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INDUSTRY Q&A | LIANG MENG & KEVIN ZHANG
[email protected]
Corporate consigliore
M&A advisors turned PE investors, Liang Meng and Kevin Zhang pooled their experiences at J.P. Morgan, D.E. Shaw and
Goldman Sachs to create Ascendent Capital Partners, and pursue a different kind of China strategy
Q: What led to the creation of
Ascendent in 2011?
MENG: Chinese private equity
has changed significantly since
2004-2005. At that time there
were fewer players, and therefore
investment banks were key to
introducing and brokering deals.
However, most international
banks didn’t really have much in
terms of advisory, as they were
mostly focused on IPOs. My M&A
team at J.P. Morgan served as
sell-side advisors for some of the
earliest PE deals. When I moved
on to D.E. Shaw in 2007 to start
and lead the firm’s Greater
China investment business,
it was a similar approach. We
helped companies think about
their issues and opportunities,
and then provided capital in
combination with advice and
solutions. Kevin and I first met
when we were both advising
CNOOC on the attempted
acquisition of Unocal in 2005
– he was at Goldman on the
capital markets side and I was
on the M&A side. Between 2007
and 2011, we co-invested around
$600 million in China PE deals,
so we knew each other’s style.
Spinning out from D.E. Shaw in
2011, I decided to partner with
him.
Q: And the advisory approach
still prevails?
MENG: Today’s environment is
even more uncertain than a few
years ago, so the combination
of capital and advice is very
powerful. Our strategy is all
about having a lot of influence,
thinking about what companies
want to do and in a lot of cases
helping them do it.
ZHANG: The market is maturing
and entrepreneurs are becoming
more sophisticated. They are
14
more open to interesting
transactions that they wouldn’t
have been open to 10 years ago.
And then the Chinese economy
is slowing. If a company is
growing at 40%, all it needs is the
cheapest cost of capital; there
is not much interested in other
opportunities. But as growth
slows, even industry leaders
must deal with challenges such
as rising costs, increasing capital
intensity and consolidation.
At this juncture, if you show
them not only capital but also
opportunities such as M&A that
offer synergistic combinations
and change the competitive
landscape, it is very interesting
to them.
Q: So you would describe your
strategy as different to
conventional private equity?
ZHANG: Chinese private equity
has seen its good days when
everyone was making money,
driven mostly by beta plays
– GDP growth and multiple
expansion. In a slower growth
environment and with a lot
of dry powder chasing those
opportunities, you really have
to deliver alpha. Our objective
is to deliver attractive riskadjusted returns. We do that by
generating our own ideas and
advising Chinese companies
on how to accelerate growth.
Through that process we
develop a trusting relationship
with entrepreneurs, which
means we get in at reasonable
valuations and can structure
deals not only towards meeting
a company’s capital needs but
optimizing our risk-return profile.
We stay very involved postinvestment, actively managing
the portfolio.
MENG: Our approach also differs
Liang Meng
“Downside
protection could
be as simple as a
put option, but
then you have to
ask if it’s really
protected” – Liang Meng
from conventional private equity
because we look at things from a
credit angle and an equity angle.
We protect our downside using
structured mechanisms but
without sacrificing too much of
the equity upside. Everyone talks
about downside protection but
how many of them have really
gone through the exercise of
loan-to-value, credit, analytics,
asset and equity pledges, and
enforcements? We are one of few
with knowledge and experience
in this area.
Q: What are the challenges
involved with downside
protection in China?
MENG: Downside protection could
be as simple as a put option, but
then you have to ask if it’s really
protected. Is your counterpart
a special purpose vehicle or
a person? Is there a personal
guarantee next to it and, if so,
does the person have sufficient
assets? Is the enforcement
mechanism strong enough. We
take precautionary measures
to protect equity pledges – we
get pre-signed instruments
of transfer with full power-ofattorney allowing us to date
and effect the transfer upon a
default. But in most cases we
have known the company for a
long time through the advisory
angle. We understand them, we
know they are creditworthy, and
we are comfortable working with
them. A lot of conversations run
along the lines of us saying, “Let’s
develop this idea together and
we will put in money to show we
believe in the idea. If things go
well, we get some equity upside.
If things go really badly, just treat
it as a loan and return the money
plus some interest.”
Q: So you wouldn’t use
protection mechanisms such
as ratcheting?
MENG: We don’t like those
situations because there is a
misalignment of interest – some
founders might fudge the
accounts rather than face losing
30% of their equity. We do it
the other way around. We tell
the founder that we think the
business is capable of 10-15%
growth, and our valuation
reflects this assumption. But
if we together manage to
achieve higher growth we will
return equity to him. Downside
protection is not a zero-sum
game. There is often some kind
of trade-off, incentives to get
them to return cash sooner
rather than later. For example, we
might own 40% of a company
with a 2x put option after four
avcj.com | July 15 2014 | Volume 27 | Number 26
LIANG MENG & KEVIN ZHANG | INDUSTRY Q&A
[email protected]
years and a preferred dividend
stream that guarantees us a
certain payout until we have
covered 1x cost. If capital can be
returned earlier we don’t mind
reducing the 40% ownership to
37.5%. It is less challenging when
interests are aligned and you are
giving them money not just to
pursue organic growth but do
something strategic to maximize
shareholder value.
Q: What sort of strategic benefits
have you achieved with your
portfolio companies?
ZHANG: We have been involved
in one take-private of a Chinese
company on the Korean Stock
Exchange. It is a complicated
process and few people have
done it before – our deal
was announced last May
and completed in October
and it wasn’t until last week
that the remaining minority
shareholders finally exited. We
invested $54 million in the form
of a convertible bond with a
And we are in the process of
bringing in one of the company’s
largest customers as a strategic
investor.
Kevin Zhang
4% coupon and an 18% put
option. Our entry valuation is
very competitive. But from the
entrepreneur’s perspective,
he owned 45% and postprivatization his stake has risen
to 70% without putting in any
additional capital. We have
invested and also helped the
company make some small
acquisitions to enter new areas.
We have been working with a
bank on an offshore syndicated
loan that will extend financing
from one-and-a-half years to
three years, lowering the risk.
Q: Most private equity firms
emphasize the operational
side of value creation…
ZHANG: We work with industry
leaders and established
companies. A food packaging
business doesn’t need us to
come in and explain how to
make a metal can at lower
cost. But they might need us
to advise on how the company
can reposition itself as a multiproduct food and beverage
packaging company. They might
have identified an acquisition
target and need help on the
transaction, or they might
want us to look at their capital
structure, not only to lower
financing costs but also to match
assets and liabilities in order to
reduce potential risks. We want
to add value in areas where
companies most need support
and right now it is not operations.
Q: Doesn’t your strategy –
building relationships with the
possibility of investing later –
limit the number of deals you
can look at?
MENG: We can probably do no
more than two or three deals
each year, but that’s okay. When
we launched Fund I we said
there would be 7-9 investments
in total with a $30-70 million
sweet spot. Three years on, we
have made five investments and
are currently working on a sixth.
If you see us doing one deal a
month then we have deviated
from our strategy. The deals
will probably become larger in
size but overall number won’t
increase much. And you won’t
see us opening four offices in
China either. It doesn’t make any
sense. We don’t need a lot of
people but it is an advice- and
intelligence-intensive strategy
– there is a lot of dialogue with
companies.
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