Carlyle Group Goes Local to Conquer China

"In order to play, you have to have a renminbi fund"

Carlyle Group is renewing its push into China, taking advantage of new rules that make it easier for foreign private equity funds to operate on the mainland. The Washington-based private equity giant, with $89 billion in assets under management worldwide, has teamed up with Fosun, a Shanghai conglomerate, to launch a local-currency fund. Having a Chinese partner will help Carlyle get regulatory approval for deals—and give it access to sectors of the economy that have been largely off limits to overseas investors. On Mar. 3, Carlyle and Fosun received approval to operate a fund worth the equivalent of $100 million in yuan, also known as renminbi. "In order to play, you have to have a renminbi fund," says Wayne Wen-Tsui Tsou, a Carlyle managing director in Hong Kong. Otherwise, "you're shut out of certain deals."

Carlyle knows what that's like. A three-year effort to buy a controlling interest in Xugong, a state-owned construction equipment company, collapsed in 2008 because of criticism in China that the Americans were trying to buy a strategic asset on the cheap. Since the flap over the Xugong deal, Carlyle and other Western private equity shops have been confined themselves to making minority investments in companies. Of course, some of these deals can be lucrative. Carlyle showed a paper profit of about $4 billion from the initial public offering in December of China Pacific Insurance, in which it had acquired a 17% interest.

New regulations that went into effect in March allow foreign private equity firms to operate as limited liability partnerships, the structure that most prefer outside the mainland. For Carlyle and others, the change will confer tax advantages as well as legal protections. It should also help crack open sectors like media, insurance, and telecom where foreign participation is subject to government caps. "The Holy Grail for foreign investors has been to adopt a structure where you can be treated as a local," says Joseph W.K. Chan, a partner in Shanghai with the Washington law firm Pillsbury Winthrop Shaw Pittman. Blackstone Group (BX) already has announced plans to launch a local-currency fund in partnership with the government of the Pudong district in Shanghai, though it has not yet concluded fund-raising.

Carlyle and Blackstone will face intensifying competition from Chinese private equity shops. In 2009 local private equity firms raised $8.7 billion in new money, vs. $4.2 billion for foreign funds focused on China, according to Beijing consultancy Zero2IPO. For the big U.S. private equity players, the rise of a homegrown industry "poses the biggest threat to their traditional business in China they've ever faced," says Michael J. Guilday, a partner in Hong Kong with Boston-based Ropes & Gray.

Carlyle already is canvassing Chinese investors for another local-currency fund. Approval is pending, but managing director X.D. Yang is confident: China's leaders, he says, "want to fully take advantage of private equity."

The bottom line: Having a Chinese partner will allow Carlyle to target companies in new sectors and may help allay concerns about "foreign" takeovers.

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