The recent failure of Chinese private equity firm CDH Investments in the IPO exit of Chinese pork company WH Group has triggered discussions on Chinese private equity firms’ capabilities in competing in the global arena. Chen Dujuan reports with additional reporting from Stephen Aldred of Reuters

China's biggest buyout firm, CDH Investments, is known as "The Blackstone of China" for its savvy dealmaking and spread of businesses, but April’s pulled IPO of pork producer WH Group Ltd is a setback to its global ambitions.

The deal thrust a spotlight on CDH, which first invested in WH Group in 2006, and exposed its limited experience in handling big IPO exits from its investments in a global financial centre.

"If we believe Chinese private equity (PE) is going to rival the Carlyles and the Blackstones, they need to clearly be able to demonstrate they can do deals - and successful deals," says Fraser Howie, co-author of the book Red Capitalism.

"Not just a deal, but have a pattern of operating successfully in a number of different fields, and frankly, no Chinese company in any industry has shown its ability to do that yet," Howie adds.

However, Sammuel Zhao, a partner at Jun He Law Offices, disagrees, as the failed exit of CDH is not a common case among Chinese PE firms.

Buyout deals are commonly carried out by global PE firms, such as when Cerberus Capital bought an 80.1 percent stake in Chrysler from automaker DaimlerChrysler in 2007. However, the Chinese counterparts of these global PE firms seldom engage in such deals, says Zhao.

CDH’s buyout deal of WH Group is a hard test for the former to coordinate with the management team, as well as for CDH’s professional capabilities, he says.

“Buyout deals are like entering water to catch fish, while the pre-IPO deals Chinese private equities are used to practising are casting nets into the water,” says Zhao.

“Just like different types of milk are suitable for different consumers, different types of deals fit different markets, and we cannot say one way is superior to the other,” he adds.

The original $5.3 billion IPO by WH Group would have been the biggest for a PE-backed company in Asia. Only The Carlyle Group has completed a similar IPO in the region recently with its $3.1 billion IPO for the China Pacific Insurance Group.

Global aspirations

CDH won kudos for engineering WH Group's $4.9 billion purchase of Smithfield Foods Inc, the largest acquisition of a U.S. company by a China firm, and Wu Shangzhi, its co-founder, a former World Bank banker and an elder statesman of China PE, suggested China's economic power would lead to more such deals.

"The competitive advantage certainly now is pointing to a different direction. There is a compelling reason for the transaction: there are going to be more of these happening," Wu said in a speech in Hong Kong.

CDH, along with peers including CITIC Capital and Hony Capital, is among a number of China firms eyeing global deals to distinguish themselves from domestic competitors as they vie for investor dollars.

CDH, which has offices in Singapore and Jakarta and investments in Japan and Vietnam, teamed up with global PE firm TPG Capital in a bid to delist a company in the U.S. It has recently been eyeing U.S. capital markets as a source of funds, bankers say, underscoring its aspirations to grow beyond its home market.

A successful WH Group exit would have cemented CDH's position, but the drawn-out collapse of the deal, mired in bad luck and blunders, generated a slew of negative headlines, and meant investors including CDH, Temasek Holdings and Goldman Sachs missed raising $1.8 billion. CDH had offered a stake of nearly $660 million.

"It would undoubtedly have been a boost for CDH, as they invested into WH Group from at least three of their funds," says one investor in the PE firm's funds.

CDH declined to comment for this article.

Whom to blame

Sources involved with the IPO told Reuters that CDH played an aggressive role in pricing the deal, even though it held only 34 percent stake in WH Group]. "Why would somebody who's a butcher know the valuation better than CDH?" asks a second investor.

Howie points to the $600 million paid out to two WH Group executives and the hiring of 29 bookrunners for the IPO as fundamental mistakes. "It's a case study in how not to do something," he says.

Bookrunners and underwriters play a bigger role than PE firms in realising successful IPOs, and the 29 bookrunners hired by WH Group are big names with strong capabilities, says Jason Liu, a partner at Zhong Lun Law Firm, stressing that WH itself may be the major reason for being dumped by potential market investors at the roadshow, which subsequently resulted in a pulled IPO.

However, he adds that PE firms which have strong capabilities can better promote companies for a quicker listing.

Sequoia Capital has pushed Chinese companies, such as sports lottery website 500.com Ltd and online cosmetics retailer Jumei.com, in which it has invested for successful IPOS in the U.S., although the two companies are not well known in China, which highlights the experienced PE firm’s marketing capability in the global capital market, says Liu.

He also recalls the recent example of successful exits for PE firms, including Chinese PE firm Hillhouse Capital Group through the U.S. IPO of JD.com, China's second-largest online retailer only after Alibaba Group, in May. Zhong Lun had advised JD on the deal.

Although JD has yet to make profits, its share price closed 10 percent up on the first day of trading, pushing its market share to $28.6 billion and making it the third largest listed Internet company in China, only after Tencent and Baidu.

JD.com has attracted many investors, partly because of good promotions by PE firms behind it, and partly because of investors’ recognition of the company’s operational model, says Liu.

The Chinese way

The second and third letters in CDH's name stand for "Ding Hui,” meaning "balance" and "potential.”

Beijing-based CDH was spun out of powerful investment bank China Investment Capital Corp (CICC) in 2002. CICC is run by Levin Zhu, the son of China's former premier, Zhu Rongji.

In China, CDH has branched into venture capital, real estate, credit and public markets investing, prompting the comparisons with U.S. giant Blackstone Group, the world's biggest PE firm, which pioneered the strategy of diversifying into multiple investment areas.

CDH raised only $102 million for its first standalone fund, but quickly found its way into a series of successful China deals, including stakes in sportswear company Li Ning Co Ltd, display advertising firm Focus Media and China Mengniu Dairy, according to Thomson Reuters data.

That first fund returned around 3.5 times its investors' money, according to Reuters data, making it one of the top-performing funds in China, and enabling it to raise capital for a series of bigger funds. Along the way, CDH and Goldman invested $256 million for a controlling stake in a struggling meat producer, then known as the Shuanghui Group.

That buyout deal, one of the first of its kind in China, sparked controversy as opponents claimed the country was selling assets too cheaply to foreign investors. Goldman sold half its stake back to CDH in 2009 for five times the amount it had originally paid.

"One of the primary problems Chinese companies face is that they are used to doing things a certain way in China, which is based on who you know and who you trust," says Howie. "When you go overseas, the need for transparency and an honest assessment is higher, and they're bad at translating that."

Chinese PE firms are quite familiar with local companies, the investment environment and exit channels in China, so their advantages lie in the Chinese market or with companies operating in China. Being accustomed to taking things such as “guanxi” and connections with government departments as well as market factors into consideration, it is difficult for them to compete in the global arena in which professional analysis and judgment are vital, according to Zhao.

Chinese PE firms also have problems with choosing investment projects and judging the timing for exits, he says.

Media reports said that CDH’s investment in sometime during the middle of 2011 in two group-buying websites at the same time - in the first round for 55tuan.com and the second round for 24quan.com - confused analysts.

Just one-and-a-half years after CDH’s investment, 24quan.com, which was one of the top five group-buying websites in China, shut down its business in early 2013.

Room to improve

CDH's successes have attracted big investors into its funds, and these include the California Public Employees' Retirement System and Canada Pension Plan Investment Board. So much so that 75 percent of CDH's PE funds now come from international investors.

In January, CDH closed its fifth fund at $2.55 billion, nearly 25 times the size of its debut 2002 fund, underscoring the strong growth it has notched up since its inception.

CDH's co-founders, Wu, Stuart Schonberger, who earned his B.A. from U.S. liberal arts school Wesleyan University, and dealmaker Jiao Zhen, are still together at the firm. But recent funds have not matched the firm’s previous performance. The firm has been on a drive to return more money to its investors by exiting its investments, Wu noted in his speech.

While CDH's 2002 fund is a top quartile fund, its 2010 fund has so far returned just over one times investors' money, and is in the bottom 25 percent of funds, according to data seen by Reuters.

This may be partly attributed to long time IPO suspension and reduced price-to-earnings for companies over the recent years in the weak market.

At the end of April 2014, the China Securities Regulatory Commission, the country’s securities watchdog, approved applications for IPOs after an 18-month suspension. Meanwhile, the IPO door for Chinese firms in the U.S. has been shut since 2011 due to a series of accounting scandals with the door having reopened recently in the middle of 2013, with more Chinese companies coming back.

As a result, underperformance was the keyword for Chinese PE firms since 2012, so they need to hold on to pull through the hard times, Zhao says.

Despite the resumption of IPOs both at home and abroad, Liu believes Chinese PE firms still face an uncertain prospect; even reshuffles within the sector.

Chinese PE firms are still learning: The key to their growth lies in creating more chances to cooperate with their global counterparts so as to accumulate experience and to learn the practices of global capital markets, rather than just poaching some experienced people, suggests Liu.

As more Chinese companies tend to go abroad, Chinese PE firms can expect an increasing number of such opportunities, he says.