Venture Capitalists Catch China Fever

It's the hot spot for private-equity investors, but beware a looming bubble

Kathy Xu is one satisfied investor these days. As China head of Baring Private Equity Partners (Asia), she has made eight deals to provide financing for local startups in the past five years. Five have either been sold or gone public, netting Barings a profit of $101 million on investments of $27 million. "People are really starting to make serious money," says Xu.

Xu isn't the only venture capitalist whistling her way to the bank. Thanks to a rash of initial public offerings, privatizations, mergers, and takeovers, opportunities for private-equity investors in China have never looked better. Last year, China attracted $1.57 billion in private equity, up from $350 million in 2002. This year, $150 million has already been raised, and all it would take is a couple of big deals to beat last year's level. "China is hot," says Chauncey Shey, CEO of Softbank China Venture Capital, which has a multimillion-dollar investment in, an Internet portal.

BIG DEALS, BIG PAYOFFS. Success stories, hard to come by a couple of years ago, are now easy to find. Carlyle Asia Venture Partners' $8 million investment in online travel company International ballooned to $100 million when the company went public last November. And International Data Group raked in a 1,900% profit on its stake in online auction company EachNet when it was bought by eBay Inc. (EBAY ) for $200 million last year. As for this year, one of the biggest deals of 2004 will come in late March, when Shanghai chipmaker SMIC is expected to raise $1.7 billion in an IPO. That will mean a big payoff for investors Goldman Sachs (GS ), Morgan Stanley (MWD ), and San Francisco-based Walden International.

Those who have cashed out, though, are the first to admit that for every investment that pays off in China, there are four that don't. Moreover, investment on the mainland can be an arduous ordeal -- first to find an enterprise worth investing in, then to work out terms with its principals. The game is not for everyone -- even players well-versed with the U.S. scene. "You have people coming from Connecticut to Beijing thinking they can clinch a deal in the coffee shop of a five-star hotel," says David H. Liu, co-head of Morgan Stanley Private Equity Asia in Hong Kong. "You need to understand the local culture and operating environment." Liu compares the process to an art dealer going house to house looking for a Picasso. Liu found his masterpiece in 1994, when Morgan Stanley picked up a stake in Ping An Insurance, the mainland's second-largest life insurer. Market-watchers expect Ping An to list in Hong Kong in the second quarter, but Liu declined to comment.

It's not just foreigners who are driving this private-equity renaissance. Many of today's entrepreneurs are Chinese returning from overseas or locals with years of experience working for multinationals. "They are very hungry and willing to go the extra step," says Seow Choong Huei, vice-president of Templeton Asset Management's strategic equity group.

Of course, no one can predict just how long this particular strain of China fever will last. Although private equity was only 3% of foreign investment last year, the IPO pipeline is bulging, and some observers warn that the euphoria is starting to feel like the late, unlamented tech bubble. New money is being poured into some dubious projects by investors hoping to cash out before the bottom drops out. "You shouldn't think about getting in and out quickly just because the market is so hot," says Weijian Shan, managing director of Newbridge Capital Ltd. in Hong Kong. Sound advice. But in superheated China, only the most prudent investors seem inclined to listen.

By Frederik Balfour in Hong Kong

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