Guanxi vs Analyst: Carlyle and the coming collapse in Asian Private Equity

John Hempton continues his investigations in China. It is becoming increasingly apparent that China is a dangerous place to invest without an in-the-know local. John finds that even that doesn’t keep you safe:

I have a friend with a fair career as an analyst in Asian private equity funds. He describes the central debate as being between the “Guanxi guy” and the “Analyst guy” (in his world they are mostly guys) and he says the “Guanxi guy” has won almost all of the battles.

“Guanxi” is one of those words proponents claim defies easy translation: something between connections and relationship. Wikipedia defines it as a personal relationship between people in which one is able to prevail on another to get things done. Whatever: Guanxi is often sold as the key to doing business in China.

At Private Equity (PE) firms the debate as to which deals to do and what price to pay has been between the Analyst guys and the Guanxi guys – and with the Guanxi guys winning almost every time. Analysts – when they have reservations about deals – are seldom heeded.

(…) To this end I present to you China Forestry. China Forestry was a billion USD Hong Kong listed Chinese company with many Private Equity funds having stakes. The leading stakeholder is Carlyle (or more precisely funds belonging to Carlyle’s clients). The stock has been suspended after admitting “accounting irregularities”. But it is worse than that.

China Forestry had a business model which consisted of fast-growth forestry to extract greenhouse gas credits – a business model that barely made sense to some analyst guys that looked at it. However it was a business model that made sense if the company had enough Guanxi – enough connections to extract a really bad (ie nonsensical) deal from the Chinese government. And the holders of China Forestry to some degree believed just that. They believed in the Chinese Guanxi. And implicitly they believed the deals were being bought to them by the Guanxi of their staff.

Now China Forestry remains suspended. No reasonable questions are being answered – so I am going to reveal to you the Analyst gossip: the bulk of the forests do not exist. Sure they had some “front” – plantations they would take potential investors to. But the vast bulk of the business was a fiction and “accounting irregularities” is code for “fiction”.

Oh – and Carlyle has dusted 105 million dollars.

(…)