KKR learns the hard way in China

KKR learns the hard way in China
Published: 10 July 2009

Two years ago, US private equity powerhouse Kohlberg Kravis Roberts took the plunge in China – making its first mainland investment by plowing US$112m into Tianrui Cement, reportedly a sizeable player in China’s cement industry and located at Ruzhou, a remote city of about 1 million people in the central western part of Henan Province. It was hailed as an innovative private equity deal, with the World Bank’s investment arm, JP Morgan and some Chinese banks all on board, ultimately providing both more equity and US$335m in long-term loans to Tianrui – reports Forbes in its daily news bulletins.

Within a year and a half, however, Tianrui had become a headache for KKR and other investors – Forbes reports. Their relationship with the cement company’s founder, Henan entrepreneur Li Liufa, soured as the shareholders fought over questionable management practices, according to a former executive at the company and others familiar with the industry in China. At one point, Tianrui Cement’s chief financial officer, who was recruited by KKR, was badly beaten in an unexplained incident.

Today, unlisted Tianrui, founded by Li Liufa in 1993, and who built it up from a small foundry through acquisitions, maintains it is prospering and KKR, which took a 43.2% stake in Tianrui at the time of the deal disclosed in September 2007, won’t elaborate, but others say problems remain. In any case, this is a story of challenges that private equity investors can face as they seek to improve governance at and introduce outside management to Chinese family enterprises, even ones of considerable size and stature. It also shows that while a deal might be structured to protect minority interests, what follows may still be bumpy.

According to the former Tianrui executive and the industry followers, the outside investors and the founder squabbled intensely last year over concerns that Li Liufa may have commingled up to tens of millions of dollars from the cement operation with funds from his other businesses. The $1 billion-in-revenue Tianrui Group, which is chaired by Li Liufa and controlled by him and his family, includes casting for freight-car trucks, aluminum, gas, power and tourism businesses. Tianrui Cement’s own outside management team also is said to have objected to the practice.

Eventually Tianrui Cement’s top management, including the company’s chairman and chief executive, Xiao Jiaxiang, was run out by Li Liufa, who installed closer associates, the sources say. The influence of the investors, including KKR which currently owns 38.9% of the cement maker, has eroded as a result, according to these accounts. KKR declined to comment.

Matters came to a head in December when then-chief financial officer Chen Qi-an was beaten by three men on the streets outside the cement company’s compound in Ruzhou city. His laptop computer lay nearby as he was pummeled, and although his laptop was taken afterward, authorities at least initially discounted robbery because the assailants had asked the victim if he was "executive Chen" before they set on him, and did not take his wallet, Forbes was told.

Chen is said to have been hospitalized for a month, during which he was visited by officials from JP Morgan and the World Bank’s private-sector arm, the International Finance Corp. (IFC). Chen in his management role is said to have raised concern about Li Liufa’s financial practices, according to the former executive and another industry source. Chen, who is said to have been brought in by KKR, has since left Tianrui and declined to comment.

"We don’t want to see anyone beaten up. In the case you’re talking about, I’ve heard about this happening," Michael Ipson, China and Mongolia manager for the IFC, said in an interview in June. "Without being able to say whether it was done by this person or that person, I don’t want to reach a conclusion that could be counter-productive to the company." The IFC owns a 4% stake in Tianrui Cement.  JP Morgan, which was reported by the South China Morning Post as having invested US$100m through Tianrui Cement’s second round of financing in 2008, wouldn’t comment.

In May, a domestic publication ranked Li Liufa as Henan Province’s richest person, with a net worth of 3.7 billion yuan (US$541 million). He has been a member of the National People’s Congress, China’s legislative body, since 2003. Li Liufa could not be reached by Forbes. In the latter part of 2008, Tianrui Cement’s chairman and chief executive Xiao Jiaxiang, an industry veteran, shocked some in the sector by saying he would leave his post. More than 10 other ranking outside managers have departed Tianrui Cement as well. Xiao, now vice general manager of Hong Kong-listed China National Building Material, told Forbes he left for "personal reasons" and declined to comment further.

"Behind this explosive development, Tianrui Group’s internal governance issues have gradually been revealed," the industry newsletter Zhongguo Shuini Wang, or China Cement Net, said in a report on Feb 16. Tianrui’s relationship with KKR could be "at an impasse, and may break down," it noted. Xiao’s departure dealt a "loss to the infant stages of developing a modern management system" at Tianrui, and will prompt business partners to "reevaluate their collaboration with Tianrui," the commentary said.

Xiao had helped reel in the 2007 KKR investment, a coup for Tianrui Cement that let it expand at a lightning pace in Henan, where it is the biggest cement maker, and into Dalian city in Liaoning Province as well. Tianrui Cement is one of 12 national cement producers selected by the Chinese government in 2006 for preferential policy support from local governments and banks, giving it special access to land and loans. Beijing has been eager to consolidate the cement industry, which remains fragmented with many private family-controlled enterprises.

Foreign investors have been eager to tap into China’s cement industry, in anticipation of ambitious infrastructure and construction projects through the country. Last year, Goldman Sachs ( GS - news - people ) bought a 25% stake in Zhejiang Province’s cement maker Hongshi Group, also privately held, for $120m. With China now in the midst of a public-construction boom as a result of $586 billion in stimulus measures unveiled by Beijing in November, Tianrui Cement will reap benefits. "Business fundamentals and momentum remain strong for Tianrui today," the company’s statement to Forbes reads. "Operating profit has grown nearly 60% every year; production capacity has more than tripled to 27 million tons; and market share has significantly increased in our core markets.

"In addition, the company has also made three strategic acquisitions. This performance is a result of the continued support from the local as well as three foreign shareholders and of the collaborative efforts by the management team and all employees," Tianrui Cement’s statement said.

Tianrui Cement’s 2008 revenue was CNY3.36bn (US$491.5m), according to KKR’s annual report. The company’s profit is not disclosed. But after weathering China’s economic slowdown, Tianrui Cement still faces challenging market conditions. With all the cement plants currently under construction, Henan Province will have "severe" excess production capacity of over 120Mt, Li Liufa told a cement industry conference held in Anhui in June. Tianrui Cement’s plan to build a 12,000tpd cement production line in Xingyang, Henan, which would be the largest one in China, was delayed last year. The US$335m in dollar- and yuan-denominated loans from the banking syndicate, which was led by JPMorgan Chase and included China Construction Bank and CITIC Bank, helped Tianrui Cement halve its borrowing costs. (Edited Forbes report)