A decade ago, Fred Hu was the consummate Goldman Sachs rainmaker. As China head of investment banking, he was responsible for delivering some of the deals that placed Goldman at the pinnacle of the industry at that time.
Goldman staff still talk about many of them today, like the billions the bank made on its private equity stake in ICBC ahead of its October 2006 IPO and its co-sponsor role on the Bank of China international listing the same year. For top-tier clients, such as Ping An and Bank of Communications, Hu was the point man with the relationships and the ability to talk them into doing business with him.
It is no surprise that he eventually opted to go it alone, founding Primavera Capital in Beijing in 2010. Alongside him as partners were several other Goldman alumni: Haitao Zhai, a former managing director responsible for Goldman’s relationships with many governmental and financial institutions on the mainland, as well as director of the office for cooperation with ICBC; Kenneth Wong, another managing director in the investment banking division; and William Wang, who was an MD in the principal investment team.
Between them they have built one of the most important, powerful and quiet private investment firms on the mainland. It is part of that growing constituency, whose other members include Hillhouse Capital, CDH Investments, Hopu Investment Management and, perhaps, Ping An. Mainland private capital is arguably the most interesting bloc of capital in the world today.
Primavera’s rise has been achieved without bombast and certainly without much public disclosure of its size, outlook or even its approach. Even relative to its modest peer group, one hears very little about Primavera or Hu. But people who have worked with him think of him very highly.
“He’s a force of nature,” says one who worked with him at Goldman. “He’s made a huge success of himself. He’s a supreme networker. In an industry full of smart people, he still stands out as a really smart guy.
“To be successful in that industry you need to be connected, and some of these places have been set up by princelings. But he’s not a princeling, he’s just someone who has worked really hard.”
Euromoney meets Hu in Shanghai at a UBS investment conference (Hu joined the UBS board last year). He is modest and polite in person, not an obvious dealmaker.
How is Primavera differentiated? Hu suggests experience, focus and research. This is pretty similar to what peers like Hillhouse also think differentiates them, but there are areas where Primavera does seem different.
“The private equity industry in China now has come of age,” says Hu. “There are many different funds and themes.
“But Primavera has a very experienced and well-trained team with long, deep experience in financial markets and investing. Some other firms may be a bit younger, a one-man show, but we have a very deep bench.”
He says the firm’s approach to analysis is also distinctive.
“The world is always changing,” he says.
Primavera combines top-down macro and industry views with bottom-up tyre-kicking on individual companies.
“I try to think: what’s really happening? What’s real and what’s fake? What’s temporary? This analysis is a defining philosophy for us,” Hu says.
“The markets change very fast and the economy has a lot of uncertainty. We want to base our decisions not on impulse or luck. If we do a deal, we have done pretty rigorous research as a foundation.”
A third distinction, he says, is that the firm is not tied to a single sector or geography, but also doesn’t try to “be everything to everyone.” The majority of its work is in technology and consumer services, and mainly in the new economy in China.
“You have never seen us invest in a coal mine in Mongolia,” says Hu. “We will never invest in a steel mill or a real estate company. We’re not going to invest in heavy machinery or construction equipment. It’s not that they are wrong, it’s just that we choose to specialize in other areas.”
Finally, he argues that of all its peers, Primavera has the greatest sector expertise in financial services, having spent so long within it.
“These are complex industries, very difficult and highly regulated,” says Hu. “The risk is tremendous. If we don’t have the expertise and the knowledge to understand the company, the chances are you make a big mistake and lose your shirt.”
Understanding
To understand the way a firm like this works, it is always best to look at an individual deal that illustrates it. At Hillhouse that deal was Belle International; at Primavera it is Yum China. This is the Chinese spinoff of New York-listed Yum! Brands, which became an independent and publicly traded business in November 2016, with exclusive rights to operate the KFC, Pizza Hut and Taco Bell brands in China, among others.
There are a lot of parallels with Hillhouse/Belle – and not just the fact that Hillhouse tried to buy Yum China last year. Just as Belle seemed a highly unlikely purchase for a new economy-focused investor (it is China’s biggest retailer of women’s shoes), Yum is, as Hu says, “on the surface, a very traditional F&B [food and beverage] company. So there’s nothing fancy tech about it.”
But, just like Belle, there is another way of looking at it.
“We are in the age of mobile consumer internet and there is so much data,” says Hu. “The motivation for us making this investment was that we saw the opportunity to use data to transform the business.”
The original deal was announced in September 2016. Back then it was said that Primavera and Ant Financial – in which Primavera is also a large investor – would invest $460 million in Yum China, concurrent with the company’s spinoff from Yum! Brands on October 31, 2016. (Primavera, with $410 million, was the most important investor.) On November 1 that year, Yum China began trading in its own right on the NYSE – with Hu as non-executive chairman.
By this stage Hu knew Ant Financial well, having invested in every funding round it has held. Hu could see the potential in putting Ant Financial’s tech, including the Alipay payment system, into a company with millions of customers and a trove of data.
“Yum China is the biggest company in Asia in terms of F&B,” says Hu. “It is bigger than two, three and four combined.”
Hu speaks of a “data-centric growth strategy, through the whole value chain of our business. We have 200 million members, think about that. We have their name, gender, mobile phone number, ID, Alipay details, their home address; we know what time they order, how they pay. And because of that, we have a much better idea in terms of how we can offer them food.”
The expansion of the use of the phone to order food delivered to the home has been transformative, he says. “It is a tremendous way to expand sales. You don’t have to expand your physical footprint. Delivery is a very dynamic scene.”
A revolution in payments has also been central to strategy.
“It is very common to go to McDonald’s, wait in line and when you get to the front you pull out your wallet, get out a credit card or use cash and wait for your change… It all takes time and slows things down. It means it takes longer for each staff employee to serve each customer.”
From day one, Primavera and Ant entered Yum intending to embed digital and mobile payments. Now, even if you go into a physical restaurant, you will usually use your phone to order what you want and Alipay (or something similar) to settle up, also on your phone. “It means you don’t have an interface with an employee and you don’t wait in line.”
When Primavera came in, only 7% of payments were digital, today it is 80%. Hu wants to hit 95%.
On top of that is the potential of social media engagement.
“For consumer businesses, you used to do advertising on TV, spending tens of millions of dollars. Now with digital media you can reach your customers and interact with them,” and it’s free.
Perhaps the biggest endorsement of what Primavera saw in Yum and has so swiftly achieved, is the $17.6 billion buyout offer from a consortium led by Hillhouse and including Baring Private Equity Asia, KKR and the China Investment Corporation in August.
Yum rejected it.
“We’re a long-term investor. We don’t like to be a flipper,” says Hu. “We want to be a responsible long-term shareholder: improve the food quality, the menu, the service. Two years is too short for that.
“I appreciate the interest from the consortium, but it wasn’t right for us and we still have a lot of good ideas waiting to be put in place to make the business bigger,” he says.
Before Yum, Primavera was best known for its early backing of Ant and Alibaba.
“We’re focused on consumer services and tech, and when they combine together, that’s the sweet spot,” says Hu. Alibaba, through underlying businesses like Taobao and T-Mall, is “a service business, facing the consumer. But it’s also using mobile internet and data, so is enabled by technology. That’s a good example of our investment strategy and focus.”
Ant Financial – for which Primavera is the only private firm to have been committed in every funding round – appeals principally because of its ambition to improve access to financial services. Ant Financial has the potential to tap huge unbanked parts of Chinese society, from individuals to small businesses, while at the same time using big data to develop a credit-scoring system that reduces the risk of doing so.
One deal Hu shies away from discussing is Primavera’s reported role in the Anbang Insurance bid for Starwood Hotels & Resorts Worldwide in 2016. This was before Anbang ran into trouble with leverage and other issues that led to the jailing of its former chairman, but, even then, its bidding battle with Marriott International was iconic in its impudence. The bid failed when Anbang dropped out, but it was reported to have included Primavera alongside buyout firm JC Flowers in its intended funding.
At the time, Hu gave a statement saying that “Anbang is a disciplined buyer” and that “Anbang has both the interest and the financial resources to do a deal of this size and more, but only at the right terms that make long-term financial sense.”
Asked about it today, Hu claims that Primavera was “not really” involved.
“We were more like an adviser,” he says. “China is going abroad, and a lot of people do not have experience. We are one of the few based here who are open in our mindset and have global experiences.”
Primavera has done deals in Australia, Canada and the US, although deals of the scale of the Starwood bid seem like a thing of the past right now.
State of play
That brings us to the current environment: the US-China trade war and the state of China’s economy and markets.
“The trade war is bad for the two countries, for the world economy and the financial markets,” Hu says. “It increases the cost of doing business. It introduces so much uncertainty into the system.”
But does it also create good investment possibilities for a firm like Primavera?
“Of course in any uncertain environment, depending on your investment strategy, you can also find opportunities. This is no exception,” he says. “But I wouldn’t give credit to the trade war. It is unambiguously negative.”
Of course, in any uncertain environment, depending on your investment strategy, you can also find opportunities. This is no exception. But I wouldn’t give credit to the trade war. It is unambiguously negative – Fred Hu, Primavera Capital
Asked for specific themes, he notes the obvious ones first: that the export sector will be hit and should be avoided.
“We have always been focused on domestic demand, which hopefully is better positioned in terms of avoiding the first direct hit from the trade war,” he says. “Having said that, we are mindful that if export industries get hit, the people you employ in those industries may see their spending power cut down. So, if you run a restaurant, you are potentially impacted.”
Nevertheless, he sees that focusing on middle-class consumption and technology stories is the best way of avoiding the hit from a trade war.
Primavera invests primarily in unlisted companies; when it buys a listed stock, it is often with the intention of taking it private through a buyout.
“We will take stakes in public companies, but not just to be passive,” Hu says. “We will want governance rights such as board representation and we will work with the management to fine tune their strategy, to help the company grow their business and improve their operating efficiency.”
Primavera got two seats on Yum China after the spinoff, for example.
That said, there have been some big drops in A-share prices in some very good companies; Tencent halved in value at one stage in 2018. Does that make him reconsider, and look at passive positions for good investment returns?
“Definitely the drop in valuation in public markets creates more attractive opportunities for investors, both public and private, because they are all related,” Hu says, pointing out that anyone trying to value a private company will make reference to its closest public equivalent. “I do think there are some companies that are becoming a lot more attractive from a valuation point of view.”
Hu returns to Alibaba, which at the time of the interview was trading at about $130 a share, although it has since rebounded considerably.
“It is an enormous company still growing at a very rapid pace, both in terms of revenue and net income,” he says. “But right now it is barely half the market value of Amazon.
“Amazon is a great company, but is it worth twice as much as Alibaba? Most likely, Alibaba is undervalued.”
