Performing due diligence continues to be a vast challenge for foreign business in China.

Many investors, however, assume that China is the problem. In fact, they themselves often appear to be mentally disabled.

Taizinai dairy – which received more than $100 million from foreign investors over a period of time beginning in 2006 to turn it into China’s dairy mecca – is a case in point.

“After two years and US$ 103 million, a group of foreign investors has won control of Taizinai – a defunct, indebted dairy,” Caijing reported.

Given these guys aren’t nearly among the Mensa crowd, they’re probably patting themselves on the back.

Should you want to follow in their footsteps, based on the Caijing article, we can surmise the following about how to be a private equity idiot in China:

1. Wet your appetite on some potentially serious B.S. A company report notes, as a Taizinai one did some years ago, that annual growth rates have been 50 percent. You being you, of course, you know that past success – especially the kind that makes you salivate uncontrollably - ensures future profitability. And so later when the company you’ve invested in posts sales of 1.1 billion yuan compared to 1.2 billion yuan last year, you can let yourself off the hook for getting caught up in a scheme that went against the laws of finance nature. In the Taizinai case, “The financial data also supported the company’s prediction that it would become the first Chinese dairy to list on a U.S. stock exchange,” Caijing noted. While foreign investors must have liked that, they eventually battled with Chinese directors to initially list in China instead of New York. Apparently, foreign investors were sold on smoke when they were the ones carrying the mirrors.

2. Agree that if the company makes lots of money, you reduce your share in it. The contract with Taizinai “apparently required the foreign investors to reduce their stakes if the company’s growth rate reached the levels estimated by the founders,” Caijing noted. “If the financials fell short of these estimates, the agreement said, the foreign investors were to win control of the company.” And what a wonderful thing it is to control a big company like Pan Am.

3. Invest an unfathomable amount of money. Yeah, you’re a big private equity man. But this is still a Chinese business you’re investing in. So $103 million is 705 million RMB. Plus, consider the fact that in China, a 100 RMB bill carries the same psychological weight as a 100 dollar bill does in the United States. Go ahead and do this psychological RMB to dollar conversion (it’s an easy 1 to 1 ratio), and then ask yourself, what foreign group in its right mind would invest nearly a billion dollars in an unproven Chinese milk company? Yours, of course.

4. Misunderstand the company’s true financial situation. “What Taizinai’s accounting books apparently failed to explain was that the dairy had been struggling to compete against several other popular makers of milk products including Yili and Mengniu, two of the country’s largest dairies, which won larger markets shares in major cities and developed their own yoghurt drinks,” Caijing noted. You’ve done a good job at failing to get bogged down in bigger details. Make sure you miss the small ones too, like worker grievances. That way, even if you’re not afraid of riots, you can still find your way down into the money pit when a court order closes your factory after unpaid employees file suit.

5. Get a seat on the board to “control” things. Each Taizinai investor got a single board seat, and the company founder served as chairman. This representation was inadequate and led to disputes, such as where to list. Time and time again, we hear in China about managerial clashes between East and West. Since you’re not so interested in winning the war, make sure you have no real ability to influence the choice of key positions such as CEO, CFO, and HR director.

6. When the house of cards is near collapse, continue to invest. Despite the company’s clear troubles (the accountants by now have frozen to near death after annual reports haven’t been submitted, and an industry-wide milk scandal is underway), foreign investors gave another US$30 million to help it solve a cash-flow crisis. “A banker who worked with the company said the cash crunch had been lingering for a long time and that the latest investment would not solve the problem,” Caijing noted. Cool, so get ready to throw more money into a fireplace that won’t even fit it all.

7. Keep vigil as the company finally expands - into businesses like clothing, media and real estate. Yep, just where the dairy company’s expertise must lie. Smile knowingly at your mischievous progeny as money isn’t made.

    Channel: Vital News     |