek (former leader of China's Nationalist government). East Asian countries such as Japan, Korea, and Vietnam all present their names in this order. To my knowledge, Hungary is the only European country that uses this approach for names.
When I first arrived in the United States as a student in the 1980s, I wrote my name the Chinese way, family name first followed by the given name: Shan Weijian. Soon afterward, I learned that Americans put their given name first, followed by the family name; so they call the given name “first name” and the family name “last name.” Needless to say, it was confusing to people that my first name is actually my last name. Americans usually greet each other by their given, or first, names. So, my new friends called me Shan. I was totally fine with it, because my given name, Weijian, is harder to pronounce or remember. Now English‐speaking people around me call me Shan, and I always sign my letters in English with just Shan.
To avoid confusion, I later conformed to the American way of writing my name: Weijian Shan.
This book presents Chinese names following the East Asian order: family name first, followed by the given name. If a Chinese person has taken a Western name—not uncommon for Western‐educated Chinese—I present their names in the Western way, such as Alex Zhang, Daniel Poon, Fred Hu, Louis Cheung, and Rachel Kwok. And for Westerners, names are presented as usual: David Bonderman, Frank Newman, or Oprah Winfrey.
When people in the same passage share a name, I use their full names for clarity. In China, there are hundreds of common surnames but millions of given names, each of which may be unique. This is just the opposite of the Anglo‐Saxon world in which there are numerous family names but a very limited number of given names. My firm, PAG, has so many Davids that we have to refer to them by their initials or full names.
A final note about names: In mainland China, a woman keeps her own family name after marriage, so there is no such concept as a maiden name. When I was growing up in China, there were no wedding rings, although some young Chinese people today adopt Western ways. How do you tell if a middle‐aged Chinese woman or man is married? You just have to ask.
Now, let's talk briefly about Chinese currency. The Chinese currency is called renminbi (RMB), which roughly translates to “the people's money.” The unit of currency similar to the dollar is the yuan. In fact, the word dollar is translated in Chinese as yuan, so the U.S. dollar is mei yuan in Chinese (mei refers to the United States). The RMB is convertible into foreign currencies for the purposes of trade, services, and direct foreign investments. However, for investments in the securities markets, such as stocks and bonds, there are various restrictions. Therefore, at the time of this writing, and at the time the events of this book take place, the RMB was not fully convertible. The aim of the Chinese government is to make its currency fully and freely convertible in the future.
Finally, the government system of China is that of a unitary state in which the central government has the ultimate power, and under it are provinces, cities, districts, and so forth. In contrast, the United States is a federalist state, a union of partially self‐governing states under a federal government. The unitary state is the more common form of government—166 of the 193 United Nations members—have a unitary system of government. In China, there is another layer of governance. The central government, headed by the president, followed by the prime minister, is not the highest decision‐making body.
The highest decision‐making body in China is the political bureau, or the Politburo, of the Chinese Communist Party (the CCP). Therefore, the chairman or the general secretary of the CCP—not the prime minister or president—is the top leader (although in the past three decades, the party secretary has also been the president). Mao Zedong ruled China as the CCP chairman; he never took a position in the government and refused the title of president. After Mao's death, Deng Xiaoping was China's paramount leader, even though his position in the government had never been higher than that of vice premier. Within the CCP, Deng was not the chairman or general secretary, but he was the chairman of CCP's central military commission. Because the CCP is the ruling party, party secretaries at different levels within the government have more seniority than the highest government administrators who are not also party secretaries. For example, the party secretary of a province ranks higher than the governor of that province, and the party secretary of a city has a higher position than the mayor of that city.
Weijian ShanAugust 2022
Part ICourtship
Chapter 1An Unexpected Question
From aboard the Star Ferry in Victoria Harbor, your view of Hong Kong Island builds, growing more dramatic as the boat makes its short trip across the water. From the Kowloon side, you can make out the bends in the Hong Kong waterfront, a mix of malls and parks, ferry landings and exhibition halls, all on flat land. But as the ferry nears its destination, the eye is drawn skyward, to the forests beyond the waterfront—actual forests of trees and fast‐rising jungle, and forests of high‐rises that wink and glitter in the shifting light, competing with one another as they reach for the sun. Depending on the time of year, the weather, and where you are in the harbor, those buildings really do seem to scrape against the clouds.
Coming into port with the Star Ferry, you land at Central Pier, where the choice lies at your feet. You will head into one forest or another—the natural or the man‐made—on an island that boasts, among other things, one of the densest populations and some of the costliest real estate anywhere on Earth.
On this particular morning in 2002, Hong Kong was sweltering. The spring fog that shrouds Victoria Peak had burned off under a blazing sun. Warm as it was outside, I knew that in those skyscrapers the offices would feel cold. Hong Kong natives have a habit of blasting their air conditioning as if to overcompensate for the heat and humidity outside.
It was Monday, April 1, and I was on my way to my company's offices, which were located by the harborfront at One International Financial Centre in Central, a 688‐foot office tower with 39 stories, connected with a sprawling shopping mall below and the Four Seasons Hotel beside it. Once I reached our conference room on the 20th floor, I really was chilled by the air conditioning. Waiting for a meeting to begin, I took in the blue sky dotted with a few white clouds. In the distance, looming behind the vast expanse of numerous low‐ and high‐rises in the city of Kowloon was Lion Rock, whose shape resembles a crouching lion, in the middle of a range of lush green mountains.
It was a lovely day, and I thought for a moment that it might augur well for the city's air quality; for much of the winter, the city had suffered under a haze of smog. But April brings summer weather to Hong Kong, and with it comes a shift in the winds. On this morning you could already sense the change. The haze was gone, and fresh sea air from the south had taken its place.
Perhaps the fine weather would also be a harbinger of things to come in that conference room.
My firm was Newbridge Capital, a private equity investment partnership established in 1994 by Richard C. Blum and David Bonderman. Blum was also the founder and chairman of Richard C. Blum & Associates (later renamed Blum Capital Partners), and Bonderman was the chairman of Texas Pacific Group (later renamed TPG).
My visitor on this April morning was Alex Zhang, a partner at Dorsey & Whitney, an American law firm headquartered in Minneapolis, with a sizable office in Hong Kong. He was a friend of many years, a veteran lawyer in a firm whose partners boasted the likes of former U.S. vice president Walter Mondale. Zhang was handsome, about six feet tall, and to me he looked like Yao Ming, the NBA basketball star, albeit a foot and a half shorter. He was unmarried and 42, but looked younger, and it had occurred to me that he made for a highly eligible bachelor. He graduated from the Institute of International Relations in Beijing and went on to receive law degrees from the China University of Political Science and Law and from the University of Minnesota before he joined Dorsey & Whitney about a dozen years earlier.
Sitting there in our conference room, just the two of us, Zhang came right to the point. “Shan,” he asked, “do you think Newbridge Capital is interested in buying a Chinese bank?” The question was unexpected. I felt a shot of workplace adrenaline. He was smiling. I may have smiled in return.
***
This is a book about a bank deal, about how it happened, and the reverberations it sent across China and the world of high finance. More than that, it is the story of a deal that changed everything, not only for the people and institutions involved, but for many who, to this day, may have never heard of Newbridge Capital, the Shenzhen Development Bank, or the people who brought the deal to fruition. It is also very much a story about change in China, and how American private equity investors, at least some of them, have thrived there.
Countless pages have been written and speeches given about “the New China.” Depending on one's frame of reference, China was “new” in 1992, again in 2002, in 2012, and so on. At all those moments the analyses and assessments of change have come from all corners. Those of us who have lived and worked in this “new” and growing China perhaps didn't notice the changes the way that outsiders did—much the same way that a parent may not notice a child's growth spurt the way a family friend might. Over the past few decades, China has seemed “new” to anyone who has not been in the country the previous year or so. Today, a first‐time visitor will often be told, Oh, you should have been here five years ago—and seen how things were. Such is the nature and pace of change in the country.
But in any historical, tectonic shift, once in a while there are moments that really do shine a light on something more profound—events that with the benefits of reflection and hindsight contribute to a greater understanding of the turns of history.
Certainly I could not have imagined that Zhang's April visit to our office might carry such significance. He was one more intermediary, bringing one more idea, and one can only imagine how many individuals were making a financial pitch in Hong Kong on any given day, trying to sell a concept or a company, or just a new way of doing things. How many people must have been doing exactly that along the Hong Kong harborfront on that very same morning? For all I know, others could have been pitching their ideas in the same skyscraper where Zhang had come to make his case.
And yet, looking back, it is hard to dispute the fact that Zhang's question would change the trajectory of things—for a company, for a major bank, for my colleagues, and for China as well.
“Yes,” I told him on that April morning. “We are interested to know more.”
***
His question was not as abrupt as it might have sounded. Newbridge Capital was well known in Asia's financial markets. We had received a good deal of press just a few years earlier, after acquiring control of Korea First Bank (KFB) from the government of South Korea. For a time, KFB had been the largest bank in Korea, but during the 1997–1998 Asian Financial Crisis the bank had failed and been nationalized. We had come in soon after, and the ensuing transaction had taken months to negotiate and consummate. Our negotiations with the Korean government had read in the press like some never‐ending soap opera, dragging on until the deal was done in January 2000. But the story had ended well for all concerned. (Those interested in learning more should read my book Money Games: The Inside Story of How American Dealmakers Saved Korea's Most Iconic Bank.) The deal had received enough good publicity that Newbridge was perceived in financial circles as a true turnaround specialist and a credible buyer of banks, especially the troubled ones. We seemed to know what to do with them.
So for Zhang to come to Newbridge with that question made sense. As for the question itself, of buying a Chinese bank—well, it had never been done. Foreign investors had taken small stakes in Chinese banks, but no institution, domestic or foreign, had ever bought outright control. That said, in those years, nearly every day brought some development in the Chinese economy that had never happened before.
I listened to Zhang, expressed our general interest, and then I chose my words carefully. There would be much to consider, I knew, but one point was paramount in my mind. “It will depend,” I began, “on whether or not we'll be able to control the bank. We wouldn't be interested in being a passive investor.”
Newbridge had managed to turn around KFB because we acquired full control. That had allowed us to appoint our own management team, install our own risk‐management system, and create a credit culture—a set of beliefs and practices based on the credit and financial conditions of the borrower—that ensured asset quality. Without such control, we would never have been able to turn it around, nor win credibility in the media and financial circles. Chinese banks were a whole other matter. They were notorious for high levels of bad loans. No sophisticated investor would want to take a ride as a passive shareholder with banks of poor‐quality assets.
“The bank in question is Shenzhen Development Bank,” Zhang said. “Do you know it?”
I knew this much about Shenzhen Development Bank (SDB): It was a nationwide bank based in Shenzhen, a booming city just across the border from Hong Kong. The city had become a kind of poster child for the explosive economic growth in southeastern China. It was also one of 13 joint‐stock commercial banks in China. The largest Chinese banks were 100% owned and controlled by the government. Joint‐stock banks had more diversified shareholding that included private ownership. We knew the model, but we did not know much about SDB itself.
Zhang filled in some blanks. SDB was controlled by the city government of Shenzhen, which was considering selling its controlling stake to a foreign investor. This much was not surprising. Since unleashing its economic reforms more than 20 years earlier, China had been moving toward a market economy, including the privatization, overhaul, and cleansing of state‐owned enterprises—especially those in competitive industries. For this purpose, foreign direct investment had been strongly encouraged, not only for the capital but also for the expertise that came with it.
The city of Shenzhen had been China's first Special Economic Zone, chosen by Deng Xiaoping (1904–1997), China's paramount leader and architect of the market reforms. It was a grand experiment that had begun in 1978 to loosen the strictures of a centrally planned economy. In two decades, Shenzhen had morphed from a fishing village into a high‐tech hub and a megalopolis of more than 10 million people. As such, it had adopted policies that were more market‐friendly than those elsewhere in the country. Shenzhen was at the frontier of market‐oriented reforms.
But for all the dizzying changes that had come to China, there was no precedent for foreign control of a Chinese national bank. Chinese regulations were generally designed to keep any single private investor from controlling a bank, while severely limiting foreign ownership. This was hardly a China‐only phenomenon; banking regulations all over the world restrict foreign takeover of banks. And we knew that if there was to be a breakthrough, it could only happen in Shenzhen.
All of which we understood. And it all made sense. But to put our initial concerns mildly, buying a Chinese bank was not for the fainthearted. The market consensus was that China's banking system was technically insolvent and badly in need of wholesale reforms. The main issue was nonperforming loans (NPLs). These were loans with borrowers who had defaulted on their debt, or simply stopped making payments. Almost all Chinese banks were laden with NPLs, unable to stand on their own without government support.
How weak exactly was the banking sector? The numbers—to the extent they could be known—boggled the mind. The People's Bank of China (PBOC), China's central bank, estimated that in 2002, as much as 30% of the loans held by the country's four biggest banks—the Industrial and Commercial Bank of China, China Construction Bank, Bank of China, and Agricultural Bank of China—were nonperforming. According to Standard & Poor's, that 30% ratio was the figure after the banks had “significantly improved their credit and risk management controls in recent years.” S&P painted a grim picture in one of its reports:
Standard & Poor’s estimates that the country’s banking sector, acting alone, will need at least 10 years and possibly as many as 20 to reduce its average nonperforming loan ratio to a more manageable 5%. The cost of the necessary write‐offs could be equivalent to US$518 billion or almost half of China’s estimated gross domestic product of US$1.1 trillion for 2001.
Put differently, China's banking problem in 2002, when Alex Zhang came to my office, was almost certainly worse than South Korea's had been in 1998, in the trough of the Asian Financial Crisis. The difference then was that the Korean government was running out of money and had to be rescued by the IMF and the World Bank. The Chinese government, by contrast, was financially quite strong and thus had the means to bail out the banks if necessary. This was why Chinese depositors had never had real concerns about the safety of their money. Although China had no deposit insurance system such as those common in the United States, South Korea, and most developed nations, the government was always there, standing behind the banks, should a bailout be required.
We sat there, Zhang and I, talking and drinking tea. I couldn't deny it: The opportunity to buy control of a bank in China, home to the fastest economic growth in the world, was certainly appealing. Tantalizing, even. If we at Newbridge could manage somehow to take control of a Chinese bank and turn it around—as we had done with KFB—we would stand to seize a rare and, maybe, profitable opportunity. My partners and I at Newbridge had always believed that investing in banks, if properly thought through and executed, was tantamount to placing a bet on the economic future of a country. And we weren't the only ones who believed, in April 2002, that a bet on growth in China was as smart a wager as one could make anywhere on the horizon of global finance. So we thought we had to take the suggestion seriously, even if we were highly skeptical that any Chinese bank could be saved without the kind of government assistance we had received in Korea.
If. If. If! The ifs danced in my mind.
Chapter 2A License to Print Money
Au Ngai was the first colleague I picked to look at the Shenzhen Development Bank opportunity. Still in his mid‐30s and carrying the title of vice president, Au had already accumulated much experience. He had joined Newbridge three years earlier than I did, after having worked at the consulting company A.T. Kearney and Bankers Trust. He had also earned an MBA from Canada's McGill University. He spoke Mandarin as well as Cantonese, the local dialect of Hong Kong and of Guangdong province, where Shenzhen is located.
A week later, Au and I went to Dorsey & Whitney's office on the 30th floor of One Pacific Place on Queensway, in the Central district of Hong Kong. Another skyscraper. Another chilly room on another warm and muggy morning. There, Alex Zhang introduced us to Zhou Lin, president of Shenzhen Development Bank.
Zhou was 51 years old. He had graduated from Nanjing University of Aeronautics and Astronautics and then obtained a master's degree from Tsinghua University, China's top engineering school. For about a decade, he had worked as a researcher in a think tank affiliated with China's State Council, the highest body of the government headed by the prime minister. Then he was appointed to be the deputy head of the Shenzhen branch of the National Development and Reform Commission, a powerful body under the State Council for national economic planning, reform policies, and approvals of major development projects. Soon, he became a banker, as the Shenzhen branch manager of Guangdong Development Bank for a few years and then as the president of SDB, a position he had occupied for five years. Medium height with a somewhat stocky build, Zhou struck me from the start as warm and friendly, full of smiles. Over time we would also come to see him as being very shrewd.
We exchanged pleasantries, and then he explained that the Shenzhen city government had decided, as part of its reform policies, to bring in a qualified foreign investor to take control of Shenzhen Development Bank. And then he picked up where Zhang had left off.
“You understand banking and you understand China,” Zhou said. “Your firm will be a most qualified foreign investor for SDB.”
I nodded, thanked him, and Zhou then proceeded to give us a brief overview of his bank. He confirmed that the government wanted to sell about 20% of SDB's shares, which were owned by several government‐controlled entities. He was candid—unusually so for a Chinese banker in those days—about his bank's bad loan problems and inadequacy of capital. After a while he threw out a number: 4 billion yuan, or about $500 million, the amount of fresh funds he believed would be needed to properly recapitalize the bank. It didn't surprise me that this bank was starved of capital. Which ones in China weren't at the time? But the magnitude still surprised me, considering the modest size of this bank.
A big number. That was my initial take. Five hundred million dollars! Newbridge was not expected to invest this amount of capital, although, at the right price, we would have been happy to consider it. No. The opportunity presented to us was to buy secondary shares from existing shareholders. Our money would not go into the bank. But Zhou pressed on, either undaunted by the amount or wishing to appear so. He had a plan.
“We've engaged Haitong Securities to do a rights issue for us,” he said. “And that should raise enough capital for the bank in the stock market.”
Haitong, based in Shanghai, was one of the largest securities firms in the country. A “rights issue” is a special offer to existing shareholders to buy new shares issued by the company, typically at a discount to its current market price. Only existing shareholders have the right to buy, hence the term “rights issue.” The discount was supposed to make such rights issues irresistible, but to ensure success, the issuing company usually would engage a securities firm like Haitong to underwrite the offering. The underwriter had to guarantee that all the new shares would be subscribed—taken and paid for. Otherwise, the underwriter would have to buy all of the unsubscribed shares for its own book.
Zhou told us that SDB stock was trading at about five times the reported book value or net asset value (NAV). A standard measurement of a bank's financial strength, NAV quite simply is an institution's total assets minus its total liabilities. I emphasize “reported” because in light of its high ratio of bad loans, the actual NAV of the bank was likely much lower or even negative. In more developed markets, banks typically traded at no more than two times NAV. SDB's stock was traded at such lofty levels both because the Chinese stock market was highly speculative and because the Chinese economy was expected to continue its spectacular rate of growth.
China's economic growth rate had been at an average rate of 11.5% per year in U.S. dollar terms in the 10 years between 1992 and 2002. Over the next eight years, between 2002 and 2010, the average GDP growth rate, in terms of U.S. dollars (including the effect of currency appreciation), would be 19.5% per year! Of course, nobody knew at the time that China's growth would accelerate from a level that had already been improbably high.
Zhou then said the bank was planning a 3‐for‐10 rights issue, meaning that 3 new shares would be issued for every 10 shares held by shareholders. Most existing shareholders were expected to subscribe to the new issue. In any case, Haitong Securities, the underwriter, would commit to purchasing whatever shares that went unsold and thus guarantee the success of the planned capital raise.
The government‐owned entities that would sell SDB shares to us did not plan to subscribe to the rights issue, although they would have been permitted to. If the rights issue occurred after we had bought SDB shares to become the controlling shareholder, we would not have bought the rights issue, either. On the one hand, we felt that the current stock price for tradable shares was too expensive and substantially overvalued. We could not have justified paying such a price. On the other hand, the nontradable shares that we were proposing to buy typically traded at about one time the reported NAV, which would be much more within reason, from our point of view, than the five times that tradable shares were fetching in the stock market. Consequently, the secondary shares available for us to purchase would be diluted as a percentage of total shares, but only slightly so.
It was all quite interesting, to say the least. Zhou had clearly thought things through. The hot stock market was going to rescue his bank, without any help from the government and without much dilution to existing shareholders. I had never thought this possible. Certainly it wouldn't have been possible anywhere else in the world, not with the magnitude of the capital raise he was talking about: roughly half a billion dollars to restore the health of a broken bank.
I pressed Zhou, asking what precisely gave him faith that his plan would work. He said that it had been done successfully before at SDB. A prior rights issue had also been underwritten by Haitong, which had ultimately become a shareholder of the bank by purchasing shares it had been unable to sell in the market. Apparently Haitong was confident enough to do it again.
Zhou also told us that the government controlled SDB, even though it held only about 20% of the shares. This was because the bank was a public company, listed on the Shenzhen Stock Exchange, and its stock was widely dispersed among public shareholders. The public float, meaning shares that were held by the general public, represented about 72% of the total outstanding. The Shenzhen government was far and away SDB's largest shareholder, and as such it appointed the bank's management as well as most of its board of directors. The relevant point for us was simple: If we bought those shares from the government, we would be able to control the bank, he said, just as the government had done.
This was good news, and critical to us because we had little faith that any contracts or other agreements would constitute a reliable means of guaranteeing control. China had only recently published new banking regulations, requiring that no single foreign investor own more than 20% of a Chinese bank, and no foreign investors collectively own more than 25%. Given such limits, it ordinarily would not have been possible for any foreign investor to acquire control of any Chinese bank. But SDB seemed a rare case, a unique one, because its shareholding was so dispersed, and therefore the 20% or so shares held by the government entities constituted a controlling block.
For us, this shareholding structure would prove the great revelation of the day. It was the possibility of being able to acquire control that made the deal a potential game‐changer—notwithstanding all those ifs that served as brakes on my initial enthusiasm. A controlling position would allow us to install the right management team, adopt a necessary risk‐management system, build a credit culture—to lend on the basis of the good credit quality of the borrower, and implement a strategy to revitalize and grow the bank.
It was a tantalizing thing to consider.
Still, we had to wonder. How broken was the bank? Would regulators really allow foreign investors to control a national bank? After an hour in that conference room, Au and I felt encouraged by Zhou's assurances—not convinced, perhaps, but encouraged. His plan assumed the stock market could hold its ground, and he was confident he would be able to help secure all the necessary approvals, because the Shenzhen government was behind the sale as part of its reform initiatives. On the whole, what Zhou had laid out made sense.
I also asked about other potential investors who might compete with us. Zhou told us he had contacted a number of foreign banks, including the likes of Citibank and HSBC, but none had shown interest. Presumably they had been put off by the risks of problem loans and bad asset quality. These were some of those same ifs that had raised doubts in my mind. Any one of these concerns might have been enough to snuff out any real interest.
We understood the concerns. By regulation, almost anywhere else in the world, a bank would have to account for the capital shortage of its banking subsidiaries whose accounts were consolidated with that of the parent. Generally, if a banking institution were to acquire a problem bank, such as SDB, the acquiring bank would have to set aside significant capital provisions—an amount from its own capital base to cover the shortage of the acquired entity. That price would often be prohibitively high.
Since Newbridge, as a nonbank buyer, was not usually required by regulators to provide capital provisions at the parent level, buying control of SDB was a more attractive proposition for us than for any banking institution. Hopefully Zhou's plan to replenish the bank's capital would work, so that Newbridge would not buy a bank with a gaping hole in its balance sheet.
Au and I were somewhat excited about the possibility of controlling a national bank in China, but we worried that the bank was too broken to be saved. We were also skeptical whether there could be a workable deal, one that would work for us as well as for the selling side. At this point, there were still too many unknowns. Nonetheless, I reaffirmed our interest.
Zhou was clearly pleased. “Now I've found someone who knows a diamond in the rough,” he said, smiling, as we parted ways. He assured us that his bank would open its books to facilitate our due diligence—thorough investigation—and he promised to help us negotiate with the government for the purchase.
Zhou had struck me as smart, affable, and smooth‐talking. He exuded the aura of a private dealmaker, not at all like the typically formal and reserved president of a government‐controlled bank. We shook hands, agreed to meet again soon, and as he bade farewell, I felt that whatever came of this opportunity, we could do business with this man.
***
Since my first meeting with Alex Zhang, we'd done a bit more research about what we were getting ourselves into. SDB was a nationwide bank, with some 200 branches in 16 major cities located in the more affluent coastal regions of China. As of late 2001, the bank employed 5,000 people and held assets worth about $14 billion. SDB was one of 15 national banks in the country. It had been formed in 1987 by combining a number of credit cooperatives and issuing stock to the public. On April 7, 1988, SDB had become the first company to be publicly listed on the Shenzhen Stock Exchange as well as the first publicly listed Chinese bank. Its stock serial number was 000001.
Banking in China was strictly controlled and regulated, more so than in most other countries. For starters, in the late 1990s, it was exceedingly difficult to obtain a banking license. In addition, interest rates were tightly regulated by the PBOC, the central bank.
Banks make money by earning a spread, the differential between lending and deposit rates. In most countries, banks are free to set their interest rates for lending and for deposits. If a bank set its lending rates too high, good customers would borrow from other banks offering lower rates. If it set its deposit rates too low, customers would deposit their money with other banks offering higher rates. So banks have to set their interest rates to be competitive. This meant the spread is usually thin.
In China at that time, interest rates were controlled by the PBOC, which set a floor to lending rates and a ceiling to deposit rates. Thus the spread was practically guaranteed by the central bank and much higher than in other markets, regardless of competition between banks. As such, banking in China was like a license to print money, provided, of course, the bank did not throw money away by making bad loans.
This “license to print money” was what strongly attracted us to the SDB opportunity—the promise of essentially controlling a money machine. It was so rare that until this moment, it had been inconceivable to a foreign investor.
Unfortunately, the state of banking in China at that time was such that banks were throwing money away, all too often making loans to borrowers who could not pay them back. The entire system was weak. It had weathered the Asian Financial Crisis largely because China's capital market was quite closed to the outside world, so there was practically no foreign holding of publicly traded Chinese stocks or bonds. Therefore capital flight was not an issue for China as it was for other Asian countries.
Although most Chinese banks were technically insolvent, they were kept afloat by liquidity: The inflow of deposits was typically greater than the money needed to make loans, even if individual banks could not collect some of their loans. This was almost like a giant Ponzi scheme, except that the government, whose finances had been strong, stood behind major banks so there was almost no risk they would fail. There were rare exceptions. For example, the small Hainan Development Bank was allowed to close in 1998. But even in that case, the government bailed out all the retail depositors. This was a unique phenomenon for global banking, in a country that had among the highest savings rates in the world—roughly 50% of gross domestic product or total economic output.
You didn't need a degree in finance to see that this system was untenable in the long run. Sooner or later the deposit growth rate would taper off or reverse, with the maturity of the economy and aging of its population. When that happened, the bad loan problem would catch up with the banks, making it impossible for them to make new loans and, more worryingly, impossible for them to repay their deposits. By the turn of the twenty‐first century, the Chinese government was keenly aware of the weakness of its banking system and was thinking about ways to reform it.
And all of a sudden, there we were at Newbridge Capital, right in the thick of things. If we bought SDB, we would find ourselves at the forefront of China's nascent banking reforms. But our objective was simple: The control of an institution with a license to print money could be a lucrative opportunity.
In the days that followed those first meetings, my colleagues and I kept focusing on two major issues. The first was simple: No foreign investor had ever bought control of a Chinese bank. It was such a radical idea that we expected government approvals would be difficult to obtain. There was no blueprint or beaten path to follow, not even for the various layers of the government bureaucracy and regulators. The second issue involved a lack of information. We had no idea how broken SDB was, and whether it could be saved. One thing we did know: If it could not be saved, then we ran the real risk of losing our capital.
But then we would tell ourselves, as the worries coursed through our minds: There was no harm in checking it out. It could be, as Zhou had suggested, a diamond in the rough.
Chapter 3The Craft of Private Equity
In 2002, private equity—acquiring or investing in private companies by financial investors—was still a rather nascent industry, although its roots could be traced back to the corporate takeovers of the late nineteenth and early twentieth centuries. That era, often dubbed the Second Industrial Revolution, was marked by technological progress and the rise of the modern financial system, in which banks and stock markets channeled massive amounts of private capital into such megaprojects as steel making, motor vehicle manufacturing, and railway construction.
One early deal that could be considered private equity, although it was not called as such at the time, was the acquisition of Carnegie Steel in 1900 by the American financier John Pierpont Morgan. Morgan's power was so immense that he was credited with creating the first billion‐dollar company in the world—United States Steel Corporation. He consolidated a vast swath of the country's railroad system under the Northern Securities Company, which had to be broken up by President Theodore Roosevelt on antitrust grounds. He was also credited with rescuing the country from financial ruin in 1907.
J.P. Morgan bought Carnegie Steel for $480 million, equivalent to about $15.6 billion in 2021 dollars. He was a man of immense financial power and capabilities, but when he died in 1913, Morgan's personal wealth was estimated to be merely $80 million (about $2.2 billion in 2021 dollars)—a respectable fortune, but pale in comparison with that of Andrew Carnegie, who received $225 million (roughly $7.3 billion in 2021 dollars) for selling his steel company. It was said that when John D. Rockefeller heard of this, he quipped: “He owned all of us and he wasn't even that rich.” In view of his limited personal wealth, where did Morgan get the money to pull off such huge acquisitions?
Simply put, Morgan used other people's money, including equity capital and debt. How he did this is, essentially, what private equity is all about: pooling capital from institutional investors and making investments in, or acquisitions of, largely private companies for the purpose of generating good returns for these investors. The manager of the money, or the private equity firm, takes a cut, generally a percentage of whatever gains it can produce from its investment.
The relationship between the manager and the investor is typically structured as a partnership. The manager is known as the general partner (GP), and investors are referred to as limited partners (LPs). These investors are typically large institutions such as sovereign wealth funds, government and corporate pension systems, insurance companies, university endowments, and the like. The general partners can raise billions or tens of billions of dollars to do large transactions.
Private equity as an industry really burst onto the scene in 1988, when the partners of KKR acquired RJR Nabisco in a $25 billion transaction. The story is told in Barbarians at the Gate by Wall Street Journal reporters Bryan Burrough and John Helyar. Today, in the United States, there are more companies that are controlled by private equity firms than there are publicly listed companies.
I joined Newbridge Capital in 1998, 10 years after the RJR Nabisco deal. Before that, I had been an investment banker at J.P. Morgan in its Hong Kong office, covering China. It was only by chance that I got into investment banking and, also by chance, into private equity.
I had grown up in China and spent many years in my youth in China's Gobi Desert as a hard laborer. I had lived in squalor and had to endure starvation and other types of hardship. Those were the days when China was extremely poor. Like many of my peers who had lived through the Cultural Revolution of the 1960s and 1970s, I had never received a secondary education: During that period of tremendous social and political turmoil, all the schools were closed and remained shut for as long as 10 years. But I was lucky enough to get a chance to study in the United States when China opened up in 1980. I was able to earn three graduate degrees, including a PhD from the University of California at Berkeley. Then I became a business professor at the Wharton School of the University of Pennsylvania after a brief stint at the World Bank—my first encounter with finance.
After six years at Wharton, I became somewhat bored with life in the ivory tower and attracted to the opportunities in China, whose economy was just about to take off. In 1993, I was approached by a senior banker at J.P. Morgan, which was looking for someone who knew China. He made me an offer that has made me wonder, ever since, why bankers are paid so much more than professors. In any case, I took the opportunity, leaving the United States with my family to relocate to Hong Kong, then in its last years as a British colony.
In 1997, Hong Kong's sovereignty was handed back to China and it became a special administrative region of the People's Republic. Under the framework of “one country, two systems,” it maintained its laissez‐faire economy and a legal system in the British common law tradition. Today Hong Kong boasts one of the highest per‐capita incomes in the world. It is an international city, with more than 10% of its population (roughly 7.5 million) comprised of foreign professionals or expatriates. Hong Kong has two official languages (Chinese and English) and is served by nonstop flights to all major cities around the globe. It has one of the world's lowest corporate and personal income tax rates (the top bracket is just 17.5%), and no capital gains or dividend tax. That, coupled with an open capital market, free flow of information, and a fully convertible currency whose exchange rate is pegged to the U.S. dollar, makes it one of the greatest financial hubs in the world, and certainly the top one in Asia.
In 1997, Asia was hit by an unprecedented financial crisis. On October 23, the Hong Kong stock index dropped a whopping 16% in one day. By the year's end, South Korea's stock market had lost 49% of its value and its currency, the won, plummeted by about 66% against the U.S. dollar. Asian countries, from Korea to Japan to Indonesia, were devastated by the financial tsunami and massive flight of capital. Despite its shaky banking system, China fared much better than other Asian countries because its capital controls had worked like a high dam keeping at bay the tsunami raging off its shores.
Just a few months before the collapse of Hong Kong's stock market in October, I had been approached by a headhunter on behalf of Newbridge. I was already restless, as I was losing interest in investment banking. The investment banking job, as I saw it, involved 80% social engineering—relationship building with clients—and just 20% financial engineering, which was the creative deal‐making and financial structuring I was most interested in. I was open to approaches by headhunters, although I hadn't decided what to do. One thing led to another, and Newbridge eventually made me an offer as a partner of the firm. I sat on the offer for weeks, because I knew practically nothing about private equity, and Newbridge was a rather obscure name at the time. Then the full force of the Asian Financial Crisis hit, and the capital market went into a deep freeze, starving the investment banking business. It was then that I decided to take Newbridge's offer, thinking that in this kind of market conditions, it would be much better to be on the buy side as an investor than on the sell side as an investment banker trying to entice investors to buy.
David Bonderman, chairman of TPG and co‐chairman of Newbridge, liked to say that many of us in the private equity business had stumbled into it. He himself was a Harvard‐trained lawyer who had also studied Islamic law in Egypt, where he learned to speak Arabic fluently. He had taught as a law professor and worked for both the government and a private law firm before an opportunity presented itself that drew him into the private equity business. I am sure that he hadn't planned on a career in private equity, and neither had I. But when the opportunity beckoned, it looked irresistible. Bonderman was well‐known in the industry, having done a number of successful high‐profile deals including the acquisition of Continental Airlines and American Savings Bank, both of which were turnarounds that were eventually highly profitable for him and his investors.
Dick Blum was the other co‐chairman of Newbridge. Seven years Bonderman's senior, Blum had been in the investment business throughout his career. He made partner at Sutro & Co., an investment brokerage firm, at the tender age of 30, and founded Blum Capital when he was 40. His successful deals included CBRE, the leading commercial property management and brokerage firm in the world, and Bank of America when it was in trouble.
